CHAPTER 10 Vocab Externality The uncompensated impact of one persons actions on the well being of a bystander Internalizing the Externality Altering incentives so that people take account of the external effects of their actions Corrective Tax A tax designed to induce private decision makers to take account of the social costs that arise from a negative externality Coase 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 own The Coase theorem says that private economic actors can potentially solve the problem of externalities among themselves Whatever the initial distribution of rights the interested parties can reach a bargain in which everyone is better off and the outcome is efficient Transaction Costs The cost the parties incur in the process of agreeing to and following through on a bargain Subsidy Assistance by the Government causes a shift to the right in supply curve if the government gives the supplier a subsidy OPPOSITE OF A TAX Externalities Negative Externality When the externality negatively affects the bystander Ex Pollution Barking Dog External cost is the vertical distance between the shift it causes which is known as the SOCIAL COST A DECREASE in quantity INCREASES economic well being The OPTIMUM is where the price and quantity change to when an externality exists To achieve this optimum point with a NEGATIVE externality a tax must be placed on the sellers which shifts the supply curve NEGATIVE EXTERNALITY SOCIAL COST CURVE OPTIMUM Equilibrium POSITIVE EXTERNALITY OPTIMUM Equilibrium Social Value Curve Positive Externality When the externality positively affects the bystander EX New Technology Technology Spillover The impact of one firms research and production efforts on other firms access to technological advance To achieve this optimum a POSITIVE externality requires a SUBSIDY Industrial Policy Government intervention in the economy that aims to promote technology enhancing industries Property Right A patent over a firms invention Command and control policies regulate behavior directly Market based policies provide incentives so that private decision makers will choose to solve the problem on their own Although regulation and corrective taxes are both capable of reducing pollution the tax accomplishes this goal more efficiently Regulation Government tells producer of negative externality to lower the amount Corrective Tax Piguvian Taxes A tax designed to induce private decision makers to take account of the social costs that arise from a negative externality Gives an economic incentive to reduce the cause of negative externality Places a price on the right to pollute PERFECTLY ELASTIC SUPPLY CURVE ECONOMISTS PREFER CORRECTIVE TAX 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 externalities Although regulation and corrective taxes are both capable of reducing pollution the tax accomplishes this goal more efficiently Pollution Permit PERFECTLY INELASTIC SUPPLY CURVE Permits will end up in the hands of those firms that value them most highly as judged by their willingness to pay A firm s willingness to pay for the right to pollute in turn will depend on its cost of reducing pollution The more costly it is for a firm to cut back on pollution the more it will be willing to pay for a permit Both corrective taxes and pollution permits internalize the externality of pollution by making it costly for firms to pollute Negative externalities lead markets to produce a larger quantity than is socially desirable Positive externalities lead markets to produce a smaller quantity than is socially desirable To remedy the problem the government can internalize the externality by taxing goods that have negative externalities and subsidizing goods that have positive externalities
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