lecture10 - Introductory Microeconomics LECTURE 10 MARKET...

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Introductory Microeconomics LECTURE 10 – MARKET FAILURE 2: EXTERNALITIES (CONTINUED) AND PUBLIC GOODS 1. Where we are up to • What is market failure? • What are externalities, and why do they cause market failure? • Government policy solutions for externalities – tax/subsidy; direct regulation 1
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2. Solutions for externalities (continued) c. A hybrid solution: Pollution permits (Case study 4.3) • The policy: a) Regulate total quantity of emission of pollutant: 1. Require a firm to own a ‘permit’ to emit that pollutant; and 2. Issue fixed total quantity of permits, and make some initial allocation of permits between firms; and b) Allow firms to trade permits - that is, firms can vary the amount of pollutants they emit by buying/selling permits. • Why the policy works: a) Can use total number of permits issued to regulate total amount of pollution emitted to be at efficient level; and b) Trade of permits between firms promotes efficient distribution of pollution emission across firms. 3
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PMC1 = SMC1 PMC2 = SMC2 $5 $10 $ $ Total decrease in pollution emission Firm 1 Firm 2 How trade in permits can improve welfare: 4
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• Suppose firms are given an amount of permits that necessitate them to reduce emissions by the same amount.
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