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Ch 15 & 16 - Externalities, Public Goods and Common Resources

Ch 15 & 16 - Externalities, Public Goods and Common Resources

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Chap 15 & 16: Chap 15 & 16: Externalities, public goods Externalities, public goods and and common resources common resources Olivier Giovannoni ECO 304K: Introduction to Microeconomics
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Externalities are consequences that arise from a given activity and that fall on the shoulders of someone not directly concerned by that activity. Those external consequences can be either positive or negative . We are going to see the following examples: 1. Negative externality: pollution is the consequence of production, yet consumers pay a cost (they suffer from it) 2. Positive externality: knowledge is the consequence of research / study, yet people not engaged in those still benefit from it (they take advantage of it). But there are many externalities everywhere. The restoration of a building has a positive impact on your well-being. Second-hand smoke irritates you. Traffic is polluting and making you late. 1. What are externalities? 1. What are externalities? Ch. 15 – Externalities – 2
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There are various types of pollution: visual pollution, noise pollution, chemical pollution… Economists just don’t want to get rid of all possible pollution. We want to find the “right”, or equilibrium level of pollution, which will minimize pollution while still allowing for production to take place. All those polluting activities have two costs: the (regular) private cost and the external cost, which is related to the externality. But economists think at the margin ; and here we are interested in the (overall) marginal social cost : 2. A negative externality: pollution pollution cost external marginal cost marginal cost social marginal MEC MC MSC + = Ch. 15 – Externalities – 3
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Two graphs represent the situation when a polluting activity takes place (chemical production): Left graph shows the equality MSC = MC + MEC. Note that here we assume an increasing MC curve, and that the gap between MC and MSC is increasing because of the greater external cost of pollution. 2. A negative externality: pollution pollution Ch. 15 – Externalities – 4
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Right graph : same, but let’s now bring in a Demand curve. The intersection of supply (=MC) and demand is an inefficient equilibrium , because it doesn’t account for the externality. 2. A negative externality: pollution pollution The efficient equilibrium is the one with the MSC, for it accounts for the pollution externality. However the pollution externality has created a DWL Ch. 15 – Externalities – 5
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But how do we reduce the inefficiency of an externality? There are two ways: property rights and direct gov’t action. Property rights are legal titles of ownership, use, or disposal of the factors of production. The property rights are a way to get the polluters involved in the consequences of their activity The property rights are an additional cost for the polluter It makes the old MC curve irrelevant by raising costs incurred by the polluter, up to the point where the new MC curve is the MSC curve.
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