chapter_18

chapter_18 - Externalities Negative Action by one party...

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Chapter 18 Slide 1 Externalities Negative Action by one party imposes a cost on another party Scenario Steel plant dumping waste in a river The entire steel market effluent can be reduced by lowering output (fixed proportions production function) Marginal External Cost (MEC) is the cost imposed on fishermen downstream for each level of production. Marginal Social Cost (MSC) is MC plus MEC. Negative Externalities encourage inefficient firms to remain in the industry and create excessive production in the long run.
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MC S = MC I D P 1 Aggregate social cost of negative externality P 1 q 1 Q 1 MSC MSC I When there are negative externalities, the marginal social cost MSC is higher than the marginal cost. External Costs Firm output Price Industry output Price MEC MEC I The difference is the marginal external cost, MEC. q* P* Q* The industry competitive output is Q 1 while the efficient level is Q*. The profit maximizing firm produces at q1 while the efficient output level is q*.
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Slide 3 The Efficient Level of Emissions Level of Emissions 2 4 6 Dollars per unit of Emissions 0 2 4 6 8 10 12 14 16 18 20 22 24 26 MSC MCA E* The efficient level of emissions is 12 ( E* ) where MCA = MSC. Assume: 1) Competitive market 2) Output and emissions decisions are independent 3) Profit maximizing output chosen At E o the marginal cost of abating emissions is greater than the marginal social cost. E 0 At E 1 the marginal social cost is greater than the marginal cost of abatement. E
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This note was uploaded on 05/09/2011 for the course ECON 111 taught by Professor Chan during the Spring '11 term at HKU.

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chapter_18 - Externalities Negative Action by one party...

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