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ch03 - Chapter 3 Externalities and Public Policy 1...

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1 Chapter 3 Externalities and Public Policy
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2 Externalities Externalities are costs or benefits of market transactions not reflected in prices. Negative externalities are costs to third parties. Positive externalities are benefits to third parties .
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3 Externalities and Efficiency The marginal external cost is the dollar value of the cost to third parties from the production or consumption of an additional unit of a good. These occur when market transactions for a good produce negative externalities .
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4 Social Costs MSC = MPC + MEC
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5 Figure 3.1 Market Equilibrium, A Negative Externality and Efficiency MPC + MEC = MSC Price, Benefit, and Cost (Dollars) Tons of Paper Per Year (Millions) D = MSB S = MPC 5 100 A 105 4.5 B 10 110 G
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6 Implications of Figure 3.1 Market equilibrium occurs where MPC = MSB Efficiency Requires that MSC = MPC + MEC = MSB
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7 Positive externalities The marginal external benefit is the dollar value of the benefit to third parties from an additional unit of production or consumption of a good. These occur when the market for a good creates positive externalities .
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8 Social Benefit MSB = MPB + MEB
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9 Figure 3.2 Market Equilibrium, A Positive Externality and Efficiency MPB + MEB = MSB H 10 V 30 12 Price, Benefit, and Cost (Dollars) Inoculations Per Year (Millions) 0 S = MSC MPB U 25 10 Z 45
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10 Figure 3.3 A Positive Externality for Which MEB Declines With Annual Output S = MSC S' = MSC' MPB i A 25 10 B 12 MPB i + MEB = MSB 16 C 20 20 Price, Benefit, and Cost (Dollars) Inoculations per Year (Millions) 0 F 30
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11 Internalization of Externalities An externality can be internalized under policies that force market participants to account for the costs of benefits of their actions.
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12 Corrective Taxes to Negative Externalities Setting a tax equal to the MEC will internalize a negative externality.
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13 Figure 3.4 A Corrective Tax
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