L23 - Economics 101:Principles of Microeconomics Professor...

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1 Economics 101:Principles of  Microeconomics Professor Jo Hertel Lecture 23: Externalities Definition and effects of externalities Private solutions Government intervention: Regulation Pigouvian taxes Permits
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2 Externalities Externalities are the effects of an activity to someone unconnected with ( external to ) that activity. Pollution, party music, bees/ orchards, car accidents .... Externalities can be positive or negative. Usually: the social benefits/costs of an activity can be measured by adding the benefits/costs of the people concerned If there are negative externalities , the marginal social cost of an activity is higher than the private cost (positive ext.: social benefit is higher)
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3 Externalities: definitions An economic activity is said to have an externality if non-market participants are affected by that activity. Costs and benefits to the market participants are called marginal private costs/benefits (MPC/MPB) Costs and benefits to non-market participants are called marginal external costs/benefits (MEC/MEB) Social costs and benefits (MSC/MSB) are the sum of all costs and benefits: MSC = MPC + MEC (MEC=0 if no neg. externality) MSB = MPB + MEB (MEC=0 if no pos. externality)
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4 Example 1: a paint factory on a river The private marginal cost of paint is just the firms’ MC. If they dump the waste in the river, there is also a marginal cost of paint for people living along the river (MEC: here constant) MSC=MC firm +MEC price of paint, MC gallons of paint Demand= marginal private benefit = marginal social benefit MSC=MC firm + MEC MEC q opt q market This is an example of a negative externality: MEC > 0, but MEB = 0
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5 Example 2: a beekeeper & an  orchard The private marginal cost of honey is the beekeeper’s MC, marginal private benefit is demand. The more honey he produces, the more bees he has: the better for the apple orchard next door MSB=MPB+MEB price of paint, MC pounds of honey Demand= MPB MSB=MPB + MEB MEB q opt q market This is an example of a positive externality: MEB > 0, but MEC = 0
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6 Where do externalities come from? Externalities arise because of insufficiently defined property rights. Usually: if you sustain damage from someone else’s activities, it is because he harms something that is yours by law – f.ex. if the paint producer dumped waste in your yard. With externalities, you sustain damage although none of your property rights are infringed.
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7 Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Market quantity and socially optimal  quantity When there is no government intervention, quantities are decided by private individuals and will maximize private gain; we call this the market quantity q market .
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