← Principles of Microeconomics

Unit 10: Externalities and Public Goods

What happens when a transaction spills costs or benefits onto people who never agreed to it, and why some goods can't be sold at all.

6 topics · 20 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 and the Social Cost of Production

  1. How it worksHow does an uncompensated cost imposed on bystanders push the social cost curve above the private marginal cost curve?
  2. Worked exampleFind the socially efficient quantity when private supply is Qs = 2P - 20, demand is Qd = 100 - P, and pollution adds 6 dollars of external cost per unit.
  3. Common mistakeWhy isn't the market price of a polluting good already reflecting the true cost that good imposes on society?
Your turn1 of 2
Demand for a good is P = 122 minus Q, and private marginal cost is MC = Q divided by 4. Producing the good also creates 10 dollars of external cost per unit. What is the socially efficient quantity?

Positive Externalities and the Social Benefit of Consumption

  1. How it worksHow does an uncompensated benefit spilling onto bystanders push the social benefit curve above private demand?
  2. Worked exampleFind the socially efficient quantity of vaccinations when private demand is Qd = 100 - 2P and each vaccination creates 10 dollars of external benefit.
  3. Going furtherWhat happens to the gap between the free-market quantity and the efficient quantity as the external benefit grows larger?
Your turn1 of 2
Private demand for vaccinations is Qd = 122 minus 2 times P, and each vaccination creates 8 dollars of external benefit to others. Private supply is Qs = 5 times P. What is the socially efficient quantity of vaccinations?

The Coase Theorem and Private Bargaining

  1. How it worksHow does clearly assigning a property right let two private parties bargain their way to the efficient outcome on their own?
  2. How it worksHow does it not matter which party initially holds the right, as long as bargaining costs stay low?
  3. Going furtherWhat happens to a Coase-style private bargain once the number of people affected by the externality grows very large?
Your turn1 of 2
A factory's noise disturbs a nearby resident. Economists suggest that if the resident is clearly given the legal right to peace and quiet, the factory and the resident could bargain their way to an efficient outcome on their own, without any government regulation setting the noise level. What makes this bargaining possible?

Pigouvian Taxes and Cap-and-Trade

  1. How it worksHow does setting a per-unit tax exactly equal to the external cost push private decisions to match the social optimum?
  2. Worked exampleFind the Pigouvian tax that corrects an externality when the marginal external cost is a constant 8 dollars per unit of pollution.
  3. How it worksHow does a cap-and-trade system fix the total quantity of pollution and let a market set the price of permits instead?
  4. Ties togetherHow does a Pigouvian tax correcting an externality's deadweight loss compare to an ordinary tax that creates one?
Your turn1 of 2
A corrective Pigouvian tax is set equal to the marginal external cost of 10 dollars per unit of pollution, and the efficient quantity of pollution is 295 units. What is the total tax revenue collected?

Public Goods and the Free-Rider Problem

  1. How it worksHow does a good being both non-excludable and non-rival let people enjoy it without paying for it?
  2. How it worksHow does the free-rider problem lead a private market to under-provide public goods like national defense?
  3. Common mistakeWhy doesn't a free public good actually cost nothing to produce just because no one pays directly for it?
Your turn1 of 2
Three residents value a public park at 34, 28, and 24 dollars. Since demand for a public good adds up each person's value at every quantity, what is the combined value these three residents place on the park?

Common Resources and the Tragedy of the Commons

  1. How it worksHow does a resource being rival but non-excludable let each user ignore the cost their use imposes on everyone else?
  2. How it worksHow does open grazing land get overused the same way an open fishery gets overfished?
  3. Going furtherWhat happens to a common resource once access to it is restricted or a fee is charged for using it?
  4. Ties togetherHow does the tragedy of the commons relate to the free-rider problem on the excludable-rival grid of the four kinds of goods?
Your turn1 of 2
A fishery's marginal social benefit from an additional boat is MSB = 122 minus 2 times N dollars, and the marginal cost of operating a boat is a constant 29 dollars. What is the socially efficient number of boats, where marginal social benefit equals marginal cost?