8 PPT_Externalities

8 PPT_Externalities - More Market Imperfections IV....

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More Market Imperfections IV. Externalities
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Definition An externality arises when a person or firm engages in an activity that influences the well-being of 3 rd parties, and yet neither pays nor receives any compensation for that effect.
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Examples Positive Negative Production externality Consumption externality
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How Externalities Affect Resource Allocation With standard goods (no externalities), we have:
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How Externalities Affect Resource Allocation Goods with an externality We will get inefficient allocations because private decisions will not lead to the socially optimal point.
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Analysis of a Negative Externality Definition : Marginal external cost (MEC) is the marginal cost per unit imposed on 3 rd parties, for which producers and consumers are not charged. Efficiency requires that:
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Graph of Negative Externality MB, MC Q
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Analysis of a Positive Externality Definition: Marginal external benefit (MEB) is the marginal benefit per unit received by 3 rd parties, for which producers and consumers are not compensated.
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Graph of Positive Externality MB, MC Q
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Can private markets deal with externalities with only a minimum of government interference?
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Coase Theorem When transactions and enforcement costs are negligible, externalities can be internalized by having the government establish property rights to resource use and by allowing for free exchange of those rights.
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Comments on the Coase Theorem • For efficient resource allocation, it doesn’t matter to whom the rights are assigned.
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8 PPT_Externalities - More Market Imperfections IV....

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