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a benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service

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externality

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a. and b. medical research and education have positive externalities

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Which of the following is an example of a good or service having the effects of a positive externality?: a. medical research b. education c. pollution d. big mac e. a and b

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a. cigarette smoking (admittedly tricky though)

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Which of the following are examples of good or services having the effects of a negative externality? a. cigarette smoking b. fireworks c. technological research d. ice cream e. both a and b

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there is an externality such as acid rain *generated by the production* of electricity

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The private cost of *producing* a good will differ from the actual cost when

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when there is an externality, such as *second hand smoke* generated by the *consumption* of cigarettes AND when there is an externality, such as *fewer diseases* generated by the *consumption* of vaccines

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When will the private benefit from *consuming* a good differ from the social benefit?

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consumer surplus and producer surplus are maximized

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What is maximized when there is economic efficiency?

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the private and social *costs* of production and the private and social *benefit* of production The market outcome is not efficient when self-interested buyers and sellers neglect the external *costs or benefits* of their actions

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Externalities affect the economic efficiency of a market equilibrium by causing a difference between

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Negative externalities by (for example) disrupting your sleep and Positive externalities by (for example) discouraging intruders

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What kinds of externalities are created by your neighbor having a barking dog?

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*negative* externality due to the emissions from automobiles *creating air pollution*

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What is an externality associated with driving? What kind of externality is it? (positive or negative)

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cars create negative externalities

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In big cities, one explanation for installing bike lanes that eliminate car lanes and on street parking is that

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the level such that the marginal cost equals the marginal benefit ( S = MC and D = MB)

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What is the economically efficient level of a negative externality?

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Yes, society would be better of if an increase in something brings you closer to MC = MB (equillibrium) See graph: society would be better off increasing pollution (decreasing the reduction of pollution...) if pollution reduction is at Q3

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Is it ever possible for for an increase in something with negative externalities to make society better off?

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The marginal cost of additional air pollution reduction rises as there is less pollution to reduce

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Explain how reducing air pollution below the equilibrium value is not efficient

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The *additional* positive gains (note: there *will* still be gains) will continue to become smaller with each reduction

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What does it mean to say that additional reductions in a negative externality will result in diminishing returns?

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the marginal benefit equals the marginal cost (note: if only given the P v Q graph with S & D curves/lines, remember that S = MC and D = MB)

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The optimal decision is to continue any activity up to the point such that (graphically)

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the difference between the the benefit and the cost

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The *net benefit* to society from an activity is equal to

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marginal benefit of the activity (activity = x axis) equals the marginal cost

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To maximize the benefit to society, continue any activity up to the point where

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the area under the marginal cost curve area under MC

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The total cost of increasing an activity is (graphically)

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the area under the marginal benefit curve area under MB

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The total benefit of increasing an activity is (graphically)

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the difference between the marginal benefit and marginal cost, thus, *the area between the marginal benefit curve and the marginal cost curve* (under MB & above MC if before equilibrium and under MC & above MB if after equilibrium)

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The net benefit is (graphically)

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SC = private + external cost Thus, to make MSC = MPC, tax producers the amount of the external cost (the difference between MSC and MPC in the y direction) See image:

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What how can a tax be implemented when marginal private cost is not equal to marginal social cost?

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the area between the MSC line, MPC line and the D line (MB)

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The deadweight loss from performing an activity in excess is

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altering the incentives so that people take into account the external effects of their actions taxes imposed so that market participants pay the social costs such that market equilibrium = social optimum

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what is "internalizing the externality"

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a tax is imposed on consumers to bridge the ga between the MSC and MPC. the value of the tax is equal to the vertical difference between MSC and MPC this subsequently shifts the demand curve down

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If consumers are internalizing a negative externality, this means that

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a tax is imposed on sellers to make MPC = MSC

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If producers are internalizing a negative externality, this means that

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the external cost (MSC) aka the vertical difference between MSC and MPC

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By imposing a tax on consumers that causes consumers to internalize the externality, the tax should be equal to

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The demand curve would shift down such that market Q = optimal Q

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How can we tell (graphically) that imposing a tax on buyers would achieve the same outcome as imposing a tax on sellers?

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When the social costs of an activity increase at a faster rate than the private costs

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When would the MSC curve have a larger/sleeper slope than the MPC curve?

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the difference between the marginal social cost of production and the marginal private cost of production *at the efficient level of output* (which is The Q at the point where MSC and D intersect)

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The value of the optimal Pigovian tax (a tax meant to correct the existance of social costs) is

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social optimum

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When market participants must pay social costs (there is a social cost line) market equilibrium =

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The Q at the point where MSC and D intersect

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When market participants must pay social costs (there is a social cost line), the efficient level of output is such that

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the marginal cost increases with output Thus, if two markets produce different levels of output, the appropriate Pigovian tax will differ

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the marginal social cost line will have a different slope from the marginal private cost line when

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