Public goods, externalities, and government intervention concepts at college depth beyond the AP-level treatment.
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- In economic terms, what is a negative externality?
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A cost imposed on third parties who did not choose to incur it and receive no compensation.- In economic terms, what is a positive externality?
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A benefit conferred on third parties who did not pay for it.- State the Coase theorem.
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If property rights are well-defined and transaction costs are low, parties will bargain to an efficient outcome regardless of initial allocation.- What does a Pigouvian tax accomplish?
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It internalizes a negative externality by taxing the polluter an amount equal to the external cost, aligning private incentives with social costs.- Define a public good.
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A good that is non-excludable and non-rival in consumption.- Define the tragedy of the commons.
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Overexploitation and depletion of a shared resource because individuals bear only their own costs while sharing the collective benefits.- What is a common pool resource?
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A resource that is rival in consumption but non-excludable, making it subject to overexploitation.- Why does a negative externality create deadweight loss in a free market?
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The marginal social cost exceeds marginal private cost; the market produces too much, and units beyond the social optimum create more social harm than private benefit.- How does a corrective subsidy address a positive externality?
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It lowers the cost of production or consumption, increasing output to the socially optimal level where marginal social benefit equals marginal social cost.- How does a cap-and-trade system correct a negative externality?
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It caps total emissions and creates tradable permits; firms choose abatement levels that equalize their marginal abatement cost to the permit price, minimizing total compliance cost.- What is the property rights approach to correcting externalities?
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Assign clear property rights so affected parties can negotiate, sue for damages, or sell rights; bargaining internalizes the externality.- Define rent-seeking.
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Expenditure of resources to capture economic rents or redistribute wealth without creating new value.- What characterizes a natural monopoly?
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A single firm can supply the entire market at lower cost than multiple firms because average costs decline throughout the relevant demand range.- Define information asymmetry.
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A situation where one party to a transaction has more or better information than the other party.- Distinguish between adverse selection and moral hazard.
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Adverse selection is an ex-ante problem where bad risks self-select into a market; moral hazard is an ex-post problem where an insured party changes behavior after purchase.
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