Transcript Externalities

Externalities
Chapter 10
EXTERNALITIES
• An externality is the uncompensated impact of one
person’s actions on another person
– Both positive & negative externalities exist
• Externalities cause markets to be inefficient
– That is, markets do not maximize total surplus
Negative Externalities
–
–
–
–
Automobile exhaust
Cigarette smoking
Barking dogs (loud pets)
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
Price of
Aluminum
Supply
(marginal cost)
MC = MB
Equilibrium
Demand
(marginal benefit)
0
QMARKET
Quantity of
Aluminum
Negative Externality:
Pollution
MCT = MCP + MCS
Price of
Aluminum
External
social Cost
Supply = MCP
(private cost)
Spillover
Cost
Optimum
Equilibrium MC = MB
Demand = MBP
(private value)
0
QOPTIMUM QMARKET
Quantity of
Aluminum
Positive Externality:
Neighbor paints House
Price
External
social benefit
Supply = MCP
(private cost)
Optimum
Equilibrium
Spillover Benefits
MBT = MBP + MBS
Demand = MBP
(private value)
0
QMARKET
QOPTIMUM
Quantity
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
Taxing Negative Externalities
Social cost (private cost + external cost)
Price of
Aluminum
External
Cost
Supply
(private cost)
Impose Tax = spillover cost
Optimum
Equilibrium
Shifts Supply Curve left
Reach social optimal output
Demand
(private value)
0
QOPTIMUM QMARKET
Quantity of
Aluminum
Total Cost = Total Benefit
Total Cost = MCP + MCS
Subsidizing Positive Externalities
Price of
Education
External
benefit
Supply
(private cost)
Impose Subsidy = spillover benefit
Optimum
Equilibrium
Shifts demand curve right
Reach social optimal output
Demand
(private value)
0
QMARKET QOPTIMUM
Quantity of
Education
Total Cost = Total Benefit
Worksheet
• Externalities