FS08EC2106_L10

FS08EC2106_L10 - ECON 2106-C Prof. B-C Kim In this chapter,...

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ECON 2106-C Prof. B-C Kim
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In this chapter, look for the answers to these questions: ± What is an externality? ± Why do externalities make market outcomes inefficient? ± What public policies aim to solve the problem of externalities? ± How can people sometimes solve the problem of externalities on their own? Why do such private solutions not always work? 1
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EXTERNALITIES 2 Introduction ± One of the principles from Chapter 1: 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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EXTERNALITIES 3 Introduction ± Self-interested buyers and sellers neglect the external costs or benefits of their actions, so the market outcome is not efficient. ± Another principle from Chapter 1: Governments can sometimes improve market outcomes. In presence of externalities, public policy can improve efficiency.
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EXTERNALITIES 4 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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EXTERNALITIES 5 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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EXTERNALITIES 6 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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EXTERNALITIES 7 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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EXTERNALITIES 8 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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EXTERNALITIES 9 “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,
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FS08EC2106_L10 - ECON 2106-C Prof. B-C Kim In this chapter,...

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