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Externalities and government intervention

What is an externality?

the uncompensated impact of one person’s actions on the well-being of a bystander

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What does it mean to internalize an externality?

alter incentives so that people take account of the external effects of their actions

What are corrective taxes?

taxes enacted to correct the effects of negative externalities

What is the 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

What are transaction costs?

the costs that parties incur in the process of agreeing to and following through on a bargain

Give an example of a negative externality and an example of a positive externality

A negative externality is exhaust fumes from cars, a positive externality is education.

how is negative externality shown in supply and demand curves in production?

A graph showing a negative externality would show the social-cost curve above the supply curve, because the social cost of production is higher than the private cost of production.

In what way does the patent system help society solve an externality problem?

The patent system helps society solve the externality problem from technology spillovers. By giving inventors exclusive use of their inventions for a certain period, the inventor can capture much of the economic benefit of the invention. In doing so, the patent system encourages research and technological advance, which benefits society through spillover effects.

List some of the ways that the problems caused by externalities can be solved without government intervention

Externalities can be solved without government intervention through moral codes and social sanctions (such as littering), charities, merging firms whose externalities affect each other, or by contract.

Imagine that you are a nonsmoker sharing a room with a smoker. According to the Coase theorem, what determines whether your roommate smokes in the room? Is this outcome efficient? How do you and your roommate reach a decision?

According to this theorem, you and your roommate will bargain over whether your roommate can continue to smoke in the room. If you value clean air more than your roommate values smoking, the bargaining process will lead to your roommate not smoking. But if your roommate values smoking more than you value clean air, the bargaining process will lead to your roommate smoking. The outcome is efficient as long as transaction costs do not prevent an agreement from taking place. The solution may be reached by one of you paying off the other either not to smoke or for the right to smoke.

Why do economists prefer corrective taxes over regulations as a way to protect the environment from pollution?

Economists prefer corrective taxes over regulation as a way to protect the environment from pollution because they can reduce pollution at a lower cost to society. The tax is just as effective as regulation and has the advantage of letting the market the least expensive way to reduce pollution and gives firms incentive to reduce pollution in order to save money.

externality

The uncompensated impact of one person’s actions on the well-being of a bystander. If the impact is adverse then it is called a negatively. If it beneficial, it is called positive externality.

internalizing the externality

Altering incentives so that people take account of the external effects of their actions.

Technology Spillover

the impact of one firm’s research and production efforts on other firms’ access to technological advance. The patent laws protect the rights of inventors by giving them exclusive use of their inventions for a period of time. The patent internalizes the externality by giving the firm property right over its invention.

Industrial Policy

Government intervention that aims to promote technology-enhancing industries. Other economists are skeptical about IP. Even in technology spillovers are common, the success of an industrial policy requires that the government be able to measure the size of the spillovers from different markets.

Corrective Tax

a tax designed to induce private decision makers to take account of the social costs that arise from a negative externality. This tax gives the factories an incentive to develop cleaner technologies because a cleaner technology would reduce the amount of tax a factory has to pay.

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.

Transaction Costs

the costs that parties incur in the process of agreeing to and following through on a bargain.

Give an example of a negative externality and a positive externality.

If an activity yields a negative externality, such as pollution, the socially optimal quantity in a market is less than equalibrium quantity. If an activity yields a positive externality, such as technology spillovers, the socially optimal quantity is greater than the equilibrium quantity.

In what way could a patent system help society solve an externality problem?

The patent laws protect the rights of inventors by giving them exclusive use of their inventions for a period of time. When a firm makes a technological breakthrough, it can patent the idea and capture much of the economic benefit for itself. The patent internalizes the externality by giving the firm a property right over its invention.

Why do economists prefer Corrective Taxes to regulations as a way to protect the environment from pollution?

Because they can reduce pollution at a lower cost to society. When you charge (ex) 50,000 dollars for each ton of pollution the factories find more efficient ways to rid of their waste.

List some of the ways that the problems caused by externalities can be solved without government intervention.

moral codes and social sanctions: “do unto others as you would have them do unto you”Charities: tax deductions.Relying on the self-interest of the relevant parties: integrating businesses.Entering into a contract: think about the bees and the trees.

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