Externalities__public_good___imperfect_i - EXTERNALITIES...

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INFORMATION (Slavin, Ch. 4, pp. 74–80) In examining the market outcomes for monopolies, oligopolies and monopolist competition, we saw that the outcomes were less-than-socially-optimal; that is, the price and quantities of the good produced were not those associated with maximizing producer and consumer surplus (at Qe and Pe). We referred to these as instances of market failure . We will now add to our analyses of market failure where the market fails to achieve the socially optimal level of output (and price) by looking at and public goods . Definition: An externality exists when the actions or decisions of one person or firm imposes a cost (or bestows a benefit) on a third party. Externalities are sometimes referred to as spillover or neighborhood effects . POLLUTION — A NEGATIVE EXTERNALITY: Pollution is a classic example of a negative externality¸ where the actions of a firm have negative impacts on others. Consider a laundry business that uses toxic chemicals to clean laundry from hotels in San Jose. The costs associated with the cleaning are represented by the marginal cost (MC) curve, and the price received for cleaning laundry is given by the market S and D curves as shown below: P P Q Q Pp MC D
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2 Suppose, however, that this laundry business dumps the toxic chemicals in the back of its plant. Some of the chemicals find their way to the water table, where we draw our water supply, and some of the chemicals eventually ends up in the Bay. As a result, some people in the society may suffer from side effects from consuming the contaminated water (birth defects for example), while the birds, fish and other animals (and plants) that live in or near the Bay, or rely on the Bay for food, are poisoned and our ecosystem is put under serious stress. Clearly, in this scenario, the costs to society of the laundry business is much more than simply the marginal cost faced by the laundry business itself. That is, the social marginal cost exceeds the private marginal cost, and the “true” MC curve to society is in fact at SMC (> MC = PMC). Thus, the socially optimal quantity that should be produced would be Qsocial; where the marginal benefit associated with producing that quantity is just equal to what the true social costs are in producing that quantity. If the same is true for the entire laundry cleaning industry, then the supply curve, which is the sum of the marginal cost curves of all producers, does not reflect the “true” social costs of producing the good, and in fact, society’s supply curve would be associated with higher costs for each quantity of the good produced, i.e., the “true” supply curve for society would lie to the left of the market supply curve. P
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Externalities__public_good___imperfect_i - EXTERNALITIES...

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