3.8 Limitations on markets

• What is an externality in economics?

  Effect of an economic activity on a third party
• What is a positive externality?

  Beneficial effect of an economic activity
• What is a negative externality?

  Harmful effect of an economic activity
• What types of externalities can occur in production and consumption?

  • Positive externalities
  • Negative externalities
• What is a negative externality caused by driving cars?

  Air and noise pollution
• What is a regressive tax?

  Lower incomes pay a higher proportion
• What is a subsidy?

  Money given by the government to firms
• How does a subsidy affect production?

  Encourages firms to produce more
• What is one benefit of subsidies?

  Increases quantity demanded of goods
• What is a cost of subsidies?

  Opportunity cost of money spent elsewhere
• What are the benefits of subsidies?

  • Increases quantity demanded
  • Encourages production of positive externalities
• What are the costs of subsidies?

  • Opportunity cost of funds
  • Excess demand if underprovided
• What is the role of legislation and regulation in markets?

  To reduce negative externalities
• What is information provision in the context of externalities?

  Efforts to reduce negative externalities
• What is a cost of information provision?

  May deter people from buying a product
• What is a benefit of information provision?

  Protects consumers from harmful goods
• How can consumer tastes change due to information provision?

  They may prefer better alternatives
• What happens to the quantity demanded with positive externalities?

  Rises at a greater rate