Economics Chapter 9

2 things to know about MSC & MSB

*As total pollution falls, the cost savings to a polluter being allowed to emit one more ton rises *Will a market economy, left to itself, arrive at the socially optimal quantity of pollution? NO

4 types of goods

-Private goods - excludable and rival in consumption (wheat) -Public goods: nonexcludable and nonrival in consumption (public sewer system) -Common resources: nonexcludable but rival in consumption (clean water in a river) -Artificially scarce goods - excludable but nonrival in consumption (on-demand movies on DirecTV)

Examples of transaction costs

-The costs of communication among the interested parties (could be very high if many people are involved) -The costs of making legally binding agreements (could be high if expensive legal services are required) -Costly delays involved in bargaining (both sides may hold out in an effort to extract more favorable terms, leading to increased effort and forgone benefit)

In the absence of government action, the quantity of pollution will be inefficient

-polluters will pollute up to the point at which the MSB of pollution is 0 -The benefit to polluters from the last unit of pollution is very low (virtually zero)... The MSC is very high

Why is an emission tax an efficient way to reduce pollution but environmental standards aren't?

Emissions tax ensures that the marginal benefit of pollution is equal for all sources of pollution - an environmental standard doesn't

2 characteristics that are essential if a good is to be efficiently provided by a market economy

Excludable & Rival in Consumption

External Benefits

a benefit that an individual or firm confers on others without receiving compensation

Private Good

a good that is both excludable and rival in consumption

Pigouvian Subsidy

a payment designed to encourage activities that yield external benefits

Emissions Tax

a tax that depends on the amount of pollution a firm produces -An emissions tax equal to the MSC at the socially optimal quantity of pollution induces polluters to internalize the externality - take into account the true costs to society of their actions

Marginal Social Benefit of Pollution

additional benefit to society as a whole from an additional unit of pollution

Marginal Social Cost of Pollution

additional cost imposed on society as a whole by an additional unit of pollution

Technology spillover

an external benefit that results when knowledge spreads among individuals and firms; Greatest sources of technology spillovers = major universities and research institutes

External Cost

an uncompensated cost that an individual or firm imposes on others

Downward sloping marginal social benefit curve (MSB)

because it is progressively harder, and more expensive, to achieve a further reduction in pollution as the total amount of pollution falls (more expensive technology must be used)

Main problem with tradable emissions permits

because it is too difficult to determine the optimal quantity of pollution, governments can find themselves either issuing too many (don't reduce pollution enough) or issuing too few (they reduce pollution too much)

Efficient wat to reduce pollution

ensure that at the industry-wide outcome, the marginal benefit of pollution is the same for all plants

Coase Theorem

even in the presence of externalities an economy can always reach an efficient solution provided that the costs of making a deal are sufficiently low

Private Goods

excludable - producers can charge for them and so have an incentive to produce them rival in consumption - it is efficient for consumers to pay a positive price (a price equal to the marginal cost of production)

Positive Externalities

external benefits

Negative Externalities

external costs

Externalities

external costs and benefits

Nonrival in Consumption

if more than one person can consume the same unit of the good at the same time

Main concern with emissions taxes

in practice, gov officials usually aren't sure how the tax should be set -Too low - too little improvement to the environment -Too high - emissions will be reduced by more than is efficient

Public Good

is both nonexcludable and nonrival in consumption; they suffer from the free-rider problem - so no private firm would be willing to produce them

Tradable Emissions Permits

licenses to emit limited quantities of pollutants that can be bought and sold by polluters -Those with lowest cost will reduce their pollution the most, those with the highest cost will reduce their pollution the least

Free-rider Problem

many individuals are unwilling to pay for their own consumption and instead will take a "free ride" on anyone who does pay

Market economy without government intervention to protect the environment

only the benefits of pollution are taken into account in choosing the quantity of pollution -NOT Qopt; IT IS Qmkt -MSB of pollution at 0 -Qmkt = higher than Qopt Marginal cost of pollution to any given polluter is 0;no incentive to limit the amount of emissions

Emissions taxes and tradable permits

provide incentives to create and use technology that emits less pollution - new technology that lowers the socially optimal level of pollution

Environmental Standards

rules that protect the environment by specifying actions by producers and consumers

Upward sloping marginal social cost curve (MSC)

shows how the marginal cost to society of an additional ton of pollution emissions varies with the quantity of emissions; Upward because nature can handle small amounts of pollution but not a lot as it increases

Research clusters

spurs innovation and competition, theoretical advances, and practical applications; Increase the economy's productivity and raise living standards

2 ways to directly control pollution

taxes & tradable permits

Pigouvian Taxes

taxes designed to reduce external costs

Transaction Costs

the costs of making a deal

Cost-benefit analysis

the estimation and comparison of the social costs and social benefits of providing a public good

How Much of a Public Good Should Be Provided?

the government should provide the good to the level at which the marginal social benefit of an additional good is no longer greater than the marginal cost

Socially Optimal Quantity of Pollution

the quantity of pollution that society would choose if all the costs and benefits of pollution were fully accounted for

Rival in Consumption

the same unit of the good cannot be consumed by more than one person at the same time

Non-excludable

the supplier cannot prevent consumption by people who do not pay for it

Excludable

the supplier of that good can prevent people who do not pay from consuming it

Public goods are provided through a variety of means

voluntary contributions - Private donations self-uninterested individuals or firms because those who produce them are able to make money in an indirect way - Broadcast TV deliberately made excludable and therefore subject to change - On-demand movies

Internalize the externality

when individuals take external costs or benefits into account