Ch 18 Externalities - 18 EXTERNALITIES Econ 100A Mortimer...

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EXTERNALITIES 18 Econ 100A Mortimer
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EXTERNALITIES AND INEFFICIENCY externality Action by either a producer or a consumer which affects other producers or consumers, but is not accounted for in the market price. The decision that harms someone else creates a negative externality (e.g., pollution) and the one that benefits someone else creates a positive externality (e.g., education ) Econ 100A Mortimer
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EXTERNALITIES AND INEFFICIENCY We will study: 1. Externalities and inefficiency: Why competitive markets may not allocate resources efficiently (DWL) when externalities are present. 2. Remedies for externalities in the private sector How private parties may identify inefficiencies associated with externalities and negotiate remedies. 3. Remedies for externalities in the public sector How government policies can potentially improve efficiency when private negotiations fail. Econ 100A Mortimer
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NEGATIVE EXTERNALITIES AND INEFFICIENCY external cost Economic harm that a negative externality imposes on others. marginal external cost Increase in cost imposed externally as one or more firms increase output by one unit. marginal social cost Sum of the marginal cost of production (marginal private cost) and the marginal external cost. Assume that: 1. the paper market is perfectly competitive and there are 200 mills; 2. paper production generates harmful water pollution; 3. paper mills cannot abate their pollution by using more environmentally friendly production methods so that there is a fixed relationship between the level of output and the level of pollution; 4. demand for paper is: Q d = 150,000-100P (Q = in thousands of tons); 5. each of the 200 paper mills have the following costs: TC = 500q+q 2 (q = in thousands of tons) MC = 500+2q EC = 100q+q 2 MEC = 100+2q MSC = 600+4q (MC+MEC) Econ 100A Mortimer
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NEGATIVE EXTERNALITIES AND INEFFICIENCY First, find the competitive equilibrium . Each mill sets P=MC, so P= 500+2q or q=(½)P-250. Then, the market supply is: Qs=200q=100P-50,000 Setting Qs=Qd: 100P-50,000=150,000-100P, we get Q*=50,000 and P*=1,000. q*=50,000/200=250. P ($ per ton ) 1,000 1,000 500 500 1,500 50 Q (mill of tons) MC P D S Paper mill Paper market P ($ per ton ) q (thousand tons) 250 Econ 100A Mortimer
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NEGATIVE EXTERNALITIES AND INEFFICIENCY Second, consider negative externalities. What is the efficient level of output? If the external costs were borne by the mills, each mill would produce the quantity for which P=MSC: P= MC+MEC=600+4q. Then, the market supply is: Q’s=200q=50P-30,000 Setting Q’s=Qd: 50P-30,000=150,000-100P, we get Q opt =30,000 and P opt =1,200. q opt =30,000/200=150. 1,000 500 Q (mill of tons) MC P S, MC Paper mill P ($ per ton ) q (thousand tons) 250 MEC MSC 100 150 P ($ per ton ) 1,000 500 1,500 50 D Paper market MSC 30 1,200 20 DWL: $6 billion Efficient outcome Competitive outcome Econ 100A Mortimer 1,200
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POSITIVE EXTERNALITIES AND INEFFICIENCY external benefit Economic gain that a positive externality provides to others
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Ch 18 Externalities - 18 EXTERNALITIES Econ 100A Mortimer...

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