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ECO 211 (54)

Econ study guide #2.docx

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University of Miami
ECO 211

Juleah Aiken Economics Study Guide chp 1018Chapter 10 Externalities VocabularyExternality the uncompensated impact of one persons actions on the wellbeing of a bystander negative and positiveInternalizing the externality altering incentives so that people take account of the external effects of their actionsCorrective taxes a tax designed to induce private decision makers to take account of the social costs that arise from a negative externalityCoase theorem the proposition that if private parties can bargain without cost over the allocation of resources they can solve the problem of externalities on their ownTransaction costs the costs that parties incur in the process of agreeing to and following through on a bargainExternalities and market efficiency Some decision maker fails to take account of the external effects of his or her behavior The government responds by trying to influence this behavior to protect the interests of bystandersNegative externalitiesthe cost to society of producing aluminum is larger than the cost to the aluminum producersThe socialcost curve is above the supply curve because it takes into account the external costs imposed on society by aluminum production The difference between these two curves reflects the cost of the pollution emittedFigure 2 Pollution and the Social OptimumIn the presence of a negative externality such as pollution the social cost of the good exceeds the private cost The optimal quantity Qis therefore smaller than the equilibrium quantity OPTIMUMQMARKET One way to achieve optimal outcome is by tax If the tax accurately reflected the external cost of pollutants released into the atmosphere the new supply curve would coincide with the socialcost curve Positive externalities To move the market equilibrium closer to the social optimum a positive externality requires a subsidyFigure 3 Education and the Social OptimumIn the presence of a positive externality the social value of the good exceeds the private value The optimal quantity Qis therefore larger than the equilibrium quantity Q OPTIMUMMARKET technology spillover the impact of one firms research and production efforts on other firms access to technological advanceGovernment intervention in the economy that aims to promote technologyenhancing industries is sometimes called industrial policyThe patent internalizes the externality by giving the firm a property right over its invention If other firms want to use the new technology they have to obtain permission from the inventing firm and pay it a royalty Thus the patent system gives firms a greater incentive to engage in research and other activities that advance technology Public Policy towards externalities Commandandcontrol policies regulationo The government can remedy an externality by making certain behaviors either required or forbidden o Sometimes it cannot completely forbid or require something so they have to decide how much to regulate Marketbased policy corrective taxes and subsidieso the government can use marketbased policies to align private incentives with social efficiency o An ideal corrective tax would equal the external cost from an activity with negative externalities and an ideal corrective subsidy would equal the external benefit from an activity with positive externalitiesMarketbased policy tradable pollution permitso The more costly it is for a firm to cut back on pollution the more it will be willing to pay for a permit o The opportunity cost of polluting is what they could have received by selling their permits on the open market Both corrective taxes and pollution permits internalize the externality of pollution by making it costly for firms to pollute
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