Ch32 - Chapter Thirty-Two Externalities Externalities An...

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Chapter Thirty-Two Externalities
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Externalities An externality is a cost or a benefit imposed upon someone by actions taken by others. The cost or benefit is thus generated externally to that somebody. An externally imposed benefit is a positive externality . An externally imposed cost is a negative externality .
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Examples of Negative Externalities Air pollution. Water pollution. Loud parties next door. Traffic congestion. Second-hand cigarette smoke. Increased insurance premiums due to alcohol or tobacco consumption.
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Examples of Positive Externalities A well-maintained property next door that raises the market value of your property. A pleasant cologne or scent worn by the person seated next to you. Improved driving habits that reduce accident risks. A scientific advance.
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Externalities and Efficiency Crucially, an externality impacts a third party ; i.e. somebody who is not a participant in the activity that produces the external cost or benefit.
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Externalities and Efficiency Externalities cause Pareto inefficiency; typically too much scarce resource is allocated to an activity which causes a negative externality too little resource is allocated to an activity which causes a positive externality.
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Externalities and Property Rights An externality will viewed as a purely public commodity . A commodity is purely public if it is consumed by everyone ( nonexcludability ), and everybody consumes the entire amount of the commodity ( nonrivalry in consumption ). E.g. a broadcast television program.
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Inefficiency & Negative Externalities Consider two agents, A and B, and two commodities, money and smoke. Both smoke and money are goods for Agent A. Money is a good and smoke is a bad for Agent B. Smoke is a purely public commodity.
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Inefficiency & Negative Externalities Agent A is endowed with $y A . Agent B is endowed with $y B . Smoke intensity is measured on a scale from 0 (no smoke) to 1 (maximum concentration).
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Inefficiency & Negative Externalities O A 1 0 Smoke m A y A Money and smoke are both goods for Agent A.
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Inefficiency & Negative Externalities O A 1 0 Smoke m A y A Money and smoke are both goods for Agent A. Better
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Inefficiency & Negative Externalities O B 1 0 Smoke m B y B Money is a good and smoke is a bad for Agent B. Better
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Inefficiency & Negative Externalities O B 1 0 Smoke m B y B Money is a good and smoke is a bad for Agent B. Better
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Inefficiency & Negative Externalities What are the efficient allocations of smoke and money?
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Inefficiency & Negative Externalities O A 1 0 Smoke m A y A O B 1 0 Smoke m B y B
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Inefficiency & Negative Externalities O A 1 0 Smoke m A O B 1 0 Smoke m B y A y B
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Inefficiency & Negative Externalities O A 1 0 Smoke m A O B 1 0 Smoke m B y A y B
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Inefficiency & Negative Externalities O A 1 0 Smoke m A O B 1 0 Smoke m B y A y B
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Inefficiency & Negative Externalities O A 1 0 Smoke m A O B 1 0 Smoke m B y A y B Efficient allocations
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Inefficiency & Negative Externalities Suppose there is no means by which
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Ch32 - Chapter Thirty-Two Externalities Externalities An...

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