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chapter 10 - Inthischapter Inthischapter What is an...

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In this chapter,  In this chapter,  look for the answers to these questions: look for the answers to these questions: What is an externality ? Why do externalities make market outcomes inefficient? What public policies aim to solve the problem of externalities ? How can people sometimes solve the problem of externalities on their own? Why do such private solutions not always work? 2
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3 Introduction One of the principles from Chapter 1: Markets are usually a good way to organize economy activity. In absence of market , the competitive market outcome is efficient, maximizes total surplus. One type of market failure: externality , the uncompensated impact of one person’s actions on the well-being of a bystander. Externalities can be or , depending on whether impact on bystander is adverse or beneficial.
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EXTERNALITIES 4 Introduction Self-interested buyers and sellers neglect the external costs or benefits of their actions, so the market outcome is not efficient. Another principle from Chapter 1: can sometimes improve market outcomes. In presence of externalities, public policy can improve efficiency.
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5 Examples of Negative Externalities Air pollution from a factory The neighbor’s barking dog Late-night stereo blasting from the dorm room next to yours Noise pollution from construction projects Health risk to others from second-hand smoke Talking on cell phone while driving makes the roads less safe for others
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6 Examples of Positive Externalities Being vaccinated against contagious diseases protects not only you, but people who visit the salad bar or produce section after you. R&D creates knowledge others can use. People going to college raise the population’s education level, which reduces crime and improves government. Your examples?
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EXTERNALITIES 7 0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Recap of Welfare Economics Demand curve shows private value , the value to buyers (the prices they are willing to pay). Supply curve shows private cost , the costs directly incurred by sellers. The market eq’m maximizes consumer + producer surplus. $2.50 25
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EXTERNALITIES 8 0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Analysis of a Negative Externality Supply (private cost) External cost = value of the negative impact on bystanders = $1 per gallon (value of harm from smog, greenhouse gases) Social cost = private + external cost external cost
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EXTERNALITIES 9 0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Analysis of a Negative Externality D S Social cost The socially optimal quantity is 20 gallons.
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