0 1 2 3 4 5 0 10 20 30 Q(gallons P $ The market for gasoline Analysis of a Negative Externality D S Social cost The socially optimal quantity is 20

0 1 2 3 4 5 0 10 20 30 q(gallons p $ the market for

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0123450102030Q(gallons)P$The market for gasolineAnalysis of a Negative ExternalityDSSocial costThe socially optimal quantity is 20 gallons.The socially optimal quantity is 20 gallons.At any Q< 20, value of additional gas exceeds social cost. At any Q< 20, value of additional gas exceeds social cost. At any Q> 20, social cost of the last gallon isgreater than its value to society.At any Q> 20, social cost of the last gallon isgreater than its value to society.25
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From the previous slide:“At any Q < 20, value of additional gas exceeds social cost.” For example, at Q = 10, the value to buyers of an additional gallon equals $4, while the social cost is only $2. Therefore, total surplus (society’s well-being) would increase with a larger quantity of gas. “At any Q > 20, social cost of the last gallon is greater than its value.” For example, at Q = 25 (the market equilibrium) the last gallon cost $3.50 (including the external cost) but the value of it to buyers was only $2.50. Hence, total surplus would be higher if Q were lower. Only at Q = 20 is society’s welfare maximized.
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0123450102030Q(gallons)P$The market for gasolineAnalysis of a Negative ExternalityDSSocial costMarket eq’m (Q= 25)is greater than social optimum (Q= 20).25One solution: tax sellers $1/gallon,would shift Scurve up $1.
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“Internalizing the Externality”Internalizing the externality: altering incentives so that people take account of the external effects of their actionsIn our example, the $1/gallon tax on sellers makes sellers’ costs = social costs.When market participants must pay social costs, market eq’m = social optimum. (Imposing the tax on buyers would achieve the same outcome; market Qwould equal optimal Q. Recall: tax incidence and the allocation of resources is the same whether a tax is imposed on buyers or sellers.)
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Examples of Positive ExternalitiesBeing vaccinated against contagious diseases protects not only you, but people who visit the salad bar or produce section after you. R&D creates knowledge others can use.People going to college raise the population’s education level, which reduces crime and improves government.And, especially important in an election year: a better educated population makes more informed voting decisions and elects higher quality lawmakers and leaders.
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Positive ExternalitiesIn the presence of a positive externality, the social valueof a good includesprivate value– the direct value to buyersexternal benefit– the value of the positive impact on bystandersThe socially optimal Qmaximizes welfare:At any lower Q, the social value of additional units exceeds their cost.At any higher Q, the cost of the last unit exceeds its social value.
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  • Spring '14
  • Externalities, Market failure, Externality, tradable pollution permits

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