Understanding Externalities: Impact on Market Equilibrium
School
William Carey University**We aren't endorsed by this school
Course
ECO 202
Subject
Economics
Date
Dec 12, 2024
Pages
8
Uploaded by BarristerScience14510
Week 3 Activities Week Three Activities o Submitted 93.33/100 Total points awarded Help Exit Explanation 1 a 10110 . . - points awarded a. When negative externalities exist in a market, @ equilibrium output will be less than the efficient output. equilibrium price will be less than the efficient output. eBook equilibrium output will be greater than the efficient price. . equilibrium output will be greater than the efficient output. € rint References b. The government could correct these divergences between equilibrium output and efficient output by shifting the demand curve down. imposing regulations that force firms to externalize the internal costs. imposing regulations that force firms to internalize the external costs. € c. An example of an external benefit is pollution. @ Prev 10f10 2§ Next > Explanation a. When negative externalities are present, equilibrium output will be greater than the efficient output. This is because the producer, who is not bearing the full cost of production, will be able to produce more at a lower price than the efficient level that would exist if true costs were reflected in the production decision. b. Government might correct external costs through regulation, which requires firms to internalize these external costs, or it might tax the externality until it becomes too expensive for the firm to incur these costs. This effectively shifts the supply curve to the left as the costs of production rise, and the new equilibrium output will be less and closer to the efficient level. External benefits can be encouraged by government subsidies to the producers of these products or by government production. In either case, the supply curve shifts to the right, which lowers the equilibrium price and leads to a greater equilibrium output level. c. Other examples of external costs might include second-hand smoke, noise from your neighbor, or pollution. External benefits might be generated from outdoor Christmas lights, attractive landscaping in the neighborhood, or the added safety provided by motion-detector lights.
Week Three Activities @ ‘Submited 93.33/100 Total points awarded Help Exit 2 H a. Spillover costs and spillover benefits are also called negative and positive externalities because 1010 spillover costs have a negative impact on third parties and spillover benefits have a positive impact on third parties. @ points awarded spillover costs have a positive impact on third parties and spillover benefits have a negative impact on third parties. @ spillover costs increase the utility of third parties and spillover benefits decrease the utility of third parties. - b. Explain how a tax can correct for a negative externality. P A tax can correct for a negative extemality because it shifts the cost onto firms producing the product, which o References output. Explain how a subsidy to producers can correct for a positive externality. A subsidy can correct for a positive externality because it [increases supply | @ and @ output. Explanation 2 of 10 Next > Explanation a. Spillover costs are called negative externalities because they are externalto the participants in the transaction and reduce the utility of affected third parties (thus "negative®). Spillover benefits are called positive externalities because they are externalto the participants in the transaction and increasethe utility of affected third parties (thus "positive"). b. Atax can correct for a negative externality because taxes will increase production costs and thus product price. As the price of the product rises, the externality is reduced because less output is produced. A subsidy to producers can correct for a positive externality by increasing market supply and thus equilibrium output. 3 —— 1010 o awardeg AN apple grower's orchard provides nectar to a neighbor's bees, while the beekeeper's bees help the apple grower by pollinating his apple blossoms. Consider the figure below to answer the questions that follow. Positive externalities
Positive externalities s 5,69 Price Quantity a. This situation of dual positive externalities might lead to an underallocation of resources to both apple growing and beekeeping because there are spillover benefits for the apple growers, but spillover costs for the beekeepers. there are spillover benefits for both the apple growers and the beekeepers. @ there are spillover costs for the apple growers, but spillover benefits for the beekeepers. there are spillover benefits for the apple growers, but not the beekeepers. b. This underallocation can get resolved via the means suggested by the Coase theorem because apple growers can rely on nearby bees at no cost apple growers and beekeepers can benefit from the other, so they will negotiate an optimal solution. @ apple growers and beekeepers can trade products with each other, so they will merge into one firm. beekeepers can rely on nearby orchards at no cost Explanation . Using the figure, the following can be said: The market demand curves for apples and honey would not include the spillover benefits accruing 10 the production of the other good. The output of both products, including the spillover benefits, would be greater than equilibrium outputs, leading to an underallocation of resources to both apple growing and beekeeping. b, Using the Coase thearem, we note that it will be to the advantage of individual apple growers and beekeepers to negotiate o that beekeepers (whose hives can be moved) locate their production in or near apple orchards. This negotiation will occur s long as property ownership is well defined, only a few people are involved, and bargaining costs are low. For example, an apple grower who owns an orchard could allow a beekeeper to use a portion of his or her land, charging below market rents so that both parties gain from the agreement. This negotiation will accur as long as property ownership is well defined, only a few people are involved, and bargaining costs are low. <
