Externalities - AP Microeconomics

What is the impact of negative externalities on social welfare?

They decrease social welfare. Harmful spillover effects reduce overall social well-being.
Which diagram is used to illustrate externalities?

Supply and demand diagrams. Shows how external effects shift social costs or benefits from private ones.
What role do property rights play in externalities?

Well-defined property rights can help resolve externalities. Clear ownership allows parties to negotiate solutions to external effects.
Which option is a market-based approach to handling externalities?

Tradable permits. Allows firms to buy and sell rights to create externalities.
What is the impact of positive externalities on social welfare?

They increase social welfare. Beneficial spillover effects enhance overall social well-being.
What is the effect of externalities on consumer surplus?

Externalities can reduce consumer surplus by distorting prices. Inefficient pricing due to unaccounted external costs or benefits.
What is meant by 'internalizing an externality'?

Adjusting incentives so that private costs or benefits reflect social costs or benefits. Making decision-makers face the full social costs and benefits of their actions.
Which type of externality is associated with underproduction?

Positive externality. Social benefits exceed private benefits, leading to insufficient market production.
State the effect of a subsidy on the supply curve.

A subsidy shifts the supply curve to the right. Lower production costs increase quantity supplied at each price level.
Which term describes the cost of transactions necessary for market exchange?

Transaction costs. The expenses of negotiating and enforcing agreements between parties.
What is a Pigovian tax?

A tax imposed on activities that generate negative externalities. Forces producers to internalize external costs they create.
What is required for tradable permits to be effective?

A well-defined cap on the total level of externality. Permits only work with enforceable limits on total pollution allowed.
What is the Coase Theorem?

It states that private parties can solve externalities if transaction costs are low. Assumes parties can negotiate without government intervention if conditions are met.
What is the primary goal of environmental regulation?

To reduce negative externalities such as pollution. Limits harmful environmental spillover effects on society.
What is the role of government in managing externalities?

To implement policies that internalize externalities. Governments can correct market failures through taxes, subsidies, or regulation.
What is the impact of externalities on the allocation of resources?

They lead to inefficient allocation of resources. External effects cause resources to go to suboptimal uses.
Identify a government intervention for negative externalities.

Regulation. Direct government rules can limit harmful external effects.
Identify a solution for positive externalities.

Subsidies. Government payments encourage activities with positive spillover benefits.
What does the Coase Theorem require to hold true?

Low transaction costs and well-defined property rights. Negotiation and enforcement costs must be minimal for market solutions to work.
Identify the type of externality: 'Factory emissions pollute nearby water sources.'

Negative externality. Industrial waste harms those not involved in production decisions.
How does a tax on negative externalities affect the supply curve?

It shifts the supply curve to the left. Higher costs reduce quantity supplied at each price level.
State a reason why markets fail to address externalities.

Lack of information about external costs or benefits. Market prices don't reflect true social costs and benefits.
State the effect of externalities on market efficiency.

Externalities cause market failure and inefficiency. Markets overproduce goods with negative externalities and underproduce those with positive ones.
What is an example of a policy to correct positive externalities?

Public funding for education. Government support increases beneficial activities that create positive spillovers.
Identify a benefit of internalizing externalities.

Improved market efficiency. Resources are allocated to their most socially beneficial uses.
What is a positive externality?

A benefit received by third parties not involved in the transaction. Creates spillover benefits that enhance social welfare.
What is the effect of externalities on producer surplus?

Externalities can reduce producer surplus due to inefficient production levels. Market distortions prevent optimal production and profit levels.
Identify a characteristic of a negative externality.

It imposes an external cost on third parties. Negative externalities create harmful spillover effects on society.
How do subsidies affect positive externalities?

Increase the production or consumption of goods with positive externalities. Lower costs encourage more of the beneficial activity.
What is an externality in the context of economics?

A cost or benefit affecting a third party not involved in the transaction. This occurs when market transactions create spillover effects.
Identify the problem with unregulated externalities in markets.

They result in overproduction or underproduction of goods. External costs and benefits are ignored by market participants.
Which policy can correct a negative externality?

Pigovian tax. Increases costs for producers generating negative externalities.
Which type of externality is associated with overproduction?

Negative externality. Social costs exceed private costs, leading to excessive market production.
What is a common example of a positive externality?

Education. Benefits society beyond the individual receiving education.
Identify the type of externality: 'Vaccination reduces disease spread to others.'

Positive externality. Individual protection creates broader community health benefits.
What is market failure?

A situation where the market does not allocate resources efficiently. Resources are not allocated to their highest-valued uses.
What is a common example of a negative externality?

Pollution. Harms third parties not involved in the polluting activity.

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