ch10 - Chapter10 Externalities 10 EXTERNALITIES ,...

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WHAT’S NEW IN THE THIRD EDITION: The section on externalities is simplified, with an emphasis solely on the distinction between positive and  negative externalities. LEARNING OBJECTIVES: By the end of this chapter, students should understand: what an externality is. why externalities can make market outcomes inefficient. how people can sometimes solve the problem of externalities on their own. why private solutions to externalities sometimes do not work. the various government policies aimed at solving the problem of externalities. CONTEXT AND PURPOSE: Chapter 10 is the first chapter in the microeconomic section of the text. It is the first chapter in a three- chapter sequence on the economics of the public sector. Chapter 10 addresses externalities—the  uncompensated impact of one person’s actions on the well-being of a bystander. Chapter 11 will address  public goods and common resources (goods that will be defined in Chapter 11) and Chapter 12 will  address the tax system. 197 EXTERNALITIES 10
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198   Chapter 10/Externalities In Chapter 10, different sources of externalities and a variety of potential cures for externalities  are addressed. Markets maximize total surplus to buyers and sellers in a market. However, if a market  generates an externality (a cost or benefit to someone external to the market) the market equilibrium may  not maximize the total benefit to society. Thus, in Chapter 10 we will see that while markets are usually a  good way to organize economic activity, governments can sometimes improve market outcomes.
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Chapter 10/Externalities   199 KEY POINTS: 1. When a transaction between a buyer and seller directly affects a third party, that effect is called an  externality.  Negative externalities, such as pollution, cause the socially optimal quantity in a market  to be less than the equilibrium quantity.  Positive externalities, such as technology spillovers, cause  the socially optimal quantity to be greater than the equilibrium quantity. 2. Those affected by externalities can sometimes solve the problem privately.  For instance, when one  business confers an externality on another business, the two businesses can internalize the  externality by merging.  Alternatively, the interested parties can solve the problem by negotiating a  contract.  According to the Coase theorem, if people can bargain without cost, then they can always  reach an agreement in which resources are allocated efficiently.  In many cases, however, reaching a  bargain among the many interested parties is difficult, so the Coase theorem does not apply.
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