Economics of Externality: Negative and Positive Externalities and Their Solutions - Prof. , Study notes of Microeconomics

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Week 15

Cong / Shirley

Externality

• Negative externality

--is also called external cost

--is an uncompensated cost that an individual or firm imposed on others

• Positive externality

--called as external benefit

--is a benefit that an individual or firm confers on others without receiving compensation

Positive Externality

• Examples

-- Preserved Farmland: Neighboring residents get the external benefit

-- Technology spillover: Knowledge and technology invented by one firm, can be quickly adopted by rival firms

Solutions to Externality

• Government intervention

-- Environmental standards: Rules or laws which specify actions by producers and consumers

-- Tax : add cost to firms or individuals who can impose external cost on others (eg. Pollution emissions tax)

-- Subsidy: give compensation to firms or individuals who can confer benefits on others (eg. Subsidy to preserved land’s owner)

• But transaction cost are not always low We can’t internalize the externality in some cases
• Transaction costs include:

--Costs of communication among interested parties

--Costs of making legally binding agreement

--Costly delays because of bargaining

Q1. The efficient level of pollution is:

a) the quantity at which its total benefits exceed its total costs by the greatest possible amount. b) the quantity at which its total benefits equal its total costs. c) where the marginal social benefit of an additional unit of pollution emission is greater than the marginal social cost of the additional unit of pollution. d) where the marginal social benefit of an additional unit of pollution emission is less than the marginal social cost of the additional unit of pollution.

Q3. When a vaccination program generates a positive externality, the:

a) market demand curve is above the marginal social benefit curve.

b) market demand curve is below the marginal social benefit curve.

c) marginal cost of production is below the market demand curve.

d) market will produce more than the efficient level of output.

Q4. Suppose an emissions tax is imposed on all dairy farms in Wisconsin. This tax would have the effect of:

a) encouraging the dairy farmers to lower prices.

b) increasing the level of emissions.

c) reducing the supply of milk in Wisconsin.

d) increasing the supply of milk in Wisconsin.

Final Reviews

• Opportunity Cost
• Supply and Demand Model

--Shift Curve VS. Move along the curve

--Reasons of curve shift and move along line

• Price ceiling and Price Floor

--The effect of binding ceiling and floor

• Elasticity

--Definitions of Demand elasticity and Supply elasticity

--Inelastic VS. Elastic

• Surplus

--Definitions and calculations of Consumer surplus and Producer surplus

--How do price changes, demand curve’s or supply curve’s move, and shift affect the surplus

• Classification of goods

--Two characteristics of Goods

--Distinguish the four types of goods

• Externality

--Definitions and Solutions