mankiw_ch10.edited

mankiw_ch10.edited - 10EXTERNALITIES Ch. 10 Pg. 1 MANKIW...

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10 EXTERNALITIES MANKIW CH. 10 Last edited July 14, 2011 PRINCIPLE #7: Governments can sometimes improve market outcomes Markets do many things well. With competition and no externalities, markets will allocate resources so as to maximize the surplus available However if these conditions are not met, markets may fail to achieve the optimal outcome = market failure Externalities Ch. 10 Pg. 1
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In previous analysis we assumed that all goods consumed or produced have been private in the sense that one individuals consumption or production of a good does not affect the other. 0 when our actions impact on those not directly involved. i.e An externality exists if one agents actions/behavior increases or decreases another’s satisfaction or profit. 0 a positive or negative effect on a third-party not directly involved as a buyer or a seller in a transaction 0 costs (or benefits) not included in the cost curve faced by the decision makers Examples of externalities - A smoker annoys others with second hand smoke -A gardener delights a neighbor with his beautiful garden -A pulp mill pollutes the air and water in town -A perfume werarer gives a friend an allergic reaction Negative Externalities Ch. 10 Pg. 2
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When economic agents not directly involved are negatively affected by actions e.g. Pollution Agents markets respond to costs and benefits they face directly If some of the costs are borne by others, then a free market tends to over-produce the good which produces a negative externality and under produce those with positive externality. On the graph (Fig. 10.2), the supply curve faced by the firm includes only its private costs = costs born directly by the producer If we include costs borne by everyone, then we get social costs = total costs of production no matter who bears them (Total or social costs = private costs + external costs) With negative externalities this produces a social cost curve up and to the left of the private cost (=supply) curve Ch. 10 Pg. 3
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see fig. 10.2 To achieve efficient output level, produce where demand = social cost With a negative externality, this will be smaller than the free- market output How can we make the market produce the optimal amount? Could impose a tax= size of the external cost which will shift
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mankiw_ch10.edited - 10EXTERNALITIES Ch. 10 Pg. 1 MANKIW...

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