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
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- Fall '12
- Externalities, Market failure, DICK, Externality