Chapter 10 - Externalities - Chapter 10 Externalities Externality uncompensated impact one persons actions on the well-being of a bystander Negative

Chapter 10 - Externalities - Chapter 10 Externalities...

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Chapter 10 – Externalities Externality – uncompensated impact one person’s actions on the well-being of a bystander Negative exterality – impact is adverse on bystander Postitivie externality – impact is positive on bystander Externalities and Market inefficiency o Negative externalities For each unit of aluminum produced, a certain amount of smoke enters the atmosphere Cost to society of producing aluminum is larger than the cost to the aluminum producers For each unit of aluminum produced, the social cost includes the private costs of the aluminum producers plus the costs to those bystanders affected adversely by the pollution Social-cost curve is above the supply curve because it takes into account the external costs imposed on society by aluminum producesrs Difference between two curves reflects cost of the pollution emitted Benevolent social Planner would choose the level of aluminum production at which the demand curve crosses the social-cost curve The planner does not produce more than this level because the social cost of producing additional aluminum exceeds the value to consumers Inefficiency occurs because the market equilibrium reflects only the private costs of production How can social planner achieve optimal outcome? Tax aluminum producers for each ton of aluminum sold Tax accurately reflects external cost of smoke released into the atmosphere new supply curve would coincide with the social cost curve Internalizing the externality – altering incentives so that people take account of the external effects of their actions Gies buyers and sellrs in the market an incentive to take into account the external effects of their actions o Positivive externalities Education yields positive externality more informed voters better government for everyone lower crime rates encourage development
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