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the impact of one person's actions on the wellbeing of a bystander

internalizing the externality

altering incentives so that peopel take acouunt of the external effects of their actions

coase theorem

if private parties can bargain without cost over the allocation of resources, they can solve the problems of externalities on their own

transaction costs

the costs that parties incur in the process of agreeing to &following thru on a bargain

corrective tax

a tax designed to induce private decisions makers to take account of the social costs that arise from a negative externality

social costs

private cost + costs to those bystanders

negative externality

lead markets to produce a larger quantity than is socially desirable.

postive externality

lead markets to produce a smaller quantity than is sociallly desirable

how does government try to fix the externality

govt. can internalize the externality by taxing goods that have negative externalities &subsidizing goods that have positive externality

technology spillover

impact of ones firms research &production efforts on other firms access to tech. advance.

industrial policy

govt. intervention in the economy that aims to promote tech. enhancing industries

property right

ownership of a good or resource

pigovian taxes

also called corrective tax


primary tools used to internalize negative externality


primary tools used to internalize positive externality

why private solutions dont always work

sometimes the private solution approach fails because transaction costs can be so high that private agreement is not possible

command and control policy

regulation: making certain behavior forbidden, or making certain behavior req.

market based policy

taxes: imposing a tax on goods w/ negative externality, or implementing a subsidy on goods w/ a positive externality

examples of negative externality

loud barking dogs, air pollution, loud music in apartment building, and littering

what principle from chapter 1

govt. can sometimes improve market outcomes

tradable pollution permits

voluntary transfer of the right to pollute from one firm to another. pollution permits which results in a new market for these permits. firms that can reduce pollution most easily will be willing to sell their permits for whatever they can get

individuals who dont take into account externalities

as a result goods tend to be under supplied or over supplied to the market. govt.policy may be able to improve the outcome

demand curve

shows willingness to pay of marginal buyer

supply curve

shows cost of the margnial seller

market allocation

maxamizes the sum of the consumer and producer surplus

social cost curve

lies above the supply curve

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