10 Externality SV

10 Externality SV - Introduction Lesson from Chapter 7:...

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1 CHAPTER 10 EXTERNALITIES Introduction Lesson from Chapter 7: Markets are usually a good way to organize economic activity. Because it maximizes social surplus. However, does market always allocate resources efficiently? Exceptions are called “Market Failure” - Externality - Market power (e.g. monopoly)
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2 CHAPTER 10 EXTERNALITIES Introduction Externality : the uncompensated impact of one person’s actions on the well-being of a bystander Negative externality : the effect on bystanders is negative Positive externality : the effect on bystanders is beneficial
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3 CHAPTER 10 EXTERNALITIES Pollution:  A Negative Externality Example of negative externality: Waste discharge by a factory upstream. The firm is utilizing a resource that it doesn’t have to pay. The cost is not truly avoided, but instead imposed on a third-party. True social cost should incorporate the external costs.
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4 CHAPTER 10 EXTERNALITIES Other Examples of Negative Externalities late-night stereo blasting from the dorm room next to yours talking on cell phone while driving makes the roads less safe for others Traffic congestion Standing up in the Horseshoe Club vs. Lojack
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5 CHAPTER 10 EXTERNALITIES 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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6 CHAPTER 10 EXTERNALITIES 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 (costs from pollution, congestion, traffic accidents) Social cost = private + external cost external cost
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7 CHAPTER 10 EXTERNALITIES 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 25
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8 CHAPTER 10 EXTERNALITIES 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 supply curve up $1.
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9 CHAPTER 10 EXTERNALITIES “Internalizing the Externality” Internalizing the externality : altering incentives so that people take account of the external effects of their actions In the previous example, the $1/gallon tax on sellers makes sellers’ costs equal to social costs. Imposing the tax on buyers would achieve the same outcome.
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This note was uploaded on 11/28/2010 for the course ECON 200 taught by Professor Newton during the Fall '08 term at Ohio State.

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10 Externality SV - Introduction Lesson from Chapter 7:...

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