externalities chapter 10. externalities an externality is the uncompensated impact of one person’s...
TRANSCRIPT
Externalities
Chapter 10
EXTERNALITIES• An externality is the uncompensated impact of one
person’s actions on another person– Both positive & negative externalities exist
• All externalities cause markets to be inefficient– That is, markets do not maximize total surplus (welfare)
Negative Externalities
– Automobile exhaust
– Cigarette smoking
– Barking dogs
– Loud stereos in an apartment building
– Noisy Students
– Neighbor’s poorly maintained property
Positive Externalties – Immunizations– Restored historic buildings– Research into new technologies– Neighbor’s well maintained property
MARKET INEFFICIENCY
• Negative externalities lead markets to overproduce
• Positive externalities lead markets to under-produce
Quantity ofAluminum
0
Price ofAluminum
EquilibriumEquilibrium
Demand(marginal benefit)
Demand(marginal benefit)
Supply(marginal cost)
Supply(marginal cost)
QMARKETQMARKET
MC = MB
Supply Curve = Marginal Cost Curve
Demand Curve = Marginal Benefit Curve
Spillover Costs & Benefits
• Spillover Costs- costs not captured by supply curve (MC)– Costs are understated
• Spillover Benefits- benefits not captured by demand curve (MB)– Benefits are understated
Negative Externality: Pollution
Equilibrium MC = MB
Quantity ofAluminum
0
Price ofAluminum
Demand = MB (private value)
Supply = MCP (private cost)
MSC (social cost)
QOPTIMUM
Optimum
QMARKET
SpilloverCost
External social Cost
P1
Positive Externality: Neighbor paints House
Quantity0
Price
MB
MC
QMARKET
External social benefit
EquilibriumOptimum
QOPTIMUM
Spillover Benefit
MSB
P1
Solutions to Externalities
• Internalizing an externality involves altering incentives
• Government Methods– Taxes (corrective taxes), Subsidies
– Patents
– Laws (immunization laws, pollution laws)
• Free market solution: – Trading pollution credits
Worksheet
• Externalities
Taxing Negative Externalities
Impose Tax = spillover cost Shifts Supply Curve left
Reach social optimal output
Total Cost = Total Benefit
Total Cost = MSC (MCP + MCS)
Equilibrium MC = MBEquilibrium MC = MB
Aluminum0
Price ofAluminum
Demand = MB(private value)
Demand = MB(private value)
Supply = MC(private cost)
Supply = MC(private cost)
MSC (social cost)
QOPTIMUMQOPTIMUM
OptimumOptimum
QMARKETQMARKET
External social Cost External
social Cost
Subsidizing Positive Externalities
Impose Subsidy = spillover benefit Shifts demand curve right
Reach social optimal output
Total Cost = Total Benefit
Quantity0
Price
MBMB
MCMC
QMARKETQMARKET
External social benefit
External social benefit
EquilibriumEquilibriumOptimumOptimum
QOPTIMUMQOPTIMUM
Spillover BenefitSpillover Benefit
MSB
Fuel Efficient Cars
Day #2
• Practice Test
Factory A Factory B
Cap & Trade Analysis
D
S
Goal: to reduce CO2 emissions
Trading SystemPollution Credits