191T12 - ECON191 (Spring 2009) 11-12.5.2009 (Tutorial 12)...

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1 ECON191 (Spring 2009) 11-12.5.2009 (Tutorial 12) Chapter 14 Externalities and Public Goods (Chapter 18 of Textbook) s Externalities occur when the welfare of some parties depends on their actions as well as actions under the control of other parties s Negative externalities: action of one party imposes a cost on another party s Positive externalities: action of one party benefits another party Pigouvian tax Coase theorm s In the absence of transaction costs and when property rights are well defined, the Pareto optimal solution can still be attained, irrespective of the specific property rights arrangement that has been chosen. s Internalization of costs Case 1 : chemical plant has the property right to produce any level of output s To maximum it’s profit, Q 1 will be produced b The fishery can pay the chemical plant and ask it t6 reduce its production b Possibility of negotiation if decrease in the profit of the chemical plant < increase in profit of the fishery b Mutual improvement is obtained and joint profit is maximized. ( Q 2 is produced) Case2 : chemical plant has no right to pollute s Production of chemical plant will be 0 b The chemical plant can buy a permit from the fishery to produce Q 2 Q P DD PMC SMC Tax Q’ Q* s Q* is the socially optimal level of production s Firm aims at maximizing its own profit chooses to produce Q ’, and it imposes a social cost on the economy b Impose a tax on the producer such that MC of the firm ( PMC ) = SMC s Problems: - Difficult for the government to know the exact social cost - Firms would have incentive to exaggerate the PMC. - There is no guarantee that the outcome would be better after the intervention Q 1 Output of chemical plant π Fishery + π Chemical plant π Chemical plant π Fishery Q 2 Profits
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2 b Possibility of negotiation if decrease in profit of the fishery < increase in the profit of chemical plant b Mutually advantageous solution is produced and joint profit is maximized. ( Q 2 is produced) s Irrespective of initial property right, socially optimal outcome could be reached s Problems: - Transaction cost (negotiation cost, information cost, etc) - Misinterpretation of profits or preference - Intergenerational negotiation is not possible Criticism of Coase Theorem s Coase Theorem holds well for cases with 2 parties involved, it may not hold for cases with more than 2 parties s Core : the core of an economy is that set of efficient (Pareto-optimal) allocations that cannot be improved upon by any agent acting alone (individually rational manner) or by any group of agents acting together (coalition) b Core is the part of contract curve that lies between the non-trade IC, and all points in the core imply efficient allocation b Core is not the same as Pareto efficiency, though PE is one of the necessary conditions of core s A group of agent (coalition) is said to improve upon a given allocation X if there is some allocation X’ such that X’ is preferred by everybody in the coalition. X
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This note was uploaded on 10/11/2009 for the course ECON 191 taught by Professor Chen during the Spring '08 term at HKUST.

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191T12 - ECON191 (Spring 2009) 11-12.5.2009 (Tutorial 12)...

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