Economics Chapter 10: Externalities

To achieve the socially optimal output...

Government can internalize an externality by imposing a tax on the producer to reduce the equilibrium quantity to the socially desirable quantity

Internalizing the Externality

Involves altering incentives so that people take into account of the external effects of their action

Negative Externalities and Socially optimal level

The social cost is less than the supply curve. Less than the market equilibrium quantity

Positive Externalities and Socially optimal level

The social value is above the demand curve. optimal output level is more than the equilibrium quantity. social value exceeds private value of good

Externalities can cause

a market to be inefficient which thus fails to maximize total surplus

Social cost

for each unit produced, the social cost includes the private costs of the producer and the cost to those bystanders adversely affected

Command and Control Policy

forbids or requires certain behavior

Patent Laws

form of tech policy that gives the individual or firm with patent protection a property right over its intervention

Industrial Policy

government intervention in the economy that aims to promote technology enhancing industries

Market based policies

government uses taxes and subsidies to align private incentive with social efficiency- tradable pollution permits allow the voluntary transfer of the rights to pollute from one firm to another (market for these permits will eventually develop, firm can reduce pollution @ low cost and sell its permit to a firm that can reduce pollution @ high cost)

If a company emits pollution, the cost to society is

larger than the cost to the producers

Subsidies

primary method to internalizing a positive externality

The Coase Theorum

private economic actors can solve the problem of externalities among themselves. w/e the initial distribution of rights, the interested parties can always reach a bargain in which everyone better off & outcome efficient

Negative externalities lead markets to

produce a larger quantity than socially desireable

Positive externalities lead markets to

produce a smaller quantity than socially desirable

Why private solutions do not always work

sometimes transaction costs so high that private agreement is not possible, each party may try to hold out for the better deal, or # of interested parties is large and coordinating everyone is costly

Pigovian Tax

taxes enacted to correct the effects of a negative externality

Transaction Cost

the cost that parties incur in the process of agreeing to and following thru on a bargain

Externality

the uncompensated impact of one person's actions on the well-being of a bystander. arise when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect.

Public policy towards Externalities

when externalities are significant and private solutions not found: government intervention

Positive Externality

when the impact on a bystander is beneficial (immunizations, new tech research)

Negative Externality

when the impact on the bystander is adverse/bad (pollution, exhaust, a loud pet, smoking)