What Is an Externality?
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Negative Externalities
In Production
In Consumption
Correcting Negative Externalities
Pigouvian tax = external cost → shifts supply up to MSC → reduces output to social optimum
Positive Externalities
In Production
In Consumption
Correcting Positive Externalities
Subsidy = external benefit → shifts demand up to MSB → increases output to social optimum
The Coase Theorem
Conditions Required 1. Well-defined property rights 2. Low transaction costs 3. Small number of parties involved
Example
Limitations
Summary Table
AP Exam Tips
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Common Mistakes
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