Unit 10: Externalities
When a trade's costs or benefits spill onto people who never agreed to the deal, and the three ways economists try to price the spillover back in.
6 topics · 22 questions
Each topic is a path, not a menu: work down it in order and every question builds on the one above. Click any of them to watch the answer draw itself.
Negative Externalities
- How it worksHow does a negative externality drive the private market quantity above the socially efficient quantity?
- Worked exampleFind the socially efficient output where social marginal cost equals demand, given a private marginal cost curve and a fixed external cost per unit.
- Common mistakeWhy isn't the efficient amount of pollution simply zero?
Your turn1 of 2
Demand is P = 122 minus 2 times Q, private marginal cost is MC = 3 times Q, and pollution adds a fixed external cost of 9 dollars per unit. Find the socially efficient quantity.Positive Externalities
- How it worksHow does a positive externality push the free-market quantity below the socially efficient quantity, the mirror image of pollution?
- Worked exampleFind the socially efficient level of education spending where social marginal benefit, not just private marginal benefit, equals marginal cost.
- Common mistakeWhy doesn't a positive externality mean the market will automatically overprovide the good out of generosity?
- Going furtherWhat happens to the underprovision problem if the government instead subsidizes vaccination by exactly the size of the external benefit?
- Ties togetherHow does the underprovision problem from a positive externality mirror the overprovision problem from a negative one on the same kind of graph?
Your turn1 of 2
Private demand for education is Qd = 122 minus 2 times P, and each unit creates 8 dollars of external benefit. Private supply is Qs = 5 times P. Find the socially efficient quantity.Pigouvian Taxes and Subsidies
- How it worksHow does a Pigouvian tax set equal to the external cost move the market quantity down to the socially efficient level?
- Worked exampleFind the Pigouvian tax per ton of carbon that closes a 30 dollar per ton gap between private and social marginal cost.
- Common mistakeWhy isn't a Pigouvian tax just a punishment aimed at making polluters pay for their sins?
Your turn1 of 2
Find the Pigouvian tax per ton of carbon that closes a 45 dollar per ton gap between private and social marginal cost.The Coase Theorem and Private Bargaining
- How it worksHow does the Coase theorem show that private parties can bargain their way to the efficient outcome once property rights are clearly assigned?
- Common mistakeWhy doesn't it matter, for efficiency, which side is initially given the property right in the Coase theorem?
- Going furtherWhat happens to private bargaining's ability to fix an externality once transaction costs get large, like among thousands of scattered pollution victims?
Your turn1 of 2
A factory's pollution imposes 85 dollars of harm on a neighbor, but reducing it would cost the factory 29 dollars. What is the maximum joint gain available from bargaining toward the efficient reduction?Tradable Pollution Permits
- How it worksHow does letting firms buy and sell pollution permits move the cheapest reductions to the firms that can cut pollution most cheaply?
- Worked exampleWalk me through two factories trading permits when Factory A can cut a ton of pollution for 20 dollars and Factory B can only cut it for 80 dollars.
- Common mistakeWhy isn't a system of tradable permits just a license to pollute with no environmental benefit?
- Going furtherWhat happens to the total amount of pollution allowed if the government issues fewer permits each year?
- Ties togetherHow does a cap-and-trade system reach the same efficient pollution quantity as a Pigouvian tax, just by fixing quantity instead of price?
Your turn1 of 2
Two factories can trade pollution permits. Factory A can cut a ton of pollution for 24 dollars, and Factory B can only cut it for 76 dollars. How many dollars does the total cost of the required reduction fall if Factory A cuts one extra ton instead of Factory B doing so?Command-and-Control Regulation vs Market-Based Policy
- How it worksHow does a market-based policy like a Pigouvian tax or tradable permits reach a pollution target at a lower total cost than a uniform technology mandate?
- Common mistakeWhy doesn't a strict technology mandate guarantee more pollution reduction than a market-based tool does?
- Ties togetherHow do a Pigouvian tax and a system of tradable permits reach the same efficient quantity of pollution from two different directions?
Your turn1 of 2
A uniform technology mandate costs an industry 129 dollars to hit a pollution target, while a market-based tool reaches the same target for 56 dollars. How many dollars does the market-based tool save?