Mankiw - Chapter_10 - Chapter 10 Externalities 10.1...

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1 Mankiw, Principles of Economics Prepared by Moon Young BAEK Yonsei University, Economics Chapter 10 Externalities 10.1 Introduction z In Chapters 4 through 9, ± We examined how markets allocate scarce resources with the forces of supply and demand ; and ± We saw that equilibrium of supply and demand is typically an efficient allocation of resources ² The invisible hand of the marketplace leads self-interested buyers and sellers in a market to maximize the total benefit that society derives from that market. z In this chapter, we examine: ± Why markets sometimes fails to allocate resources efficiently; ± How government policies can potentially improve the market’s allocation; and ± What kinds of policies are likely to work best z The market failure examined in this chapter: Externalities ± Definition : Externality is the uncompensated impact of one person’s actions on the well-being of a bystander (third parties). ± 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. ² Negative externality when the impact on the bystander is adverse. ² Positive externality when the impact is beneficial. z Because participants (buyers and sellers) in some markets may neglect the external effects of their actions when deciding how much to trade (i.e., demand or supply), the market equilibrium is not efficient when there are externalities (on a bystander) in the society. ± Such equilibrium fails to maximize the total benefit to the society as a whole.
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2 Mankiw, Principles of Economics Prepared by Moon Young BAEK Yonsei University, Economics 10.2 Externalities and market inefficiency z We will see why externalities cause markets to allocate resources inefficiently, and we examine various ways in which private individuals and public policymakers may remedy the externalities. 10.2.1 Welfare economics: a recap
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3 Mankiw, Principles of Economics Prepared by Moon Young BAEK Yonsei University, Economics 10.2.2 Negative externalities z Suppose that aluminum factories emit pollution (air-pollution), which creates a health risk for the bystanders who breathe the air – a negative externality. z How does this externality affect the efficiency of the market outcome? [Figure 2] z Because of externality, the cost to society of producing aluminum ( public cost ) is larger than the cost to the aluminum producers ( private cost ). ± The social cost = the private cost + the external cost (the cost to those bystanders affected adversely by the pollution: i.e., the additional cost imposed on society by aluminum producers): therefore, ² The social-cost curve (private + external costs) is above the supply curve (private cost only) z What quantity of aluminum should be produced? – We now observe discrepancy between a social planner’s solution to a market outcome with externality and a market outcome made by free market without considering externality. ± A social planner’s
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This note was uploaded on 04/05/2010 for the course ECONOMICS 2009 taught by Professor Lee during the Spring '09 term at Yonsei University.

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Mankiw - Chapter_10 - Chapter 10 Externalities 10.1...

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