Chapter 10-Externalities

Externalities

side effects of an activity that effect bystanders

Problem of externalities

Occurs when those involved in the activity, don’t consider the costs or benefits imposed on a bystander

Negative externalities

impose costs on bystanders

Example situation of negative externality 

Suppose I do not maintain my yard, this will lower the value of my home. This is NOT a negative externality because I am NOT a bystander. However, my neighbors are bystanders. They are effected and the value of their house falls, negative externally are imposed 

Example of Negative externality

Factories that pollute, noise pollution from airports, smoking, drunk driving -when there are negative externalities, market will overproduce than the optimal or socially efficient quantity(assuming ext. problem is not solved)

Marginal Private Cost(MPC)

these types of costs are the firms private costs, and we will relabel, MPC is firm’s S curve.

Marginal Externalities(PEC)

with negative externalities, also these things which imposes on bystanders

Marginal Social Costs

the total marginal cost to society is called marginal, social costs

Hypothetical scenario with econ surplus being maximized 

If the firms were to produce the quantity where demand curve interacts with MSC curve, then the efficient Q(i.e. the optimal Q or socially efficient Q would be produced so total econ surplus would be maximized, But this would not actually be produced(if ex problem is not solved) The amount that will be produced is the Q where the D curve intersects the MPC curve. Thus, the efficient Q is NOT being produced and total econ surplus is NOT maximized

Example of a firm producing coal with negative externalities

The amount that will be produced is where MPC(S) intersects D 

Q=70 

P=55 

Suppose the MEC=15/unit 

Recall MSC=MPC+MEC 

So, MSC=MPC +15 

The socially efficient/optimal outcomes is at the intersect of the D-curve and MSC curve 

P=65, Q=600. 

Total econ surplus is maximized

What happens when there is a negative externality

market overproduces 

Positive externalities

Provide benefits to bystanders

Example of positive externalities

-flu covid shots

-education

-football games

What happens with positive externalities 

the market will produce LESS than the optimale/socially efficient Q 

Ways to solve externality problems

1. Private Bargaining 2. Corrective taxes and substidies 3. Cap and Trade 4.Laws, Rules, and Regulations

Private Bargaining

Coase Theorem, Ex: Side payments can pay someone to stop with negative externality, can pay someone to start doing something with a positive externality

Coase Theorem

when bargaining costs are small and property rights are clear, externality problems can be solved by private bargaining

Corrective taxes

taxes on goods reduce the Q and there is an overproduction with negative externalities. Thus we can tax things with negative externalities Ex:Gasoline, Soda, Cigarettes

Corrective Subsidies

That subsdises increase Q, there is an underproduction with positive externalities Ex: Education, Flu Shot, Sports Stadiums

Cap and Trade 

Applies to polution, allocate licenses permits to firms to pollute a certain amount, allows the free to trade/sell permits 

Laws, rules, and regulations

Increase or decrease Q by requiring or restricting production or consumption Ex:-smoking bans, vaccine laws to attend schools, drunk driving and speeding laws, seat belt laws