LEC9_Externalities_Intertemporal.pdf - Announcements \u2022 Problem set 2 due*Thursday so you can have some extra office hours help \u2022 Please hand in a

LEC9_Externalities_Intertemporal.pdf - Announcements •...

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Announcements Problem set 2 due *Thursday* so you can have some extra office hours help. Please hand in a hard copy! Gradescope is difficult for Leila to work with when answers are detailed. Lecture notes on public goods and externalities posted Today’s readings: Chapter 6 from Boardman et al. (in reader) and Discount rates: A boring thing you should know about (with otters!)
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Outline Externalities Why do externalities generate market failure? Policy responses (in theory)? Intertemporal tradeoffs Mechanics of discounting Benchmark model of inter-temporal decision making Use our experiment to highlight some limitations of standard model.
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Externalities? An “externality” exists when an action or transaction generates benefits or costs for individuals outside the action or transaction. The provision of a public good results in a positive externality (which is not remunerated)
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Are externalities always external to the market? A pecuniary externality occurs when the actions or transactions between economic actors cause an increase or decrease in market prices paid by other actors who are external to the transaction. A non-pecuniary externality occurs when the actions or transactions between actors generate costs or benefits that are external to the market and not reflected in market prices.
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Simple example to elucidate market failure 2 firms located on a lake: Acme Chemical and Beatrix’s Scuba Adventure Both firms act as price takers in their respective markets.
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Profit functions (stylized)
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Profit maximizing choice of q?
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Graph
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Merger!
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Cue Pigou! Pigou (1938) the first to think about negative externalities in terms of a divergence between private and social cost. Pigou recommended either direct coercion on the part of the government (i.e. a quota or emissions cap) or the judicious use of taxes against the offending party. Taxes designed to internalize a negative externality are often referred to as “Pigouvian taxes” The idea is to eliminate the divergence between marginal private cost and marginal social cost.
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Graph Pigou
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”The Problem of Social Cost” Coase argues that externality problems are “inherently reciprocal”, arising from incompatible interactions between two parties rather than the harmful actions of one upon the other. “If we are to discuss the problem in terms of causation, both parties cause the damage” [Coase, 1960, p. 13]. From this perspective, ask which party to a harmful interaction should be induced to change his behavior (maybe both) to maximize the social product. Coase widens the range of possible solutions by emphasizing the possibility that B may be able to accommodate A more cheaply than A can accommodate B.
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The Problem of Social Cost Coase examines this problem under the standard assumptions of perfect competition, including zero transaction costs.
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