Chapter 10 – Externalities – Flashcards

An externality is a cost or a benefit that arises from production and that falls on someone other than the producer or a cost or a benefit that arises from consumption and that falls on someone other than the consumer.

A production or consumption activity that creates an external cost.

A production or consumption activity that creates an external benefit.

• Negative production externalities • Positive production externalities • Negative consumption externalities • Positive consumption externalities

Logging and the clearing of forests are sources of another negative production externality. These activities destroy the habitat of wildlife and influence the amount of carbon dioxide in the atmosphere, which has a long-term effect on temperature. So these external costs are borne by everyone and by future generations.

To produce orange blossom honey, Honey Run Honey of Chico, California, locates beehives next to an orange orchard. The honeybees collect pollen and nectar from the orange blossoms to make the honey. At the same time, they transfer pollen between the blossoms, which helps to fertilize the blossoms.

Smoking tobacco in a confined space creates fumes that many people find unpleasant and that pose a health risk and noisy parties and outdoor rock concerts that disrupt the neighborhood are other examples of negative consumption externalities.

When you get a flu vaccination, you lower your risk of being infected. If you avoid the flu, your neighbor, who didn't get vaccinated, has a better chance of remaining healthy or when the owner of a historic building restores it, everyone who sees the building gets pleasure from it.

A private cost of production is a cost that is borne by the producer of a good or service. S = MC

You've seen that an external cost is a cost of producing a good or service that is not borne by the producer but borne by other people. A marginal external cost is the cost of producing an additional unit of a good or service that falls on people other than the producer.

Marginal social cost (MSC) is the marginal cost incurred by the entire society—by the producer and by everyone else on whom the cost falls—and is the sum of marginal private cost and marginal external cost. That is, MSC= MC + Marginal external cost.

Legally established titles to the ownership, use, and disposal of factors of production and goods and services that are enforceable in the courts.

The Coase theorem is the proposition that if property rights exist, only a small number of parties are involved, and transactions costs are low, then private transactions are efficient. There are no externalities because the transacting parties take all the costs and benefits into account. Furthermore, it doesn't matter who has the property right.

The opportunity costs of conducting a transaction.

• Pollution limits • Pollution charges or taxes • Marketable pollution permits (cap-and-trade)

A pollution limit seeks an efficient outcome by placing a quantity limit on a polluting activity. If the quantity produced is limited to the efficient quantity, the price rises so that marginal benefit equals marginal social cost. But because price exceeds marginal private cost, MC, a producer surplus arises.

Pollution charges or pollution taxes seek an efficient outcome by making a polluter pay the marginal external cost of pollution.

Marketable pollution permits (also called cap-and-trade) seek an efficient outcome by assigning or selling pollution rights to individual producers who are then free to trade permits with each other.

A private benefit is a benefit that the consumer of a good or service receives. The marginal private benefit (MB) is the benefit from an additional unit of a good or service that the consumer of that good or service receives. D = MB

An external benefit is a benefit from a good or service that someone other than the consumer receives. A marginal external benefit is the benefit from an additional unit of a good or service that people other than the consumer enjoy.

Marginal social benefit (MSB) is the marginal benefit enjoyed by society—by the consumers of a good or service (marginal private benefit) and by everyone else who benefits from it (the marginal external benefit). That is, MSB= MB + Marginal external benifit.

• Public provision • Private subsidies • Vouchers

The production of a good or service by a public authority that receives most of its revenue from the government.

A subsidy is a payment by the government to a producer to cover part of the costs of production. By giving producers a subsidy, the government can induce private decision makers to consider external benefits when they make their choices.

A voucher is a token that the government provides to households, which they can use to buy specified goods or services.

• External costs are costs of production that fall on people other than the producer of a good or service. Marginal social cost equals marginal private cost plus marginal external cost. • Producers take account only of marginal private cost and produce more than the efficient quantity when there is a marginal external cost. • Sometimes it is possible to overcome a negative externality by assigning a property right. • When property rights cannot be assigned, governments might overcome a negative externality by using pollution limits, pollution charges or taxes, or marketable permits (cap-and-trade).

• External benefits are benefits that are received by people other than the consumer of a good or service. Marginal social benefit equals marginal private benefit plus marginal external benefit. • External benefits from education arise because better-educated people are better citizens, commit fewer crimes, and support social activities. • Vouchers or subsidies to private schools or the provision of public education below cost can achieve a more efficient provision of education.