externalities - econ.iastate.edu · • market failure • solutions externalities – 3 an...
TRANSCRIPT
![Page 1: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/1.jpg)
Externalities – 1
Externalities
April 25, 2011
![Page 2: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/2.jpg)
Waters
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 2
Drink waters out of thine own cistern, and
running waters out of thine own well. —
Proverbs 5:25
![Page 3: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/3.jpg)
Externalities
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 3
![Page 4: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/4.jpg)
Externalities
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 3
An externality exists whenever the welfare of some agent,either a firm or a household, depends not only on his or heractivities, but also on activities under the control of some otheragent.
![Page 5: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/5.jpg)
Externalities
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 3
An externality exists whenever the welfare of some agent,either a firm or a household, depends not only on his or heractivities, but also on activities under the control of some otheragent.
• Water pollution
![Page 6: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/6.jpg)
Externalities
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 3
An externality exists whenever the welfare of some agent,either a firm or a household, depends not only on his or heractivities, but also on activities under the control of some otheragent.
• Water pollution• Air pollution
![Page 7: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/7.jpg)
Externalities
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 3
An externality exists whenever the welfare of some agent,either a firm or a household, depends not only on his or heractivities, but also on activities under the control of some otheragent.
• Water pollution• Air pollution• Noise pollution
![Page 8: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/8.jpg)
Externalities
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 3
An externality exists whenever the welfare of some agent,either a firm or a household, depends not only on his or heractivities, but also on activities under the control of some otheragent.
• Water pollution• Air pollution• Noise pollution• Waste pollution
![Page 9: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/9.jpg)
Externalities
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 3
An externality exists whenever the welfare of some agent,either a firm or a household, depends not only on his or heractivities, but also on activities under the control of some otheragent.
• Water pollution• Air pollution• Noise pollution• Waste pollution• Scenic view pollution
![Page 10: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/10.jpg)
Externalities
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 3
An externality exists whenever the welfare of some agent,either a firm or a household, depends not only on his or heractivities, but also on activities under the control of some otheragent.
• Water pollution• Air pollution• Noise pollution• Waste pollution• Scenic view pollution• Common pool resources
![Page 11: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/11.jpg)
Externalities
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 3
An externality exists whenever the welfare of some agent,either a firm or a household, depends not only on his or heractivities, but also on activities under the control of some otheragent.
• Water pollution• Air pollution• Noise pollution• Waste pollution• Scenic view pollution• Common pool resources• Congestion with excludable resources
![Page 12: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/12.jpg)
Externalities
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 3
An externality exists whenever the welfare of some agent,either a firm or a household, depends not only on his or heractivities, but also on activities under the control of some otheragent.
• Water pollution• Air pollution• Noise pollution• Waste pollution• Scenic view pollution• Common pool resources• Congestion with excludable resources• Congestion with non-excludable resources
![Page 13: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/13.jpg)
Externalities
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 3
An externality exists whenever the welfare of some agent,either a firm or a household, depends not only on his or heractivities, but also on activities under the control of some otheragent.
• Water pollution• Air pollution• Noise pollution• Waste pollution• Scenic view pollution• Common pool resources• Congestion with excludable resources• Congestion with non-excludable resources• Angry dog
![Page 14: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/14.jpg)
The Coase Theorem
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 4
![Page 15: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/15.jpg)
The Coase Theorem
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 4
• Nice cottage beside a train track.
![Page 16: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/16.jpg)
The Coase Theorem
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 4
• Nice cottage beside a train track.
• Fresh white laundry hung out to dry
![Page 17: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/17.jpg)
The Coase Theorem
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 4
• Nice cottage beside a train track.
