Midterm 2: Externalities

Command and control regulations

Policies that require a given amount of pollution reduction with limited or no flexibility with respect to how it may be achieved. Example: technology/performance standards

Pigouvian Subsidy to get to Socially Optimal Level with negative Externality

1. "Payment" for every unit reduced 2. Set per unit payment to the equilibrium price at the socially optimal level 3. Total payment is every unit reduced times difference between equilibrium price and marginal cost at the socially optimal level MPC has shifted up due to the added opportunity cost of producing. Firm takes this into account, and adjusts production. Important because government will raise revenue somehow in order to fund the "expenditure." There are also implications regarding choosing a subsidy to remedy an externality as opposed to a tax. A subsidy might incentivize other firms to relocate to the area in order to take advantage of the subsidy. Some may also argue them to be ethically undesirable.

Technology standard

A command and control approach in which the government mandates that firms must use a specified technology in order to reduce emissions. The issue is that it offers no incentive for a firm to reduce emissions by cheaper means. If a cheaper means of doing so is available, then it is not cost effective

Performance standard

A command and control approach in which the government sets a goal for emissions reduction for each polluter. The issue is that some polluters have high costs for pollution and others don't. Because each firm must meet a goal as opposed to the industry meeting the goal as a whole, the burden cannot be spread around to firms who can achieve their goals quickly. So it is not cost effective.

Social Conventions

A means of internalizing an externality. Can be seen as attempts of communities forcing people to take into account the externalities they generate. (Candy wrapper) It is important to public economics because it shows the private response to externalities (government does not have to intervene).

Reaching the Socially Efficient Level of Production by Merger

A means of internalizing an externality. If Firm A is creating an externality that affects Firm B, the firms can internalize the externality by merging. Now the merged firm has to take into account the costs that were incurred to Firm B into the firms costs as a whole. If Firm A were to continue generating the externality that affected Firm B, then Firm B's profits would decrease, which would mean that Firm A's profits would decrease. It is important to public economics because it shows how an externality can be remedied with government intervention.

Pigouvian Tax

A pigouvian tax is a per unit tax on a polluters output just equal to the marginal damage (damage of producing one more unit) at the socially optimal level of output. Alternatively, it can also be a per unit tax on a polluter's emissions output. A pigouvian tax effectively raises the marginal cost on producers (because it makes each unit MD more expensive), which forces them to lower output and raise prices until it reaches the socially optimal level of output. It is important to public economics because it shows how the government can remedy or regulate a negative externality like pollution via taxes. It also generates revenue that can be used toward other programs.

*Fuel Economy standard for automobiles

An example of the command and control approach. These standards dictate the average gasoline mileage that vehicle fleets must attain. The goal of the policy is to reduce gasoline consumption. Cafe standards have limited flexibility because manufacturers cannot shift the burden among each other to lower overall cost. An alternative approach would be to levy a tax on gasoline, which is a form of emissions fee. (Command and control; performance standards vs incentive-based approach.)

*Positive Externality

An externality that has a positive impact on an individual or individuals outside of the market in which it was created in. (An example would be vaccines) It is important to public economics because it is an instance (example) of market failure. If a positive externality exists, it is because the MSB is greater than the MC, which means that the market underprovides a good, and the government might step in and provide a subsidy to remedy it.

*Privately produced public good

Chapter 4?

Internalization

Finding a way to ensure that a firm or individual that creates external costs pays for them all

*Blanket Approach to Regulation

In reality Lindahl pricing often fails, and govt doesn't have sufficient information (on preferences), govt arbitrarily chooses a level of spending and arbitrarily assigns tax shares to ea. group of individuals based on political concerns. Importance: Can resolve free-riding problem, get work done instead of being delayed, but often leads to inefficient levels of public good supply

Negative Externality from Consumption

Is generated by consumption of a good. Cigarette consumption leads to cigarette smoke which is a negative externality that incurs negative health costs onto third parties. It is important to public economics because the government might need to use some sort of tax or regulation in order to curb or prevent these externalities.

Coase theorem (provide an example)

Lion hunting?

Coase Theorem

States that if transactional costs are negligible, then if property rights are assigned, an efficient solution to an externality problem will be achieved through, regardless of who holds the rights. Two assumptions must hold, however: 1. Negligible transactional costs 2. The owners of a resource can identify the source of damages to their property and legally prevent damages It is relevant to public economics because it shows how an externality problem can be solved without the government stepping in (the market will fix itself).

*Lindahl pricing

The model that results in each individual facing a personalized price per unit of public good, which depends on his or her tax share. Two issues: 1) people have an incentive to lie about their preferences, and will vote accordingly (dishonestly) 2. It is extremely costly to collect information about preferences, gather consent among voters, and then formulating mutually agreeable tax shares

Private optimal level versus socially optimal level of production

The private optimal level is the efficient level of output for a producer, where MPC intersects MB. The socially optimal level of production is the efficient level of output for society, where MSC intersects MB. It is important to public economics because often the government needs to: 1. Estimate the socially optimal level of production 2. What means to achieve it (tax, subsidy, cap and trade, etc.) 3. How to raise the money or what to do with the revenue generated from whichever means the government chooses

Marginal social cost

The sum of the MPC and MD lines. It represents the marginal cost to society incurred due to an externality. (Alternatively, it is the change in total social cost brought about by the production of an additional good or service.) It is important to public economics because it represents, when it intersects the MB line, where the socially optimal level of output should be. The government then decides whether to use a tax, subsidy, or some other program (such as cap-and-trade) to get a firm(s) to produce at that level (in order to eliminate externalities)

Market failure

When the quantity demanded by consumers does not equal the quantity supplied by producers