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Chapter 10 Notes - Chapter 10 Notes Externalities"invisible...

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Chapter 10 Notes: Externalities “invisible hand” of the market place leads self-interested buyers and sellers in a market to maximize the total benefit that society derives from that market o Markets are usually a good way to organize econ activity Externality the uncompensated impact of one person’s actions on the well-being of a bystander o Person neither pays nor receives any compensation for that effect o Impact is adverse Negative externality o Impact is beneficial Positive externality Market equilibrium is not efficient when there are externalities Externalities and Market Inefficiency Welfare Economics: A Recap Market for aluminum o Demand curve Value of aluminum to consumers Height of demand curve shows willingness to pay of the marginal buyer Value to the consumer of the last unit of alum bought o Supply curve Costs of producing alum Height shows cost of the marginal seller o Absence of gov intervention Price adjusts to balance the supply/demand for alum Negative Externalities Alum factories emit pollution The cost to society of producing alum is larger than the cost to alum producers Social cost includes the private costs of the alum producers plus costs to those bystanders affected adversely by the pollution
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Social cost curve is above the supply curve o Takes into account the external costs imposed on society by alum producers o Difference b/w two curves reflects the cost of the pollution emitted Best to choose the level of alum production at which the demand curve crosses the social-cost curve o Intersection determines the optimal amount of alum from the standpoint of society o Below this level, the value of alum to consumers exceeds the social cost of producing it o Shouldn’t produce more than this level because social cost of producing additional alum exceeds the value to consumers How can you achieve the optimal outcome? o Tax alum producers o Tax would shift the supply curve for alum upward by the size of the tax o New supply curve would coincide with the social-cost curve o Internalizing the externality altering incentives so that people take account of the external effects of their actions
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