nlecture15 - externalities

nlecture15 - externalities - Topic 6: Competitive Markets...

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opic 6: Competitive Markets (4) Topic 6: Competitive Markets (4) Externalities and public goods USC Marshall
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Externalities and public goods • When do competitive markets fail to maximize aggregate surplus? Externalities • When the consumption or production of a good impacts other people (third parties) –Pollution, traffic congestion, noise,… Public goods • When everybody benefits from the availability of good National security a good. National security,… Common property resources hen a resource is available to all for free USC Marshall • When a resource is available to all for free. Lakes, rivers, beaches, highways,…
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Externalities • Efficiency of competitive markets: – Prices established in competitive markets reflect the private costs and benefits of consumption – But prices can fail to reflect the impact that the production or the consumption of a good have on third parties e involves n externality • i.e. involves an externality the presence of externalities the prices – In the presence of externalities, the prices established in competitive markets fail to reflect the social costs and benefits of production and USC Marshall consumption
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Externalities • Competitive markets equate private marginal benefit with private marginal cost – But ignores external marginal benefits and costs • The output level that maximizes aggregate surplus is given by social marginal benefit equals social marginal cost – Social = private + external USC Marshall
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Externalities Some examples: – Loud music can impose a negative externality on your neighbors – Driving increases congestion and imposes a negative externality on other drivers – A beautiful garden improves the outlook of a eighborhood and thus generates a positive neighborhood and thus generates a positive externality ducation by making people more knowledgeable Education, by making people more knowledgeable, is generally thought of as generating positive externalities USC Marshall
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Externalities • How can we restore efficiency? Private remedies • When the parties involved can be easily identified, then private negotiations under well- defined property rights will lead to the efficient outcome stablishing markets for pricing the –Establishing markets for pricing the externalities USC Marshall
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Externalities • How can we restore efficiency? Public remedies • Support private remedies –Establish clearly defined property rights –Rule of law • Quantity controls • Taxes and subsidies • Hybrid solutions USC Marshall
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Externalities An example: – A paper mill operating next to a river pollutes the river. A farmer downstream uses that water for irrigation and the pollution reduces the quality of his crops. Then, the paper mill is imposing a negative externality on the farmer. he price of paper is
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nlecture15 - externalities - Topic 6: Competitive Markets...

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