1 - I Externalities The conventional analysis A The simple argument for efficiency o o o o B The problem o o o o o o o o 1 The EPA or equivalent

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I. Externalities: The conventional analysis A. The simple argument for efficiency: o 1. If people who take actions receive the benefits and pay the costs of those actions o 2. Then they will take those actions and only those actions for which net benefits>net costs o 3. Which is the efficient rule o 4. And this condition is met in the ideal competitive market (for explanation , see a Price Theory text-preferably mine ) B. The problem : o 1. If I can take an action some of whose costs are born by other people o 2. For example, produce both steel and pollution, sell the steel, pay wages and the cost of raw materials, but not pay the cost of the pollution o 3. Then I will produce steel even if total costs, including pollution, are > total benefits for at least some of my output-i.e. produce more than the efficient quantity o 4. And I will produce steel in the way that minimizes my total cost, not all total cost-for example, I will not do costly things to reduce pollution, even if they are, on net, worth doing. C. Simple solution-direct regulation. o 1. The EPA or equivalent decides who can pollute how much where, what methods of pollution reduction have to be used, etc. o 2. The problem is that to do that right they would have to know both the damage done by pollution and the cost of all the alternatives-which they probably don't o 3. And it is not in the interest of firms to tell them, since a firm that can persuade the EPA that its output is important and there is no way of reducing the associated pollution at any reasonable cost gets to keep on polluting. D. Fancier solution-effluent tax. o 1. Charge each firm for the damage done by its pollution. o 2. It can decide whether to pollute and pay, control pollution, or stop producing. o 3. And it is in its interest to choose the most efficient alternative. E. There is still an informational problem, since the taxing authority has to estimate the damage done by the firm's pollution in order to set the tax-but at least it does not have to estimate the cost of not polluting. It can trust the firms to solve that problem in their (and our) interest. F. Both solutions face a further problem-how to make it in the interest of the regulator/taxing authority to make the rules that produce an efficient outcome. o 1. It might be more politically attractive to sell out to the polluters in exchange for campaign contributions. o 2. Or impose very stringent rules in order to be bribed not to enforce them. o 3. We will be mostly ignoring this class of problems at this point.
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o 4. But it is a good example of the general point that you can keep expanding the economic approach to incorporate what you had been interpreting as the framework: rational cops, judges, legislators, voters, . .. . II. Externalities in the law
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This note was uploaded on 04/05/2012 for the course ECON 395 taught by Professor Beckett during the Fall '11 term at Rutgers.

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1 - I Externalities The conventional analysis A The simple argument for efficiency o o o o B The problem o o o o o o o o 1 The EPA or equivalent

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