Econ

1. What are negative externalities and positive externalities?  How do they affect supply and demand curves?

externalities are like side effects on parties outside the firm. e.g. assume that I have decided to build a dam to produce hydroelectricity. In doing so, my main sources of revenue are the reserve I have developed behind the dam, the electricity I have produced and the mass of water supply people demand from me. It was not part of my intention and I could not make money from the fact people downstream now have flat land that they can build houses on and that the land beside the river is fertile so arable farming is now feasible. Hence they are positive externalities

A negative externality would be that I have disrupted an ecosystem and that people further downstream who regularly uses the river is now short on water (if we are in a 3rd world country and ownership of dams are privatised).

These externalities do not affect me, by definition. The only way they would affect me is if people's protest affect my revenues and business.

Externalities are modelled in supply and demand diagrams by adding a constant margin above the supply (negative) and/or demand (positive) curve(s). These new curves show the social marginal costs and benefits of these externalities. Where they cross shows where the socially desirable equilibrium is.

Irrespective of what sort of externality it is, price should rise as a result. Quantity will vary depending on what sort of externality it is.

You may argue that instead of adding on margins, we could have deductions i.e. parallel lines below the supply and demand curves, but if we did this, we may not show that because of these externalities things will cost more or is more in demand.

2. Explain what is meant by the principal–agent problem, and relate it to shirking. What are the different pay incentive plans that correct for shirking on the job? How does profit sharing reduce shirking? What is the reason for...