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Unformatted text preview: optimal decisions are characterized by the balance between marginal private costs and marginal private benefits. On the other hand, social optimal decisions must account for the effects of the externalities (which have been ignored by the individuals). As a result, social optimal decisions are characterized by the balance between marginal private costs and benefits "net of externalities". 261 [Marginal Private Costs] including externalities = [Marginal Private Benefits] including externalities In other words, we need to have a balance between marginal social costs and marginal social benefits as follows: [Marginal Social Costs] = [Marginal Social Benefits] For example, one of the key economic issues in environmental pollution is that a polluter is making an individual optimal decision (without having to account for its polluting activities) while society has to bear the costs of environmental clean-up. The situation is sub-optimal because we have individual optimality but a suboptimal condition for society. Many policy analysts have studied this particular issue and governments have attempted pollution fines, pollution taxes, and most recently there has been some promise in the theory of pollution permits to limit the aggregate pollution in society to an "optimal (?)" pollution level. Any sort of regulation as it pertains to pollution reduction strategies must be enforceable and needs to monitored. Perhaps, in today's generation where the environment has overtaken the economy as the foremost issue in voters' minds, government policy will find new ways (or re-address old methods) of bringing the marginal private costs of pollution in line with the marginal social costs of pollution (i.e. make industry accountable). INEFFICIENCY OF EXTERNALITIES Where does the inefficiency of externalities come from? In the presence of externalities, the usual market pricing mechanism fails to send a correct market signal to both the culprit and the victims. For example, polluters keep polluting because clean-up costs are not inc...
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- Spring '10