Transcript Externalities

Externalities
Spillover Costs & Spillover Benefits
Chapter 10
(pages 203-208)
Switzerland & Garbage
35 Liter Swiss Trash Bag
EXTERNALITIES
• An externality is the uncompensated impact of one person or
firm’s actions on another person/society
– Both positive externalities & negative externalities exist
• All externalities are considered market failures (inefficient)
– That is, markets with externalities do not maximize total surplus (welfare)
– Governments can correct externalities with taxes or subsidies
Factory A
Factory B
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 Externalities
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Immunizations
Restored historic buildings
Research into new technologies
Neighbor’s well maintained property
Volunteering
Spillover Costs & Spillover Benefits
• Spillover Costs- external costs not included in supply curve (MC)
– External costs exist with ALL negative externalities
– MC is understated => which leads to overproduction
• Spillover Benefits-external benefits not included in demand curve (MB)
– External benefits exist with ALL positive externalities
– MB is understated => which leads to underproduction
MC
MB
Graphing Externalities
• When graphing negative externalities use MC & MB curves
– Then add any spillover cost or benefit to existing curve
• Marginal Social Cost (MSC) = MC + spillover cost
(external cost)
• Marginal Social Benefit (MSB) = MB + spillover benefit
Negative Externality
MSC
MC
(external benefit)
Positive Externality
MC
MSB
MB
MB
Internalizing Externalities
• Internalizing an externality involves altering incentives to
improve market outcomes (i.e. to increase total welfare)
• Government Solutions
– Taxes or Subsidies
– Laws (immunization laws, pollution laws)
– Patents
• Free market Solution:
– Trading pollution credits => i.e. cap & trade
Internalizing Negative Externalities
Aluminum Cans
Price
Assume this Factory Pollutes
MSC
MCP
MC
P2 --------------- E
2
0
Shifts Supply Curve left
--------------------
P1
Q2
Impose Tax = spillover cost
E1
Reach social optimal output
MB
MB
P
Q1
Quantity
Total Cost = Total Benefit
Total Cost = MSC (MCP + MCS)
Total Welfare is Maximized!
WORKSHEET
Electric Cars
Large SUV Production
Price
Price
MCP
MCP
E1
P1
E1
P1
MBP
MBP
0
Q1
Quantity
0
Q1
Quantity
Subsidizing Positive Externalities
Assume these cars have external benefits
Electric 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
Bottled Water
What is the real cost?
Start 20 minutes in…
Documentary
1) Demand Section 12 min.
2) Recycle Section
Only 11 states have recycle deposits laws
Only 20% of U.S. water bottles are recycled
Internalizing Negative Externalities
Impose Tax = spillover cost
This puts a price on “external costs”
Bottled Water
Price
Reach socialy optimal output @ Q2
MSC
MCP
MC
P1
0
--------------------
P2 --------------- E
2
Q2
E1
MB
MB
P
Q1
Quantity
MSC = MCp + MCs (internal & external)