• Fresh white laundry hung out to dry
• Coal burning steam locomotive passing by
![Page 18: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/18.jpg)
Graphical Analysis
Externalities – 5
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Graphical Analysis
Externalities – 5
Demand
MCPrivate
1 2 3 4 5 6 7 8 9 10 12 14 16 18Quantity
2
4
6
8
10
12
14
16
18
20
Price
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Graphical Analysis
Externalities – 5
Demand
MCPrivate
MCSocial
1 2 3 4 5 6 7 8 9 10 12 14 16 18Quantity
2
4
6
8
10
12
14
16
18
20
Price
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Graphical Analysis
Externalities – 5
Demand
MCPrivate
MCSocial
1 2 3 4 5 6 7 8 9 10 12 14 16 18Quantity
2
4
6
8
10
12
14
16
18
20
Price
![Page 22: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/22.jpg)
Graphical Analysis
Externalities – 5
Demand
1 2 3 4 5 6 7 8 9 10 12 14 16 18Quantity
2
4
6
8
10
12
14
16
18
20
Price
![Page 23: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/23.jpg)
Graphical Analysis
Externalities – 5
Demand
MCSocial
1 2 3 4 5 6 7 8 9 10 12 14 16 18Quantity
2
4
6
8
10
12
14
16
18
20
Price
![Page 24: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/24.jpg)
Graphical Analysis
Externalities – 5
Demand
MCSocial
1 2 3 4 5 6 7 8 9 10 12 14 16 18Quantity
2
4
6
8
10
12
14
16
18
20
Price
![Page 25: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/25.jpg)
Competitive Equilibrium
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 6
There are three requirements for a competitive equilibrium,
corresponding to the requirements that producers optimize,
consumers optimize, and that “markets clear” at the equilibrium
prices.
![Page 26: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/26.jpg)
Competitive Equilibrium
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 6
There are three requirements for a competitive equilibrium,
corresponding to the requirements that producers optimize,
consumers optimize, and that “markets clear” at the equilibrium
prices.
Specifically, the allocation (x1∗, x2∗, . . . , xI∗, y1∗, y2∗, . . . , yJ∗) and
price vector p∗ ∈ RL constitutes a competitive or Walrasian
equilibrium if the following conditions are satisfied.
![Page 27: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/27.jpg)
Competitive Equilibrium
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 6
There are three requirements for a competitive equilibrium,
corresponding to the requirements that producers optimize,
consumers optimize, and that “markets clear” at the equilibrium
prices.
Specifically, the allocation (x1∗, x2∗, . . . , xI∗, y1∗, y2∗, . . . , yJ∗) and
price vector p∗ ∈ RL constitutes a competitive or Walrasian
equilibrium if the following conditions are satisfied.
1. Profit Maximization
2. Utility Maximization
3. Market Clearing
![Page 28: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/28.jpg)
Profit Maximization
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 7
The allocation (x1∗, x2∗, . . . , xI∗, y1∗, y2∗, . . . , yJ∗) and price vector
p∗ ∈ RL constitutes a competitive or Walrasian equilibrium if thefollowing conditions are satisfied.
![Page 29: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/29.jpg)
Profit Maximization
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 7
The allocation (x1∗, x2∗, . . . , xI∗, y1∗, y2∗, . . . , yJ∗) and price vector
p∗ ∈ RL constitutes a competitive or Walrasian equilibrium if thefollowing conditions are satisfied.
1. Profit Maximization
maxyj
[
L∑
ℓ=1
p∗ℓ yjℓ
]
such that [yj ∈ Y j ]
![Page 30: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/30.jpg)
Profit Maximization
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 7
The allocation (x1∗, x2∗, . . . , xI∗, y1∗, y2∗, . . . , yJ∗) and price vector
p∗ ∈ RL constitutes a competitive or Walrasian equilibrium if thefollowing conditions are satisfied.
1. Profit Maximization
maxyj
[
L∑
ℓ=1
p∗ℓ yjℓ
]
such that [yj ∈ Y j ]
2. Utility Maximization
3. Market Clearing
![Page 31: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/31.jpg)
Utility Maximization
Externalities – 8
The allocation (x1∗, x2∗, . . . , xI∗, y1∗, y2∗, . . . , yJ∗) and price vector p∗ ∈ RL
constitutes a competitive or Walrasian equilibrium if the following conditions aresatisfied.
