Chapter 5

Chapter 5 - Chapter 5: Externalities, Environmental Policy,...

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Chapter 5: Externalities, Environmental Policy, and Public Goods Externality- a benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service o Ex. population negative externality When there is negative externality, the market may produce a quantity of the good that is greater than the efficient amount When there is positive externality, the market may produce a quantity that is less than the efficient amount Public goods- goods that may not be produced at all unless the government produces them Externalities and Economic Efficiency There is a positive externality in the production of college educations because people who do not pay for college educations will nonetheless benefit from them There is a negative externality in the generation of electricity because, for example, the people with homes on a lake from which fish and wildlife have disappeared because of acid rain have incurred a cost, even though they might not have bought their electricity from the polluting utility The Effect of Externalities Externalities interfere with the economic efficiency of a market equilibrium A competitive market achieves economic efficiency by maximizing the sum of consumer and surplus and producer surplus But that result holds only if there are no externalities in production or consumption Private cost- the cost borne by the producer of a good or service Social cost- the total cost of producing a good or service, including both the private cost and any external cost Unless there is an externality, the private cost and the social cost are equal Private benefit- the benefit received by the consumer of a good or service Social benefit- the total benefit from consuming a good or service, including both the private benefit and any external benefit Unless there is an externality, the private benefit and the social benefit are equal How a Negative Externality in Production Reduces Economic Efficiency Economic surplus is reduced by deadweight loss The deadweight loss occurs because the supply curve is above the demand curve for the production of the units of electricity between Qefficient and Qmarket The additional cost, including the external cost, of producing these units is greater than the marginal benefit to consumers, as represented by the demand curve Because of the cost of the pollution, economic efficiency would be improved if less electricity were produced When there is a negative externality in producing a good or service, too much of the good or service will be produced at market equilibrium
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How a Positive Externality in Consumption Reduces Economic Efficiency The marginal benefit, including external benefit, for producing these units is greater than the marginal cost As a result, there is deadweight loss Because of the positive externality, economic efficiency would be improved if
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This note was uploaded on 02/21/2012 for the course EC 101 taught by Professor Idson during the Fall '08 term at BU.

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Chapter 5 - Chapter 5: Externalities, Environmental Policy,...

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