eco1104 - externalities

Externalities

costs/benefits imposed w/out compensation on someone other than those who caused them

Private Cost

a cost that falls directly on an economic decision maker

● E.g. costs of gasoline, wear & tear on a car, road tolls, parking fees

External Cost

a cost imposed w/out compensation on someone other than the person who incurred it

● E.g. pollution

Social Cost

the entire cost of a decision — private costs + external costs

Private Benefit

a benefit that accrue directly to the decision maker

External Benefit

a benefit that accrues w/out compensation to someone other than the person who created it ● E.g. neighbours benefit from me cleaning up my house b/c the neighbourhood looks nicer & their property may increase a bit too

Social Benefit:

the total benefit of a decision — private benefits + external benefits

Network Externality

the effect an additional user of a good or participant in an activity has on the value of the good or activity for others

Negative Production Externality

External cost that occurs when a G/S is being produced

To find external costs

how much damage is imposed on everyone every time x is produced

NPE is showed using

the supply curve b/c NPE adds an external cost to society

Why is there DWL in a market with NPE?

Deadweight loss b/c at the private equilibrium, the market does not account for external costs - They are manufacturing too many cars (cost to society > benefit to buyers buying the car)

What does chapter 5 say about DWL to society

producing where MC > Marginal Benefits results in DWL to society

What happens to equilibrium when social cost is accounted for in a NPE?

Demand Curve intersects w/ Social Cost Curve:
EP increases; EQ decreases

What causes "TOO MUCH" of NPE

When producing at a private level, producers aren't accounting for external costs, which leads to them producing more than the socially optimal amount. This results in "TOO MUCH" production

Negative Consumption Externality (NCE): Definition

an external cost that occurs when a G/S is being consumed

Why is there DWL in a market with NCE?

consuming more of a G/S beyond the efficient Q costs society more than buyers value the G/S

Positive Consumption Externality (PCE): Definition

a third-party benefit that occurs when a G/S is being consumed

What causes "TOO LITTLE" of PCE?

personal consumption only occurs when private benefits outweigh private costs, causing TOO LITTLE consumption

What happens to equilibrium point when social benefits are accounted for in a PPE?

EP & EQ in the market that accounts for external benefits is displayed by the intersection of the private supply curve (Sprivate) and social demand curve (Dsocial)

- EP & EQ increase

Why is there DWL in a market with PCE?

when equilibrium is below the efficient Q, benefits to society are greater than the costs to producers

How would you find the size of a PPE?

measure the external benefit's value to society of each unit produced

Why do externalities reduce total surplus?

Producing output different from the socially efficient Q will result in DWL

How can we restore efficiency lost to externalities?

transform external costs/benefits into private costs/benefits

Coase Theorem

an idea that even in the presence of an externality, individuals can reach an efficient equilibrium through private trades

2 Key Assumptions of the Coase Theorem

○ People can make enforceable agreements/contracts to pay one another

○ There are no transaction costs

3 Drawbacks of the Coase Theorem

1) large transaction costs (coordination & enforcement) > surplus lost to the externality
2) agreements are easy to ignore
3) says nothing about fair distribution of surplus

When might private solutions turn into public solutions?

when costs & difficulty of coordinating private solutions are too high

4 Public Policy Solutions

- taxes
- subsidies
- quotas
- tradable allowances

What does efficiency in this chapter refer to?

maximizing total/social surplus

(NOT distribution of surplus)

Pigovian Tax: Definition, Example

a tax to counterbalance a negative externality
e.g. carbon taxes, sin taxes

2 Drawbacks of the Pigovian Tax

1) Difficult to set tax at the right level without creating inefficiencies w/ equilibrium
2) There is no guarantee that the government will help those bearing external costs (turns into revenue collected by government)

How do you know if subsidy creates a socially efficient outcome?

if the subsidy equals the external benefit

What is the purpose of a subsidy?

to increase efficiency, increase social surplus, reduce DWL

Quota: Definition

a quantity limit

Are quotas efficient? Why?

quotas are not efficient b/c the invisible hand will allocate resources to those with the highest WTP

How can quotas become efficient?

if people are allowed to buy/sell quotas (tradable allowance)

Tradable Allowance: Definition

a production or consumption quota that can be privately bought or sold

What is the purpose of tradable allowances?

allows quotas to be allocated to those with the highest WTP so surplus is maximized

2 Drawbacks of Tradable Allowances

1) requires new markets
2) often has business & political opposition

Why is it risky to target individual activities that create these externalities?

it can misalign the incentives that consumers & producers face w/ the goal of minimizing the externality

What is the most common cause of market failures? Why?

externalities
b/c individual choices fail to maximize total surplus