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Lecture 21

Lecture 21 - Econ 201 Lecture 21 Externalities Sometimes...

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Econ 201 Lecture 21 Externalities Sometimes costs or benefits that result from an activity accrue to people not directly involved in the activity. These are called external costs or external benefits -- externalities for short. Example 21.1 . Sara is an accomplished classical violinist. Her neighbor Tom is a fan of classical violin music, and on summer evenings enjoys listening to Sara play in her garden. If Sara plays only in response to her own costs and benefits, will the amount of time she plays be socially optimal? For Tom, Sara's music is a positive externality. If Sara plays in response to her own costs and benefits, she will continue to play until the marginal benefit of playing another minute is equal to the marginal cost. But since Tom also benefits from her playing, at that point the total marginal benefit of playing another minute will be greater than the marginal cost. It follows that Sara plays too little. Marginal Cost to Sarah Marginal Benefit to Sarah Minutes T* (\$/minute) 0.50 0.65 MB to Tom Example 21.2 . Sara is an accomplished classical violinist. Her neighbor Harry hates the sound of violin music, and on summer evenings becomes distressed when Sara plays in her garden. If Sara plays only in response to her own costs and benefits, will the amount of time she plays be socially optimal? For Harry, Sara's music is a negative externality. If Sara plays in response to her own costs and benefits, she will continue to play until the marginal benefit of playing another minute is equal to the marginal cost. But since Harry also incurs costs from her playing, at that point the marginal benefit of playing another minute will be smaller than their combined marginal costs. If follows that Sara plays too much. Marginal Cost to Sarah Marginal Benefit to Sarah Minutes T* (\$/minute) 0.50 0.75 MC to Harry Negative externalities => too much activity Positive externalities => too little activity Example 21.3 . Smith can produce with or without a filter on his smokestack. Production without a filter results in greater smoke damage to Jones. The relevant gains and losses for the two individuals are listed in the table below. With filter Without filter ___________________________________ Gains to Smith \$200/wk \$245/wk ___________________________________ Damage to Jones \$35/wk \$85/wk ___________________________________ If Smith is not liable for smoke damages and if the two parties can negotiate costlessly with one another, will he install a filter?

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