ch03_BB - Externalities and Public Policy 1 Externalities Externalities are costs or benefits of market transactions not reflected in prices A third

ch03_BB - Externalities and Public Policy 1 Externalities...

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Unformatted text preview: Externalities and Public Policy 1 Externalities  Externalities are costs or benefits of market transactions not reflected in prices.  A third party is affected by production or consumption.  Benefits or costs to the third party not considered by buyers or sellers. 2 Externalities  Negative externalities – costs to third parties other than buyers or sellers not reflected in the market price. - Damage by industrial pollution to people and property.  Positive externalities – benefits to third parties other than buyers or sellers not reflected in prices. - Fire prevention, such as smoke alarms.  Pecuniary externalities – effects of increases or decreases in the price of a good on existing customers as a result of changes in the demand or supply of a good. 3 Externalities and Efficiency  Marginal external cost (MEC) – extra cost to third parties resulting from production of another unit of a good or service.  MEC part of the marginal social cost (MSC) of making a good available.  MEC is not reflected in the price of the good.  Producers base decisions on marginal private cost (MPC). 4 Social Costs MSC = MPC + MEC 5 Price, Benefit, and Cost (Dollars) Figure 3.1 Market Equilibrium, A Negative Externality and Efficiency 6 MPC + MEC = MSC G 110 105 100 B S = MPC 10 A D = MSB 4.5 5 Tons of Paper Per Year (Millions) Implications of Figure 3.1  Market equilibrium occurs where MPC = MSB  Efficiency Requires that MSC = MPC + MEC = MSB 7 Positive externalities  In a positive externality, prices do not fully equal the marginal social benefit (MSB) of a good or service.  Marginal external benefit (MEB) – benefit of additional output accruing to parties other than buyers and sellers of the good.  Consumers base decisions on marginal private benefit (MPB). 8 Social Benefit MSB = MPB + MEB 9 Price, Benefit, and Cost (Dollars) Figure 3.2 Market Equilibrium, A Positive Externality and Efficiency 45 30 25 10 S = MSC V U H MPB + MEB = MSB MPB 0 10 Z 10 12 Inoculations Per Year (Millions) Price, Benefit, and Cost (Dollars) Figure 3.3 A Positive Externality for Which MEB Declines With Annual Output 11 MPBi + MEB = MSB 30 F A S = MSC B S' = MSC' 25 C 20 0 MPBi 10 12 16 20 Inoculations per Year (Millions) Internalization of Externalities  Internalization of an externality – marginal private benefit or cost of goods and services are adjusted so that users consider the actual marginal social benefit or cost of their decisions. - Negative externality: MEC is added to MPC. - Positive externality: MEB is added to MPB.  Corrective tax – designed to adjust MPC of a good or service in such a way as to internalize the externality; must equal MEC per unit. 12 Price, Benefit, and Cost (Dollars) Figure 3.4 A Corrective Tax 13 S’ = MPC + T = MSC S = MPC G 110 105 100 95 B Tax Revenue = Total External Costs T A Net Gains in Well-Being D = MSB 4.5 5 Tons of Paper Per Year (Millions) Results of a Corrective Tax  Price rises.  The tax revenue is sufficient to pay costs to third parties.  Socially optimal levels of production are achieved. 14 Using a Corrective Tax  The greenhouse effect and a “Carbon Tax”  The greenhouse effect is caused by burning carbon-based fuels. A carbon tax can be imposed to limit greenhouse gasses to their socially optimal levels.  It is called a carbon tax because the amount of the tax would depend on the amount of carbon in the fuel. 15 Carbon Pricing  The 2015 Paris Agreement Lays the foundation for progress on addressing climate change  Reducing carbon emissions: mitigation pledges submitted by 186 countries (96 percent of global emissions).  Parties agreed on procedures for evaluating progress  Global temperatures projected to rise by about 3-4degrees C by 2100.  How to address loss in competitiveness ? Carbon price floor arrangements.  Disclosure of firms’ carbon footprints  What are the policy instruments best suited for implementing countries’ Intended Nationally Determined Contributions (INDCs) 16 Submitted INDCs, Largest Emitting Countries/Regions 17 Carbon Taxes around the World 18 Theory of the Second Best  General theory of second best – states that when two opposing factors contribute to efficiency losses, they can offset one another’s distortions. - Economists treat each problem on an ad hoc basis to determine if there are any “second best” problems present.  Corrective subsidy – payment made by government to either buyers or sellers so that the price paid by consumers is reduced. 19 A Polluting Monopolist  Chapter 2 showed that monopoly creates a loss to society. This chapter shows that a negative externality causes a loss as well.  The losses do not necessarily add to one another. In fact, they can cancel each other out. 20 Figure 3.5 A Second Best Efficient Solution MPC + MEC = MSC F MPC A Price PM B C D = MSB MR 21 0 QM Q* Output per Year Corrective Subsidies  Setting a subsidy equal to MEB will internalize a positive externality. 22 Price, Benefit, and Cost (Dollars) Figure 3.6 A Corrective Subsidy 23 Z 45 30 25 S = MSC R V U Subsidy Payments 10 Y X D' = MPBi +$20 = MSB D = MPBi 0 10 12 Inoculations per Year (Millions) Property Rights and Internalization of Externalities  Externalities arise because some resource users’ property rights are not considered in the marketplace by buyers or sellers of products.  Governments can give businesses the right to emit wastes in the air and water or it can give individuals the right to clean air and water. 24 Coase's Theorem  By establishing rights to use resources, government can internalize externalities when transactions or bargaining costs are zero. 25 The Significance of Coase’s Theorem  The efficient mix of output will result simply as a consequence of the establishment of exchangeable property rights.  It makes no difference which party is assigned the right to use a resource.  If the transactions costs of exchanging the rights are zero, the efficient mix of outputs among competing uses of the resource will emerge. 26 Figure 3.7 Coase’s Theorem B MPCB + MEC = MSC MPCB PB QB* QB1 Beef Output per Year 27 Price of Wheat (Dollars) Price of Beef (Dollars) A MCW MCW* PW QW1QW* Wheat Output per Year Limitations of Coase’s Theorem  Transactions costs are not zero in many situations.  However you allocate the property rights, the distribution of income is affected. 28 Applying Coase's Theorem  The Clean Air Act of 1990 allows for the sale of the "right to pollute." Firms face a tradeoff when they pollute. If they pollute, they forgo the right to sell their emission permits to others.  In markets for electricity, Clean Air Act has motivated firms to shift to natural gas and away from coal as a means of producing electricity. 29 Price and Marginal Social Benefit 30 Figure 3.8 Pollution Rights and Emissions S = Supply of Pollution Rights $20 0 D = MSB of Emitting Wastes 75,000 100,000 Tons of Annual Emissions and Number of Pollution Rights Marginal Social Cost and Benefit Figure 3.9 The Efficient Amount of Pollution Abatement 31 MSC E MSB A* 0 100 Percent Reduction in Waste Emitted per Year ...
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  • Fall '16
  • Externalities, Externality, MEB, Marginal private benefit, MEC

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