L24 - Economics 101:Principles of Microeconomics Professor...

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1 Economics 101:Principles of  Microeconomics Professor Jo Hertel Lecture 24: Externalities and public policy. Public goods and common resources. Characteristics of different goods Why markets don’t work with common resources: overuse Government intervention and common resources Why markets don’t work with public goods: free- riding Government intervention and public goods
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2 Pigouvian taxes for SO 2  emission (1) Instead of regulation, the government could set an emissions tax of C opt per unit of SO 2 emitted This will increase MPC by exactly C opt Then q market =q opt MB,MC q of SO 2 MPB q market MPC MSC q opt C opt MPC’ emissions tax ‘internalizing the externality’!
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3 Pigouvian taxes (2) – the inside look The tax raises MPC Utility A now produces q A , Utility B produces q B (where q A +q B =q opt ) Total cost of this reduction is now smaller: the tax equalizes MPB across firms! MB to ind. polluter q of SO 2 MPB A MPB B q B q A Costs to A Costs to B MPC C opt MPC’
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4 Pigouvian taxes and subsidies: definition A Pigouvian tax (subsidy) is a tax that is exactly equal to the marginal external cost (benefit) at the socially efficient quantity q opt . This shifts the private marginal cost curve up (down) to equal marginal private benefit at q opt , leading to the efficient level of production (and pollution). Pigouvian taxes allow companies to meet pollution targets more efficiently. Those for whom it is easy to reduce emissions, reduce a lot. Those for whom it is difficult, pay the tax. Quantity regulation is a “one size fits all” approach. Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition Definition
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5 Pigouvian taxes – pros and cons Pigouvian taxes are efficient – least cost way of achieving optimal quantity They bring additional revenue Quantities need to be closely monitored (not as big a problem as it sounds, as we’ll see) Biggest problem: to set Pigouvian taxes properly, the government needs to know q opt and the marginal external cost at q opt
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6 Regulation: tradable permits (1) Blend of quantity regulation with the flexibility of taxes (and the market). The government offers a limited number of permits, entitling the owner of the permit to emit one unit of pollution (per permit).
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