Chapter 3 Externalities and Public Policy
Externalities Externalities are costs or benefits of market transactions not reflected in prices. Negative externalities are costs to third parties. Positive externalities are benefits to third parties .
Externalities and Efficiency The marginal external cost is the dollar value of the cost to third parties from the production or consumption of an additional unit of a good. This occurs when there is a negative externality .
Social Costs MSC = MPC + MEC
Figure 3.1 Market Equilibrium, A Negative Externality and Efficiency D = MSB S = MPC MPC + MEC = MSC 10 Price, Benefit, and Cost (Dollars) Tons of Paper Per Year (Millions) 110 105 100 4.5 5 A B G 10
Implications of Figure 3.1 Market equilibrium occurs where MSC = MSB Efficiency Requires that MSC = MPC + MEC = MSB
Positive externalities The marginal external benefit is the dollar value of the benefit to third parties from an additional unit of production of consumption of a good. This occurs when there is a positive externality .
Social Benefit MSB = MPB + MEB
Figure 3.2 Market Equilibrium, A Positive Externality and Efficiency S = MSC MPB + MEB = MSB H Z U V Price, Benefit, and Cost (Dollars) Inoculations Per Year (Millions) 10 25 30 45 10 12 0
Figure 3.3 A Positive Externality for Which MEB Declines With Annual Output S' = MSC' C B F A S = MSC MPB i MPB i + MEB = MSB Price, Benefit, and Cost (Dollars) Inoculations per Year (Millions) 0 30 25 20 10 12 16 20
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- Winter '97