Week 13 A - COMM/FRE 295 Nov 28, 2010 Externalities 1...

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1 COMM/FRE 295 Nov 28, 2010 Externalities
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Learning Outcomes • Description of positive and negative externality • Illustration of why externalities result in a DWL • Mathematical example of DWL resulting from negative externality • How a tax can be used to eliminate DWL from negative externality • Concept of marginal cost of abatement • Comparing fees/taxes with standards for controlling negative externality
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Overview • A person-to-person Externality arises when the action of one person impacts the well-being of another person in the absence of a transaction – playing loud music in an apartment building – chatting during class • A firm-to-firm externality arises when the actions of one firm affects the profits of a second firm in the absence of a transaction • The absence of a transaction implies that individual welfare/profit is maximized but not joint welfare or profits 3
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Inefficient Output • The person or firm creating the externality does not internalize the external cost or benefit, so the equilibrium level of “output” is inefficient – The neighbor’s music is excessively loud – The pizza has an excessive level of sodium and fat – The driver fails to carry chains to the ski resort – The firm dumps too much waste into the river • Inefficient output shrinks the economic “pie” • Eliminating the externality would increase the size of the pie and potentially make everyone better off 4
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Positive or Negative Externalities • Negative Externality causes a negative impact on other person or firm – CO 2 emissions by Canada causes flooding of low- laying countries • Positive externality causes a positive impact on other person or firm – R&D by one firm makes discoveries by second- generation firms easier • We often focus on negative externalities, but positive externalities are also important 5
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Dead Weight Loss • In economics we identify specific sources of market failure • A market failure results in dead-weight loss • Market power and asymmetric information are both sources of market failure • Externalities (negative or positive) are another important source of market failure • In Comm 394 you will also learn about public goods as a source of market failure 6
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Negotiating Externalities • In some cases, the parties can negotiate a solution • Negotiating typically means that one party gains and the other party loses • If the party that loses has property rights to the
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This note was uploaded on 01/03/2011 for the course COMM 290 taught by Professor Brian during the Winter '09 term at The University of British Columbia.

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Week 13 A - COMM/FRE 295 Nov 28, 2010 Externalities 1...

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