EXTERNALITIES 1 INTRODUCTION TO ENVIRONMENTAL ECONOMICS AND PUBLIC POLICY LECTURE 11: EXTERNALITIES FEBRUARY 24, 2015 1
In this chapter, In this chapter, look for the answers to these look for the answers to these questions: questions: What is an externality? Why do externalities make market outcomes inefficient? What public policies aim to solve the problem of externalities? How can people sometimes solve the problem of externalities on their own? Why do such private solutions not always work? 2
EXTERNALITIES 3 Introduction One of the principles from Chapter 1: Markets are usually a good way to organize economy activity. In absence of market failures, the competitive market outcome is efficient, maximizes total surplus. One type of market failure: externality , the uncompensated impact of one persons actions on the well being of a bystander. Externalities can be negative or positive , depending on whether impact on bystander is adverse or beneficial.
EXTERNALITIES 4 Introduction Self-interested buyers and sellers neglect the external costs or benefits of their actions, so the market outcome is not efficient. Another principle from Chapter 1: Governments can sometimes improve market outcomes. In presence of externalities, public policy
EXTERNALITIES 5 Examples of Negative Externalities Air pollution from a factory The neighbor’s barking dog Late-night stereo blasting from the dorm room next to yours Noise pollution from construction projects Health risk to others from second-hand smoke Talking on cell phone while driving makes the roads less safe for others
EXTERNALITIES 6 0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Recap of Welfare Economics Demand curve shows private value , he value to buyers. (the P they are willing to pay) Supply curve shows private cost , the costs directly incurred by sellers. The market eq’m maximizes consumer + producer surplus. $2.50 25
EXTERNALITIES 7 0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Analysis of a Negative Externality Supply (private cost) External cost = value of the negative impact on bystanders = $1/gallon Social cost = private + external costs External cost
EXTERNALITIES 8 0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Analysis of a Negative Externality D S Social cost The socially optimal Q is 20 gallons The socially optimal Q is 20 gallons At any Q < 20, value of additional gas exceeds social cost. At any Q < 20, value of additional gas exceeds social cost. Any Q > 20, social cost of the last gallon is greater than its value to the society Any Q > 20, social cost of the last gallon is greater than its value to the society 25
EXTERNALITIES 9 0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Analysis of a Negative Externality D S Social cost Market eq’m ( Q = 25) Is _greater__ social optimum ( Q = 20).