class9_externality_

class9_externality_ - Econ 51, Winter 2011 Class #9...

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1 Econ 51, Winter 2011 Class #9 • Reminders: – Midterm on Tuesday in BISHOPAUD (Bishop Auditorium) in the GSB building (note that the room has been changed!) – Closed books/notes, but bring a calculator! – We’ll start at 9:00am (not 9:05) sharp. – Exam covers material until GE with production. –Special OH on Monday 8am-10 in Landau 239. – graded PS #2 available on Friday. PS #3 due Friday: Solution available on Friday night on Coursework. – No PS this week; PS #4 will be posted next week. • Please take 5 minutes to do the mid-quarter evaluations (open until Sunday, 6th. For the link, see my Coursework announcement from Monday) • Today: Externalities Tuesday, February 1, 2011
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2 When do markets fail? GE w/ prod. So far we have seen that free markets are extremely useful. Markets always lead to Pareto efficient allocations. That’s the best we could ask for. Can markets fail at all? Of course, when our assumptions do not hold. The rest of the course will deal with such cases. Tuesday, February 1, 2011
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3 Causes for market failure GE w/ prod. Externalities. Public goods. Market power and strategic considerations. Asymmetric information. Tuesday, February 1, 2011
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4 Definition and examples Externalities Some consumption or production decisions directly affect the utilities or the production possibilities of other consumers or producers. Such effects are called externalities. Examples of externalities: •Positive externalities in consumption: e-mail connection, cell phone, altruism. • Negative externalities in consumption: smoking, fishing. •Positive externalities in production: silicon valley labor pool. • Negative externalities in production: river pollution. Tuesday, February 1, 2011
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5 Externalities and efficiency Externalities The first welfare theorem says that the outcome of a Walrasian equilibrium is Pareto efficient. The reason for this result is that competitive market prices fully reflect the social costs and benefits of the decisions of the economic agents involved. With externalities, this is no longer true, so an equilibrium outcome is not necessarily efficient. With externalities, the social marginal cost/utility is different from the private marginal cost/utility. Tuesday, February 1, 2011
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6 Negative ext. in consumption Externalities A smoker extends his consumption of cigarettes up to the point where his marginal utility of cigarettes equals the price of cigarettes. His smoking, however, does not only affect his own utility but also the utility of the people around him. Therefore, the social cost of smoking is not just the price of cigarettes (which only reflects production costs), but also the utility loss of other individuals. The smoker does not “internalize” these costs; this is what creates the wedge between private and social costs. Note that this negative externality has nothing to do with the fact that
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This note was uploaded on 03/19/2011 for the course ECON 51 taught by Professor Tendall,m during the Winter '07 term at Stanford.

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class9_externality_ - Econ 51, Winter 2011 Class #9...

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