25 one solution tax sellers 1gallon would shift s

25
One solution:
tax sellers
$1/gallon,
would shift S
curve up $1

EXTERNALITIES
10
“Internalizing the Externality”

Internalizing the externality : altering
incentives so that people take into account the
external effects of their actions

In our example, the $1/gallon tax on sellers
makes sellers’ costs = social costs

When market participants pay social costs,
market equilibrium = social optimum
(Imposing the tax on buyers would achieve the
same outcome; market Q would equal optimal
Q .)

EXTERNALITIES
11
Examples of Positive
Externalities

Being 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.
Thank you for
not contaminating
the fruit supply!

EXTERNALITIES
12
Positive Externalities

In the presence of a positive externality,
the social value of a good includes

private value – the direct value to buyers

external benefit – the value of the positive
impact on bystanders

The socially optimal Q maximizes welfare:

At any lower Q , the social value of the last unit
exceeds their costs

At any higher Q , the cost of the last unit exceed
its social value

A C T I V E L E A R N I N G
A C T I V E L E A R N I N G
1
1
Analysis of a positive externality
Analysis of a positive externality
13
The market for flu shots
D
S
0
10
20
30
40
50
0 10 20 30
P
Q
$
External benefit
= $10/shot

Draw the social
value curve.

Find the socially
optimal Q .

What policy would
internalize this
externality?

A C T I V E L E A R N I N G
A C T I V E L E A R N I N G
1
1
Answers
Answers
14
Social optimal Q =
25 shots. To
internalize this
externality, offer a
$10 subsidy
The market for flu shots
D
S
0
10
20
30
40
50
0 10 20 30
P
Q
$
External
benefit
25
Social value =
Private value +
$10 external benefit

EXTERNALITIES
15
If negative externality

Market quantity later than socially desirable
If positive externality

Market quantity smaller than socially desirable
To remedy the problem,
“internalize the externality”

Tax goods with negative externalities

Subsidize goods with positive externalities
If negative externality

Market quantity later than socially desirable
If positive externality

Market quantity smaller than socially desirable
To remedy the problem,
“internalize the externality”

Tax goods with negative externalities

Subsidize goods with positive externalities
Effects of Externalities:
Effects of Externalities:
Summary
Summary

EXTERNALITIES
16
Public Policies Toward
Externalities
Two approaches:

Command-and-control policies regulate behavior
directly. Ex.

Limits of quantity of pollution

Requirements that firms adopt a particular technology
to reduce emissions

Market-based policies provide incentives so that private
decision-makers will choose to solve the problem on their
own. Ex:

Corrective taxes and subsidies

Tradable pollution permits

EXTERNALITIES
17
Corrective Taxes & Subsidies

Corrective tax : a tax designed to induce private
decision-makers to take account of the social
costs that arise from a negative externality