chapter 10 vocabulary

Chapter 10 - o Coase theorem The proposition that if private parties can bargain without cost over the allocation of resources they can solve the

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o Coase theorem The proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own. o corrective tax A tax designed to induce private decision makers to take account of the social costs that arise from a negative externality. o externality The uncompensated impact of one person's actions on the well-being of a bystander. o internalizing the externality Altering incentives so that people take account of the external effects of their actions. o transaction costs The costs that parties incur in the process of agreeing to and following through on a bargain. Chapter Recap: Summary o When a transaction between a buyer and seller directly affects a third party, the effect is called an externality. If an activity yields negative externalities, such as pollution, the socially optimal quantity in a market is less than the equilibrium quantity. If an activity yields positive externalities, such as technology spillovers, the socially optimal quantity is greater than the equilibrium quantity. o Governments pursue various policies to remedy the inefficiencies caused by externalities. Sometimes the government prevents socially inefficient activity by regulating behavior. Other times it internalizes an externality using corrective taxes. Another public policy is to issue permits. For example, the government could protect the environment by issuing a limited number of pollution permits. The result of this policy is largely the same as imposing corrective taxes on polluters. o Those affected by externalities can sometimes solve the problem privately. For instance, when one business imposes an externality on another business, the two businesses can internalize the externality by merging. Alternatively, the interested parties can solve the problem by negotiating a contract. According to the Coase theorem, if people can bargain without cost, then they can always reach an agreement in which resources are allocated efficiently. In many cases, however, reaching a bargain among the many interested parties is difficult, so the Coase theorem does not apply. Chapter Recap: Questions for Review 1. Give an example of a negative externality and an example of a positive externality. 2. Draw a supply-and-demand diagram to explain the effect of a negative externality that occurs as a result of a firm's production process.
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3. In what way does the patent system help society solve an externality problem? 4. What are corrective taxes? Why do economists prefer them to regulations as a way to protect the environment from pollution? 5. List some of the ways that the problems caused by externalities can be solved without government intervention. 6.
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This note was uploaded on 07/14/2011 for the course ECO 1001 taught by Professor Barcia during the Spring '08 term at CUNY Baruch.

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Chapter 10 - o Coase theorem The proposition that if private parties can bargain without cost over the allocation of resources they can solve the

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