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43 Cards in this Set
- Front
- Back
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What is the market failure associated with externalities? |
Prices and profits are signals which determine the allocation of resources. However, a misallocation of resources will occur if market prices do not accurately reflect the costs and benefits to society of economics activities. This can lead to either overproduction or under production or a fall in overall utility |
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What are the three types of costs? |
Private Cost External Cost (Negative Externality) Social Cost |
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Define Private Cost |
Costs internal to an exchange and are paid by an individual economic agent i.e. producers and consumers |
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Define External Cost/Negative Externality |
Costs from production or consumption that have a negative effect on a third party not involved in the economic decision. |
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Define Social Cost |
The cost to society of an economic decision. Private Cost + External Cost |
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What are the three types of benefits |
Private Benefit External Benefit/Positive Externality Social Benefit |
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Define Private Benefit |
Benefits internal to an exchange and are received by an individual economic agent i.e. producers and consumers |
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Define Positive Externality/External Benefit |
Benefits (utility) from production or consumption that have a positive effect on a third party not involved in the economic decision |
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Define Social Benefit |
The benefit to society of an economic decision. Private Benefit + External Benefit |
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When can you tell that an economy has allocated resources efficiently and how is this show on a diagram? |
Resources have been allocated efficient when social benefits and social costs are equal. This is represented on a diagram where MSC (marginal social cost) equals MSB (marginal social benefit) |
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How do economic agents (consumers and producers) usually tend to produce and how is this represented on a diagram? |
They tend to produce where their private benefit is maximised relative to private cost and are not concerned with the costs and benefits of others. This is represented on a diagram where marginal private cost (MPC) equals marginal private benefit (MPB). Respectively, it’s the same as where supply equals demand. |
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What would happen if externalities were not included when economic agents make decisions? |
This would lead to a deadweight loss in society as there will be an over production of negative externalities and an underproduction of positive externalities |
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What does a negative externalities diagram look like? |
Marginal Private Benefits= Marginal Social Benefits as there is zero External Benefits. Difference between MSC and MPB is the external cost. |
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What does a positive externalities diagram look like? |
Marginal Private Cost= Marginal Social Cost as there is zero external benefit. Difference between MPB and MSB is the external benefit. Triangle ABC is Welfare Loss as it shows what the potential welfare gain could be if resources were allocated effectively |
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Explain how the policy of regulation can tackle negative externalities. (What are the two types? What does the diagram look like!) |
Either prohibition where sufficient dangerous goods e.g. heroin are banned completely. Restriction where the government can set limits on the production of goods/the amount of pollution. E.g. Limit the amount of sugar in good to the social optimum Q2. |
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Explain how the policy of indirect taxes can tackle negative externalities. (What does the diagram look like!) |
Without government intervention there is an overconsumption of the good as the negative externality has not been considered. By charging consumers an additional amount equal to the externality, the externality has been “internalised.” Price will rise from P1 to P2, allowing for a shift from the Free Market Equillibrium at A to the Social equilibrium at B Consumer Incidence: P2BFP1 Producer Incidence: P1FDE Tax Revenue:P2BDE Deadweight loss: triangle BAE |
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List 3 disadvantages of regulations |
Monitoring required which involves a cost to the government Overly harsh limits create costs to businesses which can lead to higher prices and unemployment Limits could be set too low due to government failure and regulatory capture (when the regulator(usually the government) acts in the firms interest rather than public’s interest. |
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Explain how the policy of extended property rights can tackle negative externalities. |
If a resource has no owner then it is liable to be overused or abused. E.g. fishing in the sea. This is often referred to the tragedy of the commons. The government, therefore, allocate ownership rights of an area to an organisation (e.g. Environment Agency) who can then charge (or sue through the courts) for the use/abuse of this resource. |
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List 3 Advantages of Extended Property Rights |
Ensures externalities are internalised Reduced burden on the government Those who own the resource are compensated |
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Explain how the policy of minimum prices can tackle negative externalities. (What does the diagram look like!) |
In a minimum price scheme the government may impose a limit on how much the price of a certain good can fall. This should lead to a decline in output from QE to Q1. Total incidence falls on the consumer. This is because over consumption may leed to negative externalities. |
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Explain how the policy of Tradable Permits can tackle negative externalities. |
