AP Micro externalities key terms

What is an externality?

An externality is a cost or benefit incurred by a third party not involved in a transaction.

Positive externality example

Education increases societal knowledge, benefiting others beyond the individual.

True or false: All externalities are negative.

False, because externalities can be positive or negative.

What is a negative externality?

A cost suffered by a third party because of an economic transaction, like pollution.

Fill in the blank: A __________ externality benefits third parties.

positive

Difference between internal and external costs

Internal costs are borne by the parties involved; external costs affect third parties.

What does the Coase Theorem state?

If property rights are clear and transaction costs are low, parties will negotiate to resolve externalities.

True or false: Externalities affect market efficiency.

True, because they lead to overproduction or underproduction of goods.

What is a market failure?

A situation where the allocation of goods and services is not efficient, often due to externalities.

Example of government intervention for externalities

Taxes on pollutants aim to reduce negative externalities by increasing costs of harmful activities.

What is a Pigovian tax?

A tax imposed on activities that generate negative externalities, aimed at reducing them.

Fill in the blank: Positive externalities lead to __________ production.

under

True or false: Subsidies can encourage positive externalities.

True, because they lower the cost for the beneficial activity.

What is an external cost?

A cost incurred by someone who did not choose to incur that cost.

What is the social cost?

The total cost to society, including both private and external costs.

Difference between private benefit and social benefit

Private benefit is the gain to the individual; social benefit includes all societal gains.

What is a social optimum?

The level of production where the social cost equals the social benefit.

Scenario: Factory pollution lowers property values; classify this externality.

Negative externality affecting nearby residents.

What role does the government play in externalities?

To regulate practices that create negative externalities and encourage positive ones.