ECON 251 Module 9: Externalities and Public Goods

Externality

a side effect of an activity that affects bystanders whose interests weren’t taken into account

Positive externality

when there is a beneficial effect on a bystander (can effect supply/demand); example is getting vaccinated, this help is an external benefit

Negative externality

when there is a harmful effect on a bystander (can effect supply/demand); example is driving causes pollution, this harm is an external cost

Positive production externality

true MC<perceived MC, subtract from supply, example being production of honey has a positive impact on pollination and agricultural production

Negative production externality

true MC>perceived MC, add to supply, example being pollution

Positive consumption externality

true MB>perceived MB, add to demand, examples being neighbor’s garden and vaccines

Negative consumption externality

true MB<perceived MB, subtract from demand, example being second-hand smoke

Problem with negative externalities

people. make decisions without taking full account of the costs imposed on others, guided by private costs instead of social costs

Private costs

costs that you bear

Social costs

all costs, no matter who bears them

Problem with positive externalities

people making decisions without taking full account of benefits others enjoy, guided by private benefits instead of social benefits

Three steps for analyzing externalities

predict equilibrium outcome, assess what externalities are involved, evaluate what outcome is in society’s best interest

Key idea for dealing with externalities

find a way to internalize the externality, ensure people tale account of efforts on others

Solutions to externalities

private bargaining, fix the price (corrective taxes and subsidies), fix the quantity (cap and trade), laws, rules, regulations, and norms

Private bargaining

individual agents can negotiate to arrive at a more efficient outcome, benefits both parties, is costly

Coase theory

if bargaining is costless, then externality problems can be solved by private bargaining (role for government, facilitate private bargaining)

Corrective taxes

if markets don’t fully capture costs and benefits, taxes drive the quantity away from what the market generates and the the efficient quantity, creates financial costs, raise government revenue

Cap and trade

limit production to that efficient quantity, but allow those with differing costs and benefits to use market mechanisms to arrive at the efficient outcomes, creates opportunity costs

The cap

a quota on total production

And trade

allows firms to trade these permits, allows efficient firms to buy permits off inefficient firms

Cap and trade consequences for government revenue

can raise similar revenue if the government auctions off emissions permits, raises no revenue if government gives away permits

Laws

lead to better outcomes, are blunt instrument

Club goods

excludable, but nonrival in competition, example being Sirius XM

Public good

nonexcludable, but nonrival in competition, example being national defense

Common resources

nonexcludable and rival in consumption, leads to tragedy of the commons, example being town commons

Private good

excludable and rival in consumption, example being cookies