AP Microeconomics Flashcards: Externalities
Written by AP Content Team, Verified for 2026 AP Exams, Last updated: May 2026
Review key ideas with interactive flashcards. This set includes 14 cards to help you master important concepts.
How does a corrective tax (Pigouvian tax) address a negative externality?
A corrective tax increases the private cost of production or consumption, forcing agents to internalize the external cost and reducing the quantity toward the socially optimal level.
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How does a corrective tax (Pigouvian tax) address a negative externality?
A corrective tax increases the private cost of production or consumption, forcing agents to internalize the external cost and reducing the quantity toward the socially optimal level.
What is the market outcome for a good with a positive externality?
The market underproduces the good because the private benefit is less than the social benefit, resulting in a quantity that is less than the socially optimal level.
What is the socially optimal quantity of a good?
The socially optimal quantity occurs where the marginal social benefit (MSB) of consuming the last unit equals the marginal social cost (MSC) of producing that unit, maximizing total economic surplus.
How do rational agents behave in the presence of externalities?
In the presence of externalities, rational agents respond to their private costs and benefits and do not consider the external costs and benefits imposed on others.
Besides taxes and subsidies, list three other policies that can address externalities.
Other policies include environmental regulation, public provision of the good, and the assignment or reassignment of property rights.
How can assigning property rights potentially solve an externality problem without government intervention?
Assigning property rights allows the affected parties to negotiate a private transaction, which can lead to an efficient outcome by internalizing the externality.
What is the relationship between public provision and externalities?
Public provision is a policy where the government provides a good to address a market failure, often used for goods with significant positive externalities.
Why do private markets fail to be efficient when externalities are present?
Private markets fail because they do not take into consideration social costs or social benefits; rational agents respond only to private costs and benefits, ignoring external effects.
What are the two primary causes of externalities?
Externalities primarily arise from a lack of well-defined property rights and/or the presence of high transaction costs between parties.
What is the market outcome for a good with a negative externality?
The market overproduces the good because the private cost is less than the social cost, resulting in a quantity that is greater than the socially optimal level.
At what specific point is total economic surplus maximized?
Total economic surplus is maximized where the marginal social benefit of consuming the last unit equals the marginal social cost of producing that last unit.
What is an externality?
An externality is a cost or benefit arising from an economic activity that affects a third party not directly involved in the transaction, often due to a lack of well-defined property rights.
When do rational agents have an incentive to free ride?
Rational agents have an incentive to free ride when a good is non-excludable, allowing them to benefit from the good without paying for it.
How does a corrective subsidy address a positive externality?
A corrective subsidy reduces the private cost or increases the private benefit, forcing agents to internalize the external benefit and increasing the quantity toward the socially optimal level.