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ECO105Y1- Final Exam Guide - Comprehensive Notes for the exam ( 33 pages long!)


Department
Economics
Course Code
ECO105Y1
Professor
Avi Cohen
Study Guide
Final

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UTSG
ECO105Y1
Final EXAM
STUDY GUIDE

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Economics Test 3 Study Guide
CHAPTER 11: ACID RAIN ON OTHERS’ PARADES
11.1Handcuffing the Invisible Hand: Market Failure with Externalities
Negative Externalities (external costs)
Costs to society from your private choice that affect others, but that you do not pay
When there are negative externalities, opportunity costs include both private costs and
external costs
So the costs to societysocial costsare greater than just private costs.
Social Costs = Private (Opportunity) Costs + External (Opportunity) Costs
The Invisible Hand Fails
When there are negative externalities, smart private choices are different from smart
social choices
There is market failure—the outoe is ieffiiet ad ot i soiet’s est iteests
The invisible hand fails to coordinate smart individual choices and smart social choices
those that balance social benefits with social costs
Because we generally do not pay external costs, consumers buy, and businesses
produce, too many products and services with negative externalities.
Positive externalities (external benefits)
Benefits to society from your private choice that affect others, but that others do not
pay you for
When there are positive externalities, benefits include both private benefits and
external benefits
So, when positive externalities are factored in, social benefits are greater than private
benefits.
Social Benefits + Private Benefits + External Benefits
Free Riders
Economists call people who consume products or service without paying free riders
External eefits allo othes to fee ide o ou piate hoies
There again is market failure—the outoe is ieffiiet ad ot i soiet’s est
interests
NOTE: Externalities occur when clear property rights are missing
Tragedy of the Commons
The lack of clear property rights causes another common environmental problem with
the daati ae the taged of the oos
It is caused by the overuse and depletion of a resourcethe destruction of the common
good
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It is a free-rider problem that results in negative externalities
NOTE: When externalities exist, prices do not reflect all social costs and benefits, and markets
fail to produce efficient outcomes
11.2Why Radical Environmentalists Dislike Economists: Efficient Pollution
Trade-Offs between Pollution and Living Standards
Eooists olude that soe leel of pollutio is effiietthere is a smart choice
that balances the costs of a lower standard of living against the benefits of lower
pollution
NOTE: Effiiet pollutio alaes the additioal environmental benefits of lower pollution
with the additional opportunity costs of reduced living standards
Efficient Combinations of Output and Pollution
For any product or service (output) whose production also creates a negative
externality, the rule for smart choices is:
Choose the Quantity of Output Where
Marginal Social Cost = Marginal Social Benefit
(MSC) = (MSB)
Marginal Social Cost
Marginal private cost (MC) plus marginal external cost
When there are negative externalities, social costs are greater than private costs.
When we focus on additional costs and benefits, that relationship is:
Marginal Social Cost (MSC) = Marginal Private Costs Directly Paid by Producers (MC) +
Marginal External Cost Imposed on Others
Marginal Social Benefit
Marginal private benefit (MB) plus marginal external benefit
When there are positive externalities, social benefits are greater than private benefits.
Marginal Social Benefits (MSB) = Marginal Private Benefit Directly Received by Consumers (MB)
+ Marginal External Benefit Enjoyed by Others
NOTE: Marginal external cost = price of preventing or cleaning up damage to others external of
the original activity.
NOTE: Marginal external benefit = price of the value or savings to others external to the original
activity
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