AP Economics

Mr. Bernstein

Module 74: Introduction to Externalities

January 9, 2015

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The Economics of Pollution• Environmentalists argue unregulated electricity

producers overpollute because they do not consider harmful effects

• Producers argue regulation interferes with ability to produce at lowest cost

• Economists view as topic for cost-benefit analysis where the socially optimal level is where Marginal Social Costs (MSC) intersect with Marginal Social Benefits (MSB)

AP EconomicsMr. Bernstein

3

AP EconomicsMr. Bernstein

The Economics of Pollution• MSC curve is

upward sloping• MSB curve is

downward sloping(~ cleanup cost savings?)

• Will society reach OOPT?

• NO!

(Note optimal pollution is not 0)

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AP EconomicsMr. Bernstein

The External Costs of Pollution• Negative Externality is an uncompensated cost that

a firm or individual imposes on others• Pollution from an Ohio River electricity plant lands

on Jersey residents who do not benefit from the electricity

• The unregulated market does not care about the pollution costs and produces until MSB = 0

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AP EconomicsMr. Bernstein

The External Costs of Pollution• Society would gain the entireshaded triangle ifpollution is reducedfrom Qmkt (MSB=0) to

Qopt

Qopt

MSB

MSC

MSC=MSB

Qmkt

$1000

MSC and MSBof pollution

Qty of Pollution Emitted (tons)

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AP EconomicsMr. Bernstein

Private Solutions to Externalities• Coase Theorem• Ronald Coase (1960)• Requires clearly defined property rights plus minimal

transactions costs • A private solution can be worked out (ie $$ settlement)• Hurdles include communication problems, high legal

costs, delaying tactics