pt 2

External Costs and Taxation

• When firms cause external costs to society, the optimal tax amount should equal the marginal external cost.
• The tax incentivizes producers to shift away from harmful practices (e.g., pesticide use) towards cleaner options.
• Targeting the source of the harm (e.g., specific pesticide) is more effective than broad measures (e.g., banning entire plantations).

Positive Externalities: Education

• Individuals pursue higher education for personal benefits like higher earnings and enjoyment of learning.
• Positive externalities arise from higher education, benefiting society beyond the individual's gains.
• Examples include:
  • A more skilled workforce (doctors, teachers, specialists).
  • Creation of new knowledge and products.
• Marginal social benefit of studying exceeds the marginal private benefit by the marginal external benefit.
• Underproduction: Fewer people pursue university education than is optimal for society, resulting in a deadweight loss.

Subsidies as a Solution

• Solution: Provide subsidies equal to the marginal external benefits per student.
• Government subsidies to universities increase their revenue, enabling them to:
  • Teach more students.
  • Build more facilities (classrooms, residences).
  • Offer more bursaries.
• This encourages more people to attend university.

Free Riding

• Temptation to free ride: Enjoy the benefit of a good without paying for it.
• Market failure: The market will not provide an efficient level of non-rivalrous goods due to free-riding.
• Solution: Subsidized private provision.

Exercise: Investment Function and Tax Revenue

• Investment function:
  $0.5p = 300 - q$
• Solving for p (price):
  $p = (300 - q) / 0.5$
  $p = 600 - 2q$
• Equating to marginal cost function:
  $600 - 2q = \text{marginal cost function}$
• If the tax is $10$ per unit, tax revenue is $T = 10q$ (tax times quantity).