CHAP 15 & 16 - Externalities and Public Goods

CHAP 15 & 16 - Externalities and Public Goods - CHAP...

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Unformatted text preview: CHAP 15 & 16 CHAP 15 & 16 Externalities and public Externalities and public goods goods Olivier Giovannoni 304K: Introduction to Microeconomics Nov. 26, Externalities are consequences that arise from a given activity and that fall on the shoulders of someone not directly concerned by that activity. Those external consequences can be either positive or negative . We are going to see the following examples: ◦ Negative externality: pollution is the consequence of production, yet consumers pay a cost (they suffer from it) ◦ Positive externality: knowledge is the consequence of research, yet consumers benefit from it (they take advantage of it). ◦ But there are many externalities everywhere. The restoration of a building has a positive impact on your well-being. Second-hand smoke irritates you. Traffic is 1. What are externalities? 1. What are externalities? There are various types of pollution: visual pollution, noise pollution, chemical pollution… All those activities have two costs: the (regular) private cost and the external cost, which is related to the externality. But economists think at the margin ; and here we are interested in the (overall) marginal social cost : MSC = MC + MEC In addition, economists just don’t want to get rid of all possible pollution. We want to find the “right”, or equilibrium level of pollution, which will minimize pollution while still allowing for 2. a negative externality: pollution 2. a negative externality: pollution Two graphs represent the situation when a polluting activity takes place (chemical production): 2. a negative externality: pollution 2. a negative externality: pollution Left graph shows the equality MSC = MC + MEC. Note that here we assume an increasing MC curve, and that the gap between MC and MSC is increasing because of the greater external cost of pollution. Right graph : same, but let’s now bring in a Demand curve. The intersection of supply (=MC) and demand is an inefficient equilibrium , because the it does not take into account the externality The efficient equilibrium is the one with the MSC, for it accounts for the pollution externality. However the pollution externality has created a deadweight loss . → But how do we reduce the inefficiency of an externality? There are two ways: property rights and direct gov’t action....
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This note was uploaded on 04/27/2008 for the course ECON 304K taught by Professor Ledyard during the Fall '08 term at University of Texas.

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CHAP 15 & 16 - Externalities and Public Goods - CHAP...

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