Externalities and public goods

Some effects fall on people outside a purchase. Other goods are hard to reserve for paying customers. These features can make private incentives differ from public outcomes.

Lesson 3 of 33 parts Practice Flashcards

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Externality and Negative externality

Objective: Explain externality and negative externality, distinguish their meanings, and apply them to a described case.

Externality: An externality is a cost or benefit affecting others that is not fully reflected in the transaction. Negative externality: A negative externality imposes an uncompensated external cost. Market structures are analytical descriptions with different assumptions about entry, information, product similarity, and strategic behavior. Efficiency comparisons also require attention to external effects. Market power is constrained by buyers' alternatives, not unlimited authority to set any profitable price. A policy proposal should identify the relevant market and mechanism, then compare benefits, burdens, and implementation rather than infer results from a category name alone. Application: A factory's emissions impose costs on nearby residents. This most directly illustrates externality. Noise from an activity disturbs people outside the transaction. This most directly illustrates negative externality.

Worked examples

Try itOriginal teaching scenario: A factory's emissions impose costs on nearby residents. Which idea from this section does it most directly illustrate?Show answer

Step 1 — Read the observation: A factory's emissions impose costs on nearby residents. Step 2 — Recall the relevant idea: An externality is a cost or benefit affecting others that is not fully reflected in the transaction. Step 3 — Connect the observation to the idea: The scenario is an illustration of externality. Step 4 — Check the limit: This short scenario illustrates the concept; it does not establish every detail or exclude every other influence in a real situation.

Try itOriginal teaching scenario: Noise from an activity disturbs people outside the transaction. Which idea from this section does it most directly illustrate?Show answer

Step 1 — Read the observation: Noise from an activity disturbs people outside the transaction. Step 2 — Recall the relevant idea: A negative externality imposes an uncompensated external cost. Step 3 — Connect the observation to the idea: The scenario is an illustration of negative externality. Step 4 — Check the limit: This short scenario illustrates the concept; it does not establish every detail or exclude every other influence in a real situation.

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Externality and Negative externality

Objective: Explain externality and negative externality, distinguish their meanings, and apply them to a described case.

Worked examples

Try itOriginal teaching scenario: A factory's emissions impose costs on nearby residents. Which idea from this section does it most directly illustrate?Show answer

Try itOriginal teaching scenario: Noise from an activity disturbs people outside the transaction. Which idea from this section does it most directly illustrate?Show answer

Positive externality and Public good

Objective: Explain positive externality and public good, distinguish their meanings, and apply them to a described case.

Positive externality: A positive externality provides an external benefit. Public good: A pure public good is nonrival and nonexcludable. Market structures are analytical descriptions with different assumptions about entry, information, product similarity, and strategic behavior. Efficiency comparisons also require attention to external effects. Market power is constrained by buyers' alternatives, not unlimited authority to set any profitable price. A policy proposal should identify the relevant market and mechanism, then compare benefits, burdens, and implementation rather than infer results from a category name alone. Application: An action benefits neighbors who did not purchase the service. This most directly illustrates positive externality. One person's use of a warning signal does not reduce others' access. This most directly illustrates public good.

Worked examples

Try itOriginal teaching scenario: An action benefits neighbors who did not purchase the service. Which idea from this section does it most directly illustrate?Show answer

Step 1 — Read the observation: An action benefits neighbors who did not purchase the service. Step 2 — Recall the relevant idea: A positive externality provides an external benefit. Step 3 — Connect the observation to the idea: The scenario is an illustration of positive externality. Step 4 — Check the limit: This short scenario illustrates the concept; it does not establish every detail or exclude every other influence in a real situation.

Try itOriginal teaching scenario: One person's use of a warning signal does not reduce others' access. Which idea from this section does it most directly illustrate?Show answer

Step 1 — Read the observation: One person's use of a warning signal does not reduce others' access. Step 2 — Recall the relevant idea: A pure public good is nonrival and nonexcludable. Step 3 — Connect the observation to the idea: The scenario is an illustration of public good. Step 4 — Check the limit: This short scenario illustrates the concept; it does not establish every detail or exclude every other influence in a real situation.

Free-rider problem and Common-pool resource

Objective: Explain free-rider problem and common-pool resource, distinguish their meanings, and apply them to a described case.

Free-rider problem: Free riding occurs when people benefit without contributing, weakening voluntary funding incentives. Common-pool resource: A common-pool resource is rival but difficult to exclude users from. Market structures are analytical descriptions with different assumptions about entry, information, product similarity, and strategic behavior. Efficiency comparisons also require attention to external effects. Market power is constrained by buyers' alternatives, not unlimited authority to set any profitable price. A policy proposal should identify the relevant market and mechanism, then compare benefits, burdens, and implementation rather than infer results from a category name alone. Application: People enjoy a shared service while leaving payment to others. This most directly illustrates free-rider problem. Open-access harvest reduces the fish available to others. This most directly illustrates common-pool resource.

Worked examples

Try itOriginal teaching scenario: People enjoy a shared service while leaving payment to others. Which idea from this section does it most directly illustrate?Show answer

Step 1 — Read the observation: People enjoy a shared service while leaving payment to others. Step 2 — Recall the relevant idea: Free riding occurs when people benefit without contributing, weakening voluntary funding incentives. Step 3 — Connect the observation to the idea: The scenario is an illustration of free-rider problem. Step 4 — Check the limit: This short scenario illustrates the concept; it does not establish every detail or exclude every other influence in a real situation.

Try itOriginal teaching scenario: Open-access harvest reduces the fish available to others. Which idea from this section does it most directly illustrate?Show answer

Step 1 — Read the observation: Open-access harvest reduces the fish available to others. Step 2 — Recall the relevant idea: A common-pool resource is rival but difficult to exclude users from. Step 3 — Connect the observation to the idea: The scenario is an illustration of common-pool resource. Step 4 — Check the limit: This short scenario illustrates the concept; it does not establish every detail or exclude every other influence in a real situation.

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