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Unformatted text preview: Chapter 21 Externalities in Competitive Markets At this point you may have gotten the impression that economists believe markets always and unambiguously result in efficient outcomes with total surplus maximized when markets operate without interference from other institutions. If this were the case, there would be no efficiency role for non-market institutions in society, and the only justification for non-market institutions would lie in concerns about the distribution of surplus concerns about equity and fairness issues as they relate to market allocation of scarce resources. While the existence of non-market institutions, including government, is often based on concerns over equity issues raised by a purely market-based allocation of resources, we will in this and the coming chapters investigate conditions under which such institutions are motivated by efficiency rather than equity concerns. Thus far, we have explicitly and implicitly assumed away the possibility for such an efficiency-role for non-market institutions, but the real world is full of conditions that raise efficiency concerns. Not all markets, for instance, are perfectly competitive implying that some economic agents may not be price takers and thus have market power they can use to their advantage and to the disadvantage of others in ways that create dead weight losses. Information in markets is not always equally distributed, giving some an advantage that may cause markets to operate inefficiently in the absence of other institutions. And there are goods that societies may value but that are not produced by markets for reasons that will become clearer later and that are linked closely to the concepts we will introduce in this chapter. Before we get to the issues just raised, we will take a look at yet another condition that creates incentives within markets even when they are perfectly competitive and when information is readily available to all sides of the market that lead to dead weight losses in the absence of other institutions. These conditions are called externalities , and they arise whenever decisions of some parties in the market have a direct impact on others in ways that are not captured by market prices. When a firms production process emits pollution into the air, for instance, this pollution potentially has a direct impact on many. Put differently, the emission of pollution imposes costs on society that are typically not priced by the market and thus are not costs taken into account by producers unless some other institution imposes those costs on them. When I decide to get in the car and enter a congested road, I am contributing to the overall congestion and thus am delaying others from getting to where they want to go, but I dont think about others when I make the 618 Chapter 21. Externalities in Competitive Markets decision of whether to get in the car. When I play loud music on my patio at home, my neighbors get to enjoy the music as well. These are all examples of externalities of external costs orget to enjoy the music as well....
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This note was uploaded on 04/07/2008 for the course ECON 55 taught by Professor Rothstein during the Fall '07 term at Duke.
- Fall '07