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Nov 5, Externalities - Externalities Introduction Summary...

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Externalities Introduction Summary of the past lecture The notion of comparative advantage o Why people and countries win from more specialization o Who are the winners and the losers The impact of the implementation of tariffs and quotas Trade agreements Context and Purpose First lecture in a two-lecture sequence on the economics of the public sector o Today, different sources of externalities and a variety of potential cures, with a special emphasis on environmental issues o Next week, we address public goods and common resources Markets usually maximize total surplus of buyers and sellers If a market generates an externality, it is not the case anymore Governments can sometimes improve market outcome Cost and Benefits vs. Rights and Wrongs Assessing based on the costs and benefits involved is ingrained in the economist’s way of thinking o Thinking in terms of costs and benefits helps us with positive analysis of environmental problems Understanding behaviour and how to influence it o Measured costs and benefits help guide resource use decisions : Provides a judgment about what is better or worse Judging actions in terms of whether they seem right or wrong can be superficial and misleading o Zero pollution is not an option. All societies pollute. The key questions are how much, why and how best to deal with it o People can be “tidy” about their immediate environment. The key issue comes when examining how they treat their broader habitat Definition An externality refers to the uncompensated impact of one person’s action on the well-being of a bystander An externality arises when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect. Externalities cause markets to be inefficient, and thus fail to maximize total surplus Examples of negative externalities
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When the impact on the bystander is adverse , the externality is called a negative externality. Automobile exhaust Cigarette smoking Barking dogs (loud pets) Loud stereos in an apartment building Negative externalities lead markets to produce a larger quantity than is socially desirable
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