Transcript Lecture Slides 11 - Yogesh Uppal`s Website

Econ 2610: Principles of
Microeconomics
Yogesh Uppal
Email: [email protected]
Chapter 11
Externalities and Property Rights
External Costs and Benefits

External cost is a cost of an activity that is
paid by people other than those who pursue
the activity


Also called a negative externality
External benefit is a benefit of an activity
received by a third party

Also called a positive externality
Externalities Affect Resource
Allocation

Externalities reduce economic efficiency


Solutions to externalities may be efficient
When efficient solutions to externalities are not
possible, government intervention or other
collective action may be used
Honeybee Keeper – Scenario 1

Phoebe harvests and sells honey from her
bees

Bees pollinate the apple orchards


No payments made to Phoebe
The bees provide a free service to the local
farmers

Phoebe is giving away a service

Private costs are equal to private benefits

Social costs are less than social benefits
When external benefits exist,
maximizing private profits produces less
than the social optimum
Honeybee Keeper – Scenario 2



Phoebe harvests and sells honey from her
bees
Neighboring school and nursing homes are
bothered by bee stings
The bees are a nuisance to the neighbors

Phoebe is not paying all the costs of her
honeybees

Private costs are equal to private benefits

Social costs are greater than social benefits
When external costs exist,
maximizing private profits produces more
than the social optimum
External Costs
External Cost
Private
MC
1.3
D
12,000
Quantity (tons/year)
Price ($000s / ton)
Price ($000s / ton)
No External Cost
Social MC
$1,000/ton
2.3
2.0
Private
MC
1.3
D
8,000
12,000
Quantity (tons/year)
Deadweight loss from
pollution = $2 M/yr
Social
Optimum
Private
Equilibrium
Positive Externality for
Consumers
Deadweight loss from
positive externality
XB
Price
MBPVT + XB
MC
MBSOC
MBPVT
Social
Demand
Private Demand
Private
Equilibrium
QPVT
Quantity
QSOC
Social
Optimum
Effects of Externalities
With externalities,
private market outcomes
do not achieve
the largest possible economic surplus
Cash is left on the table
Abercrombie the Polluter –
Scenario 1

Abercrombie’s company dumps toxic waste
in the river



Abercrombie could install a filter to remove
the harm to Fitch



Fitch cannot fish the river
No one else is harmed
Filter imposes costs on Abercrombie
Filter benefits Fitch
Parties do not communicate
Abercrombie's Filter Options
With Filter
Without
Filter
Abercrombie's
Gains
$100 / day
$130 / day
Fitch's Gains
$100 / day
$50 / day
Total Gains
$200 / day
$180 / day
 Abercrombie does not install the filter
 Marginal cost of filter to Abercrombie is $30 per day
 The marginal benefit to Fitch is $50 per day
 There is a net welfare loss of $20 per day
Abercrombie the Polluter –
Scenario 2

Communications changes the outcome


Fitch pays Abercrombie between $30 and $50 per
day to use the filter
Net gain in total surplus of $20 per day
With Filter
Without
Filter
Abercrombie's
Gains
$100 / day
$130 / day
Fitch's Gains
$100 / day
$50 / day
Total Gains
$200 / day
$180 / day
The Coase Theorem




If people can negotiate the right to perform activities
that cause externalities, they can always arrive at
efficient solutions to problems caused by
externalities
 Negotiations must be costless
Sometimes those harmed pay to stop pollution
 The case of Abercrombie and Fitch
Sometimes polluter buys the right to pollute
 Abercrombie pays Fitch if the value of polluting is
greater than the harm to Fitch
The adjustment to the externality is usually done by
the party with the lowest cost
Abercrombie the Polluter –
Scenario 3

Abercrombie’s company produces toxic
waste


Laws prohibit dumping the waste in the river
UNLESS Fitch agrees
New gains matrix
Without
With Filter
Filter
Abercrombie's
Gains
$100 / day
$150 / day
Fitch's Gains
$100 / day
$70 / day
Total Gains
$200 / day
$220 / day
Examples of Legal Remedies
for Externalities


Noise regulations (cars, parties, honking
horns)
Most traffic and traffic-related laws




Car emission standards and inspections
Zoning laws
Building height and footprint regulations
(sunshine laws)
Air and water pollution laws
Three Cases
Free Speech
First Amendment
recognizes the value of
open communications

Hard to identify speech that
has a net cost
Some


limitations
Yelling "fire" in a crowded
theatre
Promote the violent
overthrow of the
government
Planting Trees
Government subsidizes
trees on private property


Decreases chances of
flooding and landslides
Net reduction of CO2 in the
atmosphere
Basic Research
 Millions of dollars spent by
federal government yearly
 Externalities of new
knowledge
Optimal Amount of Negative
Externalities
MC & MB
MC
Optimal amount
of pollution
MC = MB
MB
Q
Quantity of Pollution
Taxing a Negative Externality
Pollution Tax
$1,000 / ton
Social MC
2.3
2.0
XC
Private
MC
1.3
D
Private MC + Tax
Tax
2.0
Private MC
1.3
D
8,000 12,000
8,000 12,000
Quantity (tons/year)
Social
Optimum
Price ($000s / ton)
Price ($000s / ton)
No Pollution Tax
Private
Equilibrium
Quantity (tons/year)
After Tax
Equilibrium
Before Tax
Equilibrium
Subsidizing a Positive
Externality
14
MC
XB
10
8
Social
Demand
Subsidy
Price ($ / ton)
Price ($ / ton)
No Subsidy
Subsidy
14
10
8
Subsidized
Demand
Private
Demand
12 16
Quantity
(000s tons/year)
MC
Private
Demand
12 16
Quantity
(000s tons/year)
Tragedy of Commons

When use of a communally owned resource
has no price, the costs of using it are not
considered

Use of the property will increase until MB = 0
Property Rights and the Tragedy
of Commons
Blackberries in the Park
Sweetness increases as
the berry ripens
Blackberries are
common property

Berries will be eaten before
they are fully ripe
Other Examples

Timber on remote public
land
Whales in open oceans
Worldwide


Decrease appreciation of
its flavor
Drinking slowly increases
appreciation
If
Harvesting

Shared Milkshakes
Milkshakes chill taste
buds
pollution
two people share the
milkshake, it is a
common good

They will drink faster than
if it were a private good