All Flashcards
What is an externality?
A side effect of an economic decision affecting a third party.
Define negative externality.
An economic activity that creates costs for others.
Define positive externality.
An economic activity that creates benefits for others.
What does MSC stand for?
Marginal Social Cost: total cost to society of producing one more unit.
What does MPC stand for?
Marginal Private Cost: the cost to the firm of producing one more unit.
What does MSB stand for?
Marginal Social Benefit: the total benefit to society of consuming one more unit.
What does MPB stand for?
Marginal Private Benefit: the benefit to the consumer of consuming one more unit.
Define Pigouvian Tax.
Taxes on goods with negative externalities to reduce output.
Define Pigouvian Subsidy.
Subsidies on goods with positive externalities to increase output.
Define deadweight loss.
The inefficiency of the free market, often due to externalities.
How does pollution relate to negative externalities?
Pollution is a classic example where a factory's production imposes costs (health, environmental) on others.
How do vaccinations relate to positive externalities?
Vaccinations benefit not only the individual but also prevent the spread of disease to others.
Why does the market overproduce with negative externalities?
Firms don't bear the full social cost, leading to excess production.
Why does the market underproduce with positive externalities?
Consumers don't capture the full social benefit, leading to insufficient production.
How does education create positive externalities?
Education leads to a more informed and productive society, benefiting everyone.
What is the effect of a per-unit tax on production?
It increases the cost of production, shifting the MPC curve leftward and reducing output.
What is the effect of a per-unit subsidy on consumption?
It decreases the cost of consumption, shifting the MPB curve rightward and increasing output.
How do Pigouvian taxes correct market failure?
By internalizing the external costs of negative externalities, leading to a socially optimal output.
How do Pigouvian subsidies correct market failure?
By internalizing the external benefits of positive externalities, leading to a socially optimal output.
How does secondhand smoke relate to negative externalities?
It negatively affects the health of those nearby, imposing a cost on them.
What is the goal of a per-unit tax on negative externalities?
To reduce production to the socially optimal quantity.
What is the goal of a per-unit subsidy on positive externalities?
To increase production to the socially optimal quantity.
How does a Pigouvian tax affect the supply curve?
It shifts the supply curve to the left, reducing output.
How does a Pigouvian subsidy affect the demand curve?
It shifts the demand curve to the right, increasing output.
What is the impact of a tax on a monopolist with a negative externality?
It can increase deadweight loss if it causes the firm to underproduce relative to the socially optimal quantity.
What happens if a tax is greater than the external cost?
Overcorrection; production falls below the socially optimal level.
What happens if a subsidy is greater than the external benefit?
Overcorrection; production rises above the socially optimal level.
What is the effect of tradable pollution permits?
Firms can buy and sell permits, creating a market for pollution and incentivizing reduction.
What is a command-and-control regulation?
Direct regulation of pollution levels or production processes.
What is a disadvantage of command-and-control regulation?
It may be less efficient than market-based solutions like taxes or permits.