Review - Review Session Andres Cooper 1 Externalities a...

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Review Session Andres Cooper 1. Externalities a. Defn: the cost of producing a good or the benefits from consuming a good spill over to those not producing or consuming the good b. Graphs (shift supply curve) i. Negative: (Mg social cost = Mg private costs + Mg external costs) ii. Positive: (Mg social benefit = Mg private benefit + Mg external benefits) c. Private equilibrium: Mg priv Cost = Mg private benefit i. Not efficient (efficient where Mg Social cost = Mg Social Benefit) ii. Negative: overproduction, Positive: underproduction iii. Deadweight Loss (triangle points to Optimal Eq). d. Solutions: i. Government actions through regulations or provisions 1. Taxes or subsidies make the firms internalize the externality. (Problem: information. Sometimes medicine is worse than illness.) 2. After proper taxes or subsidies, society is better in DWL amount. (Since there is no longer DWL). ii. Trading rights 1. Model: (read from left to right) a. Each firm has a marginal cost of pollution abatement. (If they are not forced, firms pollute the maximum, where MCA is zero). Note that Total cost of reducing abatement is the area of the triangle (Summation of Mg costs). b. Society has a Marginal Social Damage (or marginal benefit for society of reducing pollution abatement). c. Optimal is where MCA = MSD 2. Trading: a. Now firms are given some permits to pollute (summation of permits should be consistent with optimal level of pollution).
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