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Lecture_29_Externalities

Lecture_29_Externalities - Lecture 29 Externalities c 2008...

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Lecture 29: Externalities c ° 2008 Je/rey A. Miron Outline 1. Introduction 2. Externalities: De°nition 2. Externalities and Property Rights 3. The Coase Theorem 4. Production Externalities 5. Interpretations 6. The Tragedy of the Commons 1 Introduction As noted a few lectures back, most of the course has focussed on issues of positive economics: developing models of how the economy operates. We used these models to address normative issues in certain instances ± for example, when we discussed monopoly ±and we addressed welfare economics in our discussion of general equilibrium. Overall, however, we have not spent much time on policy questions. There are two reasons for this. One is simply that we need to understand how the economy operates before taking a stand on whether policy interventions are desirable. The second reason is that, given the assumptions we have usually made, laissez- faire outcomes are e¢ cient, so there is limited scope for policy intervention to improve the workings of the economy. As discussed last time, Pareto e¢ cient outcomes are not necessarily desirable from a distributional perspective, but, if the only policy issue is the appropriate distribution of wealth, the set of policy issues to discuss is small. 1
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In practice, governments intervene enormously and employ a wide variety of poli- cies other than redistribution. The goal of the next several lectures is to understand the possible justi°cations for government intervention. These justi°cations typi- cally fall into two broad categories: those based on externalities and those based on public goods. This lecture addresses externalities. 2 Externalities: De°nitions An externality occurs when one agent²s production or consumption directly a/ects the utility or production possibilities of another agent. Consider some standard examples. If your roommate plays loud music at all hours and makes it hard for you to sleep or study, that is a negative externality. If the farmers bordering a lake use pesticides that run o/ into the lake and kill the °sh, that is a negative externality for commercial or recreational °shermen. If the government subsidizes health care, and I engage in a risky behavior (such as riding a motorcyle without a helmet) that increases my use of this health care, that is a negative externality because everyone else must pay higher taxes to fund the health care system. Externalities can of course be positive as well as negative. If one student in a classroom asks good questions that raise the understanding of other students, the question-asking student generates a positive externality. If one °rm develops a successful business model or a non-patented new product that is easily copied by other °rms, that °rm is generating a positive externality.
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