Price of steel

p1

p2

0 Q2 Q1

This framework does not capture the harm done to

the fishery, however.

The steel firm sets PMB=PMC to find its privately optimal profit maximizing output, Q1.

QSTEEL

D = PMB = SMB

S=PMCSMC = PMC + MD

MD

Figure 2 Negative Production Externalities

The socially optimal level of production is at Q2, the

intersection of SMC and SMB.

The yellow triangle is the consumer and producer

surplus at Q1.The marginal damage

curve (MD) represents the fishery’s harm per unit.

The social marginal cost is the sum of PMC and MD, and represents the cost to society.

The red triangle is the deadweight loss from the private production level.

The steel firm overproduces from society’s viewpoint.

QCIGARETTES

Price of cigarettes

0 Q2

D=PMB

Q1

p1

S=PMC=SMC

SMB=PMB-MD

MDp2

The yellow triangle is the surplus to the smokers (and producers) at Q1.

This framework does not capture the harm done to non-smokers, however.

The smoker sets PMB=PMC to find his

privately optimal quantity of cigarettes, Q1.The MD curve represents

the nonsmoker’s harm per pack of cigarettes.

The social marginal benefit is the difference between PMB

and MD.

The socially optimal level of smoking is at Q2, the

intersection of SMC and SMB.

The smoker consumes too many cigarettes from society’s

viewpoint.

The red triangle is the deadweight loss from the private production level.

Figure 3 Negative Consumption Externalities

QSTEEL

Price of steel

0 Q2

D = PMB SMB

Q1

p1

S = PMCSMC = PMC + MD

MD

p2

But there is room to bargain. The steel firm gets a lot of surplus from the first unit.

1 2

This bargaining process will continue until the socially

efficient level.

There is still room to bargain. The steel firm gets a bit less surplus from the second unit.

Thus, it is possible for the steel firm to “bribe” the fishery in

order to produce the first unit.

The reason is because any steel production makes the

fishery worse off.

Thus, it is possible for the steel firm to “bribe” the fishery in

order to produce the next unit.

If the fishery had property rights, it would initially impose

zero steel production.

While the fishery suffers only a modest amount of damage.

While the fishery suffers the same damage as from the

first unit.

Figure 5

Negative Production Externalities and Bargaining: Giving the Fish People Property Rights

The gain to society is this area, the difference between (PMB -PMC)

and MD for the second unit.

The gain to society is this area, the difference between (PMB -PMC) and MD for the first unit.

Figure 6

Negative Production Externalities and Bargaining: Steel Producers Have Property Rights

QSTEEL

Price of steel

0 Q2

D=PMB=SMB

Q1

p1

S = PMCSMC = PMC + MD

MD

p2

The fishery gets a lot of surplus from cutting back

steel production by one unit.

This level of production maximizes the consumer and

producer surplus.

If the steel firm had property rights, it would initially choose

Q1.

While the steel firm suffers a larger loss in profits.

The gain to society is this area, the difference between MD and (PMB-

PMC) by cutting back 1 unit.While the steel firm suffers

only a modest loss in profits.

The gain to society is this area, the difference between MD and (PMB -

PMC) by cutting another unit.

This bargaining process will continue until the socially

efficient level.

Thus, it is possible for the fishery to “bribe” the steel firm

to cut back another unit.

Thus, it is possible for the fishery to “bribe” the steel firm

to cut back.

The fishery gets the same surplus as cutting back from

the first unit.

QSTEEL

Price of steel

0 Q2

D = PMB = SMB

Q1

p1

S=PMCSMC=PMC+MD

p2

The steel firm initially produces at Q1, the intersection of PMC

and PMB.Imposing a tax shifts the PMC

curve upward and reduces steel production.

S=PMC+tax

Imposing a tax equal to the MD shifts the PMC curve such that

it equals SMC.

The socially optimal level of production, Q2, then maximizes

profits.

Figure 7 Corrective (“Pigouvian”) Taxation

QSTEEL

Price of steel

0 Q2

D = PMB = SMB

Q1

p1

S = PMCSMC = PMC + MD

p2

The firm has an incentive to produce Q1.

Yet the government could simply require it to produce no

more than Q2.

Figure 9 Quantity Regulation

Table 2

Top 25 Fossil Fuel CO2 Emitters in 2000

0

200

400

600

800

1000

1200

1400

1600

UN

ITE

D S

TA

TE

S

CH

INA

RU

SS

IAN

FE

D.

JAP

AN

IND

IA

GE

RM

AN

Y

UN

ITE

D K

ING

DO

M

CA

NA

DA

ITA

LY

SO

UT

H K

OR

EA

ME

XIC

O

SA

UD

I A

RA

BIA

FR

AN

CE

AU

ST

RA

LIA

UK

RA

INE

SO

UT

H A

FR

ICA

IRA

N

BR

AZ

IL

PO

LAN

D

SP

AIN

IND

ON

ES

IA

TU

RK

EY

TA

IWA

N

TH

AIL

AN

D

NO

RT

H K

OR

EAM

illi

on

s o

f M

etri

c T

on

s o

f C

arb

on

The U.S. is currently responsible for nearly 25% of the planet’s

carbon dioxide emissions.

Japan contributes only 5% of annual emissions.

Developing counties like China and India emit large quantities of

greenhouse gasses.