1. Profit Maximization
![Page 32: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/32.jpg)
Utility Maximization
Externalities – 8
The allocation (x1∗, x2∗, . . . , xI∗, y1∗, y2∗, . . . , yJ∗) and price vector p∗ ∈ RL
constitutes a competitive or Walrasian equilibrium if the following conditions aresatisfied.
1. Profit Maximization
2. Utility Maximization For each consumer the consumption bundle is maximal
for �i in the budget set defined by the initial endowment (valued at the
equilibrium prices) and their share of the profits of the J firms in theeconomy. Specifically, for each consumer i, xi∗ solves
maxxi
vi(xi)
such that
L∑
ℓ=1
p∗ℓ xiℓ ≤
L∑
ℓ=1
p∗ℓ ωiℓ +
J∑
j=1
θijp∗
ℓ yj∗ℓ
![Page 33: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/33.jpg)
Utility Maximization
Externalities – 8
The allocation (x1∗, x2∗, . . . , xI∗, y1∗, y2∗, . . . , yJ∗) and price vector p∗ ∈ RL
constitutes a competitive or Walrasian equilibrium if the following conditions aresatisfied.
1. Profit Maximization
2. Utility Maximization For each consumer the consumption bundle is maximal
for �i in the budget set defined by the initial endowment (valued at the
equilibrium prices) and their share of the profits of the J firms in theeconomy. Specifically, for each consumer i, xi∗ solves
maxxi
vi(xi)
such that
L∑
ℓ=1
p∗ℓ xiℓ ≤
L∑
ℓ=1
p∗ℓ ωiℓ +
J∑
j=1
θijp∗
ℓ yj∗ℓ
3. Market Clearing
![Page 34: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/34.jpg)
Market Clearing
Externalities – 9
The allocation (x1∗, x2∗, . . . , xI∗, y1∗, y2∗, . . . , yJ∗) and price vector p∗ ∈ RL
constitutes a competitive or Walrasian equilibrium if the following conditions aresatisfied.
1. Profit Maximization
2. Utility Maximization
![Page 35: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/35.jpg)
Market Clearing
Externalities – 9
The allocation (x1∗, x2∗, . . . , xI∗, y1∗, y2∗, . . . , yJ∗) and price vector p∗ ∈ RL
constitutes a competitive or Walrasian equilibrium if the following conditions aresatisfied.
1. Profit Maximization
2. Utility Maximization
3. Market Clearing The total consumption of products by consumers is equal
to initial endowments plus the net output of firms. Specifically, for eachgood ℓ = 1, 2, . . . , L,
I∑
i=1
xi∗ℓ ≤
I∑
i=1
ωiℓ +
J∑
j=1
yj∗ℓ
⇒
I∑
i=1
xi∗ℓ ≤ ωℓ +J∑
j=1
yj∗ℓ
![Page 36: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/36.jpg)
First Theorem of Welfare Economics
Externalities – 10
• If the price p∗ and allocation(
x11
∗
, x21
∗
, . . . , xI1
∗
, q1∗
, q2∗
, . . . , qJ∗)
constitute a competitive equilibrium, then this allocation is Pareto Optimal.
![Page 37: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/37.jpg)
First Theorem of Welfare Economics
Externalities – 10
• If the price p∗ and allocation(
x11
∗
, x21
∗
, . . . , xI1
∗
, q1∗
, q2∗
, . . . , qJ∗)
constitute a competitive equilibrium, then this allocation is Pareto Optimal.
• One of the goals economists often state for an economy is efficiency in thesense there is not a way to rearrange production to get “more” output from
the same “input”.
