Pollution Externalities, Social Costs, and Market Equilibrium

All flashcards

Externality

An effect of a market transaction on a third party outside that exchange.

Negative externality

An external effect that imposes an unwanted cost on a third party.

Positive externality

An external effect that provides an unrequested benefit to a third party.

Social cost

The sum of private production costs and external costs.

Pollution costs and equilibrium

Including external pollution costs raises supply and, in the examples, raises equilibrium price and lowers output.

Quiz questions

1. How is social cost defined when production imposes external costs?Answer: Private production cost plus external cost.
2. When producers account for previously unpaid pollution costs, what happens to the supply curve in the examples?Answer: It shifts upward to reflect higher production costs.
3. In the refrigerator example, what is the equilibrium after firms account for the $100 external cost per unit?Answer: $700 per refrigerator and 40,000 refrigerators.
4. What does market failure mean in the context of pollution externalities?Answer: The market fails to achieve an efficient outcome because relevant costs or benefits are omitted from decisions.
5. When pollution costs are omitted from firms' decisions, how can market output compare with socially efficient output?Answer: Market output can exceed socially efficient output.