6.2 Externalities

• What is an externality in economics?

  Cost or benefit to third parties
• An externality occurs when the market price does not reflect the full costs
• What is a positive externality?

  Benefit to third parties
• A beekeeper's bees pollinating nearby orchards is an example of a positive externality.
• What is a negative externality?

  Cost to third parties
• A factory's pollution affecting nearby residents is an example of a negative externality
• An externality can be either a cost or a benefit to third parties.
• What is the mathematical expression for the total benefits of a vaccination program?

  $\text{Total Benefits} =$$\text{Benefits to vaccinators} +$$\text{Benefits to unvaccinated}$
• Driving cars emitting pollutants is an example of a negative externality in consumption
• What is the mathematical expression for the benefits of bees pollinating orchards?

  $\text{Benefits} =$ \text{Increase \in fruit production}
• Vaccinations reducing disease spread are an example of a positive externality in consumption.
• What is market efficiency in economics?

  Resource allocation maximizes social welfare
• Negative externalities cause overproduction because the market price doesn't cover the external costs
• Positive externalities result in underproduction because the market price doesn't capture external benefits.
• What is a Pigouvian tax used for?

  Reduce negative externalities
• A Pigouvian tax should equal the external cost to correct negative externalities.
• Subsidies are financial support to encourage activities with positive externalities
• What is a market-based solution for externalities called?

  Cap-and-trade system
• What is an externality in economics?

  Cost or benefit to third parties
• Positive externalities confer a benefit
• Negative externalities impose costs on third parties.
• Bees pollinating orchards is an example of a positive externality.
• Negative externalities in production increase social costs.
• What is an example of a negative externality in production?

  Factory emissions causing air pollution
• The source of a negative externality in production is the manufacturing process.
• Positive externalities lead to optimal production levels.

  False
• Why do negative externalities cause overproduction in a market?

  Market prices ignore external costs
• Positive externalities lead to underproduction because market prices don't capture external benefits.
• Arrange the following government interventions in order of their primary goal:

  1️⃣ Regulation

  2️⃣ Pigouvian Taxes

  3️⃣ Subsidies

  4️⃣ Market-based approaches
• Match the government intervention with its purpose:

  Regulation ↔️ Direct control through rules

  Pigouvian Taxes ↔️ Charge activities creating negative externalities

  Subsidies ↔️ Encourage positive externalities

  Market-based approaches ↔️ Cap-and-trade systems
• What is the purpose of Pigouvian taxes?

  Align private and social costs
• Pigouvian taxes encourage innovation by making negative externalities more expensive.
• Subsidies for renewable energy may distort the market.
• What is the primary goal of subsidies in addressing externalities?

  Encourage positive externalities
• Direct grants are a type of subsidy that lowers operating costs for firms.
• Match the subsidy method with its impact:

  Direct Grants ↔️ Lower operating costs

  Tax Credits ↔️ Reduce tax liabilities

  Loan Guarantees ↔️ Reduce borrowing costs
• What is the purpose of regulations and standards in economics?

  Minimize negative externalities
• Technology-based regulations require specific technologies, such as catalytic converters in cars.
• Regulations are inflexible without updates while Pigouvian taxes are flexible as market prices change.
• What are market-based solutions designed to correct externalities?

  Internalize external costs