Tradable Permits involve the government setting a quota on the amount of pollution allowed in an industry and then allocating pollution permits to individual firms. Number of permits is equal to the social optimum level of production Each firm is allowed to pollute up to levels set by its permit. It is also possibly for firms to buy and sell any surplus permits or to bank them for future years. Permits can also be awarded for firms who create greener technology. |
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List 4 advantages of Tradable Permits |
Internalise the externality Revenue for the government(If auctioned) Incentive to invest in clean technology/increases efficiency of firms The market decided on the price of carbon unlike taxes where the government do |
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List 5 disadvantages of Tradable Permits |
Difficult to issue the right number of permits (Imperfect information) Less pressure on firms if permits are easily available High cost of monitoring for the government May not be a worldwide system Firms from rich countries may invest into developing countries with green technology rather than their country as it is cheaper, therefore easier to gain permits. Shows a lack of responsibility. |
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What are the 5 policies the government could implement to deal with negative externalities? |
Indirect Taxes Minimum Prices Regulation Extended Property Rights Tradable Permits |
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Give an example where tradable permits are used? |
EU Trading Emissions System |
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What are some examples where indirect taxes have been used combat negative externalities? |
Plastic Cups (Environmental) Congestion Charge (Environmental) Cigarettes (Health/Stress on NHS) |
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Give 3 advantages of indirect taxes |
Internalises externalities so that polluters pay Used price mechanism to change incentives and choices e.g. to reduce pollution A tax raises extra tax revenue which might be used for other sectors |
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Give 5 disadvantages of indirect taxes |
- If there is low Price Elasticity of demand, behaviours may not change -Regressive Tax, May increase inequality. Lower income family’s May be facing the taxes (driving may be better for them/ those that live in inner city/ lower class people tend to smoke more-stress) -Could encourage black market/evasion(cigarette smuggling) -Difficult to set tax at correct level -may force firms out of business , or make them move to other countries |
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List 3 advantages of minimum prices |
Reduces consumption of harmful goods Targeted at groups most likely to be abusing product. (Poorer People can be more likely to over consume, they may not be able to afford the product with this scheme) No Cost to government |
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List 4 disadvantages of minimum prices |
No effect if set below equilibrium Less effect on goods that could have inelastic demand Could encourage black market No extra tax revenue gained(+loss in VAT and Excise Duty) |
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Explain how the policy of Subsidies can tackle the problem of positive externalities.(What does the diagram look like?) |
A subsidy in a grant usually provided by the government to encourage supplies to increase the production of a good or service. Often directly paid to producers but as they respond by increasing output (from q1 to q2) the market price falls and this indirectly passed some of the gain onto consumers |
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What are some examples of subsidies? |
Public Transport, Higher Education, Healthier Foods |
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List 6 disadvantages of guaranteed minimum price |
No effect if set below equilibrium Higher prices for consumers May create incentives for wasteful excess supply (production of rice in Thailand) Storage cost of agricultural guaranteed minimum prices Opportunity cost to the government of buying up excess production -Damage to the developing world of dumping excess production |
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List 4 Advantages of a Subsidy |
Ensures external benefits are included Lower Prices for the consumer (increased consumer surplus) Higher prices for firms(Increased producer surplus) Reduced inequality |
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Explain how the policy of Maximum Prices can tackle the problem of positive externalities.(What does the diagram look like?) |
In a maximum price scheme the government may impose a limit on how much prices of certain goods and services can rise. This will reduce the price from Pe to the maximum price, leading to excess demand between Q2 and Q1 |
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What are some examples of maximum prices? |
Rent control, Rail Tickets |
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List 3 advantages of maximum Prices |
Helps reduce inequality Stops exploitation of the consumer Low Cost to government |
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Explain how the policy of Guaranteed Minimum Prices can tackle the problem of positive externalities.(What does the diagram look like?) |
In a guaranteed minimum price scheme the government wants to ensure producers get sufficient income. They will set a minimum price above the equilibrium and then will buy up the excess supply (Q2-Q1) |
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Whats an example of a guaranteed minimum price scheme? |
Common Agricultural Policy |
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List 2 advantages of a guaranteed minimum price scheme |
Provides a reasonable level of income for producers (e.g. farmers) More certainty about income would help |
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List 3 advantages of Regulation |
Ensures social optimum is reached Required if demand is inelastic and policies changing prices don’t work Can incentivise firms to innovate |
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List 5 disadvantages of extended property rights |
-Difficult to Calculate the value if damages -Externalities are difficult to trace - High legal costs of prosecutions -Time taken to resolve -Difficult to use for international issues |
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List 4 disadvantages of Subsidies |
Productive inefficiency if firms rely on subsidies Opportunity cost to the government Difficult to quantify external benefits which mean amount of subsidy could be incorrect Maybe be given out for political and not economic reasons e.g. labour making uni free |
