Elasticity of Prices

Consequences of Externalities 📊

Internalising Externalities: Policy Tools 🔨

Indirect Tax 💵
An indirect tax is a tax imposed by the government that increases the supply costs of producers.

Pros:

• Works through the price mechanism to move the market toward the social optimum.
• Generates revenue that can compensate those harmed by the external cost.

Cons:

• Information gap: it's difficult to monitor and to determine the optimal tax level.
• They're regressive as they hit the poor the hardest.

Quality Controls (Regulation) 🏦
Pros:

• Enforced by fines/ imprisonment; this makes avoidance harder than in a free market economy.
• Can set standards that keep the externality close to the social optimum.

Cons:

• It may have harmful side-effects, causing unemployment.
• It can encourage the creation of a shadow market as QCs are costly to enforce.

Subsidies for Positive Externalities 🤑
Pros:

• Prices the externality by lowering production costs, moving output toward the social optimum.
• Can generate long-term benefits, such as healthier workers who pay more taxes.

Cons:

• Information problems: determining the optimal subsidy size is hard.
• Opportunity cost: tax money could be spent elsewhere, and there's risk of bureaucratic inefficiency.

Breakdown 📚

Private Costs - Private costs are the costs incurred by individuals or firms directly involved in an economic activity. These are the costs of producing a good or service that are borne solely by the producer or consumer.

External Costs (Negative Externalities) - When producing or consuming a good or service imposes a cost (negative effect) upon a third party.

Social Costs - Social costs are the total costs of an economic activity, which include both private costs and any external costs.

Marginal Private Benefit (MPB) - The additional benefit received by an individual from consuming or producing one more unit.

Marginal Private Cost (MPC) - The additional cost borne by a producer or consumer for one more unit.

Marginal Social Benefit (MSB) - Total benefit to society from one extra unit

Marginal Social Cost (MSC) - Total cost to society from one extra unit

Market Failure - Market failure happens when the price mechanism fails to allocate scarce resources efficiently or when the operation of market forces lead to a net social welfare loss

How The Basic Economic Problem Is Solved In A Free Market 🏪

• Markets assign values to scarce resources; price adjustments reflect changes in supply and demand, providing incentives that guide allocation decisions.