Externalities 1 - PAM2040 February4th2010 Externalities Environment HealthCare Transportation ExternalityTheory = P f k l wl rk Pumpedintoriver

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PAM 2040  February 4 th  2010
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Externalities Classic market failure Environment Health Care Transportation
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Externality Theory Steel plant maximizes profits: Each unit of steel produces results in “sludge”  Pumped into river What is the firm’s marginal cost of producing one more  unit of steel? Private  marginal cost ( 29 rk wl l k f P - - × = , π
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Externality Theory Add second entity – fishermen Production depends on quantity of fish in river Steel production causes  damage  to profit of fishermen First fundamental theorem violated Social Cost  of steel incorporates both steel plant  and fishermen’s profit functions Social Marginal Cost = PMC + MD
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Vertical Addition of Individual Cost  Curves
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Externality Theory Consumption Externalities work the same way In steel example, PMB=SMB Smoking in restaurants violates FFT Your consumption of cigarettes reduces my enjoyment  SMB=PMB-MD
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Vertical Subtraction of Individual Benefit  Curves
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This document was uploaded on 10/26/2011 for the course PAM 2040 at Cornell University (Engineering School).

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Externalities 1 - PAM2040 February4th2010 Externalities Environment HealthCare Transportation ExternalityTheory = P f k l wl rk Pumpedintoriver

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