![Page 38: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/38.jpg)
First Theorem of Welfare Economics
Externalities – 10
• If the price p∗ and allocation(
x11
∗
, x21
∗
, . . . , xI1
∗
, q1∗
, q2∗
, . . . , qJ∗)
constitute a competitive equilibrium, then this allocation is Pareto Optimal.
• One of the goals economists often state for an economy is efficiency in thesense there is not a way to rearrange production to get “more” output from
the same “input”.
• Economists are also interested in allocative efficiency in the sense that no
one can be made better off without making some one else worse off.
![Page 39: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/39.jpg)
First Theorem of Welfare Economics
Externalities – 10
• If the price p∗ and allocation(
x11
∗
, x21
∗
, . . . , xI1
∗
, q1∗
, q2∗
, . . . , qJ∗)
constitute a competitive equilibrium, then this allocation is Pareto Optimal.
• One of the goals economists often state for an economy is efficiency in thesense there is not a way to rearrange production to get “more” output from
the same “input”.
• Economists are also interested in allocative efficiency in the sense that no
one can be made better off without making some one else worse off.
• A feasible allocation (x1, x2, . . . , xI , y1, y2, . . . , yJ ) is Pareto Optimal or
Pareto Efficient if there is no other feasible allocation (x1′
, x2′
, . . . , xI′
, y1′
,y2
′
, . . . , yJ′
) such that ui(x1′
) ≥ ui(x1) for all i, with strict inequality for at
least one i.
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First Theorem of Welfare Economics
Externalities – 10
• If the price p∗ and allocation(
x11
∗
, x21
∗
, . . . , xI1
∗
, q1∗
, q2∗
, . . . , qJ∗)
constitute a competitive equilibrium, then this allocation is Pareto Optimal.
• One of the goals economists often state for an economy is efficiency in thesense there is not a way to rearrange production to get “more” output from
the same “input”.
• Economists are also interested in allocative efficiency in the sense that no
one can be made better off without making some one else worse off.
• A feasible allocation (x1, x2, . . . , xI , y1, y2, . . . , yJ ) is Pareto Optimal or
Pareto Efficient if there is no other feasible allocation (x1′
, x2′
, . . . , xI′
, y1′
,y2
′
, . . . , yJ′
) such that ui(x1′
) ≥ ui(x1) for all i, with strict inequality for at
least one i.
• A Pareto optimal allocation is efficient in the sense that there is no other
way to reorganize society’s productive facilities in order to make somebody
better of without harming somebody else.
![Page 41: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/41.jpg)
Market Failure
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 11
If the various assumptions of the First Theorem of Welfare
Economics do not hold then we have what is called a market failure.
• Public goods
![Page 42: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/42.jpg)
Market Failure
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 11
If the various assumptions of the First Theorem of Welfare
Economics do not hold then we have what is called a market failure.
• Public goods
• Externalities
![Page 43: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/43.jpg)
Market Failure
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 11
If the various assumptions of the First Theorem of Welfare
Economics do not hold then we have what is called a market failure.
• Public goods
• Externalities
• Natural monopoly
![Page 44: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/44.jpg)
Possible Solutions to Market Failure
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 12
• Taxes
![Page 45: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/45.jpg)
Possible Solutions to Market Failure
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 12
• Taxes
• Subsidies
![Page 46: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/46.jpg)
Possible Solutions to Market Failure
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 12
• Taxes
• Subsidies
• Quotas
![Page 47: Externalities - econ.iastate.edu · • Market Failure • Solutions Externalities – 3 An externality exists whenever the welfare of some agent, either a firm or a household, depends](https://reader036.vdocuments.site/reader036/viewer/2022062919/5edfc665ad6a402d666b1635/html5/thumbnails/47.jpg)
Possible Solutions to Market Failure
Externalities
• Waters
• Definition
• Coase Theorem
• Graph
• CE
• CE1
• UtilMax
• MarketClear
• First Theorem
• Market Failure
• Solutions
Externalities – 12
• Taxes
• Subsidies
• Quotas
• Tradable permits