Microeconomics Chapter 9

External Costs and Benefits

-An external cost is an uncompensated cost that an individual or firm imposes on others. -An external benefit is a benefit that an individual or firm confers on others without receiving compensation. -Together external costs and external benefits are called externalities.

Policies Toward Pollution

-Environmental standards are rules that protect the environment by specifying actions of producers and consumers. They are generally inefficient because they are inflexible. -An emissions tax is a tax that depends on the amount of pollution a firm produces. -A Pigouvian tax is a tax equal to the marginal external cost. -Tradable emissions permits are licenses to emit limited quantities of pollutants that can be bought and sold by polluters.

Private Solutions to Externalities

-In a 1960 article, economist Ronald Coase said that in an ideal world the private sector could deal with all externalities. -According to the Coase theorem, even in the presence of externalities an economy can reach an efficient solution if transaction costs—costs to individuals of making a deal—are sufficiently low. -Implication is that externalities need not lead to inefficiency because individuals have incentives to make mutually beneficial deals—deals in which they consider externalities when making decisions. -When individuals do take externalities into account, economists say they internalize the externality. -Individuals can't always internalize externalities because transaction costs prevent them from making efficient deals. --> Examples of transaction costs are: -costs of communication among the interested parties -costs of legal agreements -costly delays involved in bargaining

The Economics of Pollution

-Pollution is a bad thing. Yet most pollution is a side effect of activities that provide us with good things: Our air is polluted by power plants generating the electricity that lights our cities, and our rivers are damaged by fertilizer runoff from farms that grow our food. -Pollution is a side effect of useful activities, so the optimal quantity of pollution isn't zero. -Then, how much pollution should a society have? What are the costs and benefits of pollution?

Pollution: An External Cost

-Pollution is an example of an external cost, or negative externality. -In contrast, some activities can give rise to external benefits, or positive externalities. -Left to itself, a market economy will typically generate too much pollution because polluters have no incentive to take into account the costs they impose on others.

Costs and Benefits of Pollution

-The marginal social cost of pollution is the additional cost imposed on society by an additional unit of pollution. -The marginal social benefit of pollution is the additional gain to society from an additional unit of pollution. -The socially optimal quantity of pollution is the quantity of pollution that society would choose if all the costs and benefits of pollution were fully accounted for.