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
• All externalities cause markets to be inefficient
– That is, markets do not maximize total surplus (welfare)
Negative Externalities
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Automobile exhaust
Cigarette smoking
Barking dogs
Loud stereos in an apartment building
Noisy Students
Neighbor’s poorly maintained property
Positive Externalties
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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)
Supply Curve = Marginal Cost Curve
Equilibrium
Demand Curve = Marginal Benefit Curve
MC = MB
Demand
(marginal benefit)
0
QMARKET
Quantity of
Aluminum
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
MSC
Price of
Aluminum
External
social Cost
(social cost)
Supply = MCP
(private
Spillover
Cost
Optimum
P1
cost)
Equilibrium MC = MB
Demand = MB
(private
0
QOPTIMUM QMARKET
value)
Quantity of
Aluminum
Positive Externality:
Neighbor paints House
Price
External
social benefit
MC
Optimum
Equilibrium
P1
Spillover Benefit
MSB
MB
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
Worksheet
• Externalities
Taxing Negative Externalities
MSC
Price of
Aluminum
External
social Cost
(social cost)
Supply = MC
(private
cost)
Impose Tax = spillover cost
Optimum
Equilibrium MC = MB
Shifts Supply Curve left
Reach social optimal output
Demand = MB
(private
0
value)
QOPTIMUM QMARKET
Aluminum
Total Cost = Total Benefit
Total Cost = MSC (MCP + MCS)
Subsidizing Positive Externalities
Fuel Efficient Cars
Price
External
social benefit
Impose Subsidy = spillover benefit
MC
Shifts demand curve right
Optimum
Equilibrium
Spillover Benefit
MSB
Total Cost = Total Benefit
MB
0
QMARKET QOPTIMUM
Reach social optimal output
Quantity
Day #2
• Practice Test
Factory A
Factory B
Cap & Trade Analysis
Goal: to reduce CO2 emissions
Pollution Credits
Trading System
S
D