1 Chapter 3 Externalities and Public Policy
2 Externalities Externalities are costs or benefits of market transactions not reflected in prices. Negative externalities are costs to third parties. Positive externalities are benefits to third parties .
3 Externalities and Efficiency The marginal external cost is the dollar value of the cost to third parties from the production or consumption of an additional unit of a good. These occur when market transactions for a good produce negative externalities .
4 Social Costs MSC = MPC + MEC
5 Figure 3.1 Market Equilibrium, A Negative Externality and Efficiency MPC + MEC = MSC Price, Benefit, and Cost (Dollars) Tons of Paper Per Year (Millions) D = MSB S = MPC 5 100 A 105 4.5 B 10 110 G
6 Implications of Figure 3.1 Market equilibrium occurs where MPC = MSB Efficiency Requires that MSC = MPC + MEC = MSB
7 Positive externalities The marginal external benefit is the dollar value of the benefit to third parties from an additional unit of production or consumption of a good. These occur when the market for a good creates positive externalities .
8 Social Benefit MSB = MPB + MEB
9 Figure 3.2 Market Equilibrium, A Positive Externality and Efficiency MPB + MEB = MSB H 10 V 30 12 Price, Benefit, and Cost (Dollars) Inoculations Per Year (Millions) 0 S = MSC MPB U 25 10 Z 45
10 Figure 3.3 A Positive Externality for Which MEB Declines With Annual Output S = MSC S' = MSC' MPB i A 25 10 B 12 MPB i + MEB = MSB 16 C 20 20 Price, Benefit, and Cost (Dollars) Inoculations per Year (Millions) 0 F 30
11 Internalization of Externalities An externality can be internalized under policies that force market participants to account for the costs of benefits of their actions.
12 Corrective Taxes to Negative Externalities Setting a tax equal to the MEC will internalize a negative externality.
13 Figure 3.4 A Corrective Tax
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