lecture_11 - ECOS2001 Lecture 11 1 Externalities- an...

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Unformatted text preview: ECOS2001 Lecture 11 1 Externalities- an externality impacts a third party; i.e. somebody who is not a participant in the activity that produces the external cost or benefit- the practical problems with externalities generally arise because of poorly defined property rights- negotiate to internalise externality ECOS2001 Lecture 11 2 Coase theorem- if all agents preferences are quasilinear in money, then the efficient level of the externality generating commodity is produced no matter which agent is assigned the property right- demand for goods do not depend on the distribution of income (no income effects) ECOS2001 Lecture 11 3 Production externalities Steel production function The first-order conditions are: and ( , ) ( , ) s s s s x p s c s x = ( , ) s s c s x p s = ( , ) s c s x x = ECOS2001 Lecture 11 4 The fisherys production function is: The first-order profit maximisation condition is: Note, higher pollution x raises the marginal cost of production this is the externality- steel firm produces too much pollution from a social point of view as it ignores the impact of pollution on the fishery ( ; ) ( ; ) F F F f x p f c f x = ( ; ) F F c f x p f = ECOS2001 Lecture 11 5 Ways of overcoming the externality : Merging the operations . Now the joint-profit function is: yielding first-order conditions: , , max ( , ) ( , ) s f s f s f x p s p f c s x c f x + ( , ) F F c f x p f = ( , ) ( , ) f s c f x c s x x x = + ( , ) s s c s x p s = ECOS2001 Lecture 11 6 In terms of pollution, this means that:...
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lecture_11 - ECOS2001 Lecture 11 1 Externalities- an...

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