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?
- 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?
- A benefit conferred on third parties who did not pay for it.
- State the Coase theorem.
- 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?
- 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.
- A good that is non-excludable and non-rival in consumption.
- What are the two defining characteristics of a public good?
- Non-excludability (cannot prevent others from consuming it) and non-rivalry (one person's consumption does not diminish another's).
- Define the tragedy of the commons.
- 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?
- 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?
- 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?
- 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?
- 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?
- Assign clear property rights so affected parties can negotiate, sue for damages, or sell rights; bargaining internalizes the externality.
- Define rent-seeking.
- Expenditure of resources to capture economic rents or redistribute wealth without creating new value.
- What characterizes a natural monopoly?
- 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.
- A situation where one party to a transaction has more or better information than the other party.