Externalities - Externalities Introduction One of the basic...

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Externalities
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Introduction One of the basic principles: Markets are usually a good way to organize economy activity. In absence of market failures, the competitive market outcome is efficient, maximizes total surplus. One type of market failure: externality , the uncompensated impact of one person’s actions on the well-being of a bystander. Externalities can be negative or positive , depending on whether impact on bystander is adverse or beneficial.
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Introduction Self-interested buyers and sellers neglect the external costs or benefits of their actions, so the market outcome is not efficient. Governments can sometimes improve market outcomes. In presence of externalities, public policy can improve efficiency.
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Examples of Negative Externalities Air pollution from a factory The neighbor’s barking dog Late-night stereo blasting from the dorm room next to yours Noise pollution from construction projects Health risk to others from second-hand smoke Talking on cell phone while driving makes the roads less safe for others
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0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Recap of Welfare Economics Demand curve shows private value , the value to buyers (the prices they are willing to pay). Supply curve shows private cost , the costs directly incurred by sellers. The market eq’m maximizes consumer + producer surplus. $2.50 25
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0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Analysis of a Negative Externality Supply (private cost) External cost = value of the negative impact on bystanders = $1 per gallon (value of harm from smog, greenhouse gases) Social cost = private + external cost external cost
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0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Analysis of a Negative Externality D S Social cost The socially optimal quantity is 20 gallons. At any Q < 20, value of additional gas exceeds social cost. At any Q > 20, social cost of the last gallon is greater than its value to society. 25
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0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Analysis of a Negative Externality D S Social cost Market eq’m ( Q = 25) is greater than social optimum ( Q = 20). 25 One solution: tax sellers $1/gallon, would shift S curve up $1.
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“Internalizing the Externality” Internalizing the externality : altering incentives so that people take account of the external effects of their actions In our example, the $1/gallon tax on sellers makes sellers’ costs = social costs. When market participants must pay social costs, market eq’m = social optimum. (Imposing the tax on buyers would achieve the same outcome; market Q would equal optimal Q .)
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Being vaccinated against contagious diseases protects not only you, but people who visit the salad bar or other public places.
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This note was uploaded on 11/23/2010 for the course ECONOMICS Econ 13 taught by Professor Georgesarraf during the Winter '10 term at UC Irvine.

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Externalities - Externalities Introduction One of the basic...

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