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Week Three Activities @) ‘Suomied 93.33/100 Total points awarded Help Exit 7 == 1010 points awarded €D - voovces e oveatocoted [regaive s © b. Xochitl installs a very nice front garden, raising the property values of all the other houses on her block [positive externality] @ Match each of the following characteristics or scenarios with either the term negative externality or the term positive externality. eBook print . Market demand curves are too far to the left (too low) [positive externality | @ References d. Resources are underallocated [positive exterality | @ . Water pollution from a factory forces neighbors to buy water purifiers [negative externality | @ Explanation a. Negative externality. Resources are overallocated to products that impose negative extenalities on third parties. This happens because the firms imposing negative externalities on third parties fail to take into account the costs that would be needed to either prevent the negative externalities or compensate those who suffer from them. Not taking those costs into account renders the firms' profits artificially high—which leads them to overproduce. As they do so, resources are overallocated to the production of their products and taken away from the production of other products that would have produced greater net benefits for society. In terms of a supply-and-demand diagram, the negative externalities lower the polluting firms' MC curves and shift the market supply curve to the right. This resuits in an equilibrium quantity in excess of the optimal output level that would prevail if the firms' MC curves correctly accounted for the negative externalities. b. Positive externality. Xochitl's garden provides a positive externality for her neighbors because while her main intent was to make herself happy by improving the look of her own property, she has also provided a free benefit to her neighbors. They receive higher property values without having to pay Xochitl anything for them. <. Positive extemnality. Positive extemnalities cause market demand curves to be too far to the left (too low) relative to total-benefit demand curves. The problem is that when there are positive exteralities, the people receiving the positive extenalities do not have to pay for the benefits they receive. Thus, their willingness to pay for those benefits is not captured by the market demand curve. This causes the market demand curve to end up 100 far to the left, leading to a market equilibrium quantity that is less than the optimal output. And because output s less than optimal, resources that should have flowed to producing more of the good in question flow instead to the production of other products that are less valued by consumers. d. Positive externality. Resources are underallocated to products that impose positive externalities on third parties. The problem is that when there are positive externalities, the people receiving the positive externalities do not have to pay producers for the benefits that they are receiving. This lowers producer profits and causes them to produce less than the socially optimal output. Because output is below the optimal level, resources that should have flowed to producing more of the goods in question flow instead to the production of other products that are less valued by consumers. In terms of a supply-and-demand diagram, the positive externality means that the demand curve is too far to the left (too low) relative to the total-benefit demand curve that includes the willingness to pay of the people receiving the positive externalities. With the demand curve shifted to the left in this way, the market equilibrium output ends up lower than the optimal output. e. Negative externality. The factory’s water pollution imposes a negative extemality on its neighbors because the factory does not take into account the costs that it imposes on them
Week Three Activities §§) Supmied 93.33/100 Total points awarded Help Exit 8 1010 asymmetric information. points awarded moral hazard. @ o advrse selcton eBook People drive faster when they have auto insurance. This example illustrates: Explanation print People driving faster when they have auto insurance is an example of moral hazard. This is true because moral hazard is the tendency of one party to & contract or an agreement to alter his or her behavior after the contract is signed in ways that could be costly to the other party. In this case, drivers who have signed auto insurance contracts alter their driving behavior in a way that is likely to be very costly to the insurance companies, who will have to pay for any increase in the number of accidents that is caused by their customers driving faster References Week Three Activities @) Submited 93.33/100 Total points awarded Help Exit Explanation & 1010 e avargeg Use the diagram below to answer the following questions. Assume an initial market price of $4. @ a. Identify the initial area of consumer surplus (CS{) when the market price is $4. Next, assume that supply decreases and the market price rises to $5. Draw the new supply curve and then identify the new area of consumer surplus (CS2). eBook Instructions: print 1. Use the tool provided 'CSy' to identify the initial area of consumer surplus. This will drop a small triangle with three endpoints onto the graph. Drag the endpoints to the appropriate position to identify the initial area of consumer surplus. 2. Then use the tool provided 'Sy’ to draw the new supply curve. 3. Use the tool provided 'CS' and follow the same process as before to identify the second area of consumer surplus. Week Three Activities @) Submited 93.33/100 Total points awarded Help Exit 9 e 1010 points awarded a0 Sample Answer Click to enlarge. ‘o to cs, cs, Price / o 10 20 30 40 50 60 70 80 90 100 S ° 2 Quantity % < Preyv. 9 of 10 Next >
Week Three Activities €@ Suomited 93.33/100 Total points awarded Help Exit T 10 o o The diagram below represents the market for fire extinguishers. Use the diagram to illustrate the areas of consumer surplus and 1o producer surplus generated in this market. points awarded @ Instructions: Use the tool provided 'CS' to identify the area of consumer surplus. This will drop a small triangle with three endpoints onto the graph. Drag the endpoints to the appropriate positions to identify the area of consumer surplus. Then use the tool provided 'PS' and follow the same procedure for producer surplus. eBook Frint Your Graph Score: 100% References Week Three Activities @) ‘Suomied 93.33/100 Total points awarded Help Exit 10 i Sample Answer 50 10110 w0 points awarded 30 3 8 eBook & 204 Click to enlarge print References o o o cs Ps Demand ; o 0 20 30 40 50 Quantity Explanation Consumer surplus is the difference between the maximum price consumers are willing to pay for a product and the actual price that they do pay. Graphically, consumer surplus is represented by the triangle under the demand curve and above the actual price. Producer surplus is the difference between the minimum price that a producer is willing to accept for a product and the higher price actually received. Graphically, producer surplus is shown by the triangle above the supply curve and below the actual price.