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
3IntroductionOne 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 uncompensatedimpact 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.
EXTERNALITIES4IntroductionSelf-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.
5Examples of Negative ExternalitiesAir pollution from a factoryThe neighbor’s barking dogLate-night stereo blasting from the dorm room next to yoursNoise pollution from construction projectsHealth risk to others from second-hand smokeTalking on cell phone while driving makes the roads less safe for others
6Examples of Positive ExternalitiesBeing 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?
EXTERNALITIES70123450102030Q(gallons)P$The market for gasolineRecap of Welfare EconomicsDemand 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.$2.5025
EXTERNALITIES80123450102030Q(gallons)P$The market for gasolineAnalysis of a Negative ExternalitySupply (private cost)External cost= value of the negative impact on bystanders = $1 per gallon(value of harm from smog, greenhouse gases)Social cost= private + external costexternal cost
EXTERNALITIES90123450102030Q(gallons)P$The market for gasolineAnalysis of a Negative ExternalityDSSocial costThe socially optimal quantity is 20 gallons.
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- Fall '06
- Externalities, Market failure, DICK, Externality, tradable pollution permits