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Unformatted text preview: 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 • 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 pollut ion emitted • Best to choose the level of alum production at which the demand curve crosses the social-cost curve o Intersection determ ines 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 addit ional 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 incent ives so that people take account of the external effects of their actions...
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