1、PowerPoint Slides prepared by:Andreea CHIRITESCUEastern Illinois University1010Externalities 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a
2、password-protected website for classroom use.1Externalities Government action can sometimes improve upon market outcomesWhy markets sometimes fail to allocate resources efficientlyHow government policies can potentially improve the markets allocationWhat kinds of policies are likely to work best 201
3、5 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.2Externalities ExternalityThe uncompensated impact
4、of one persons actions on the well-being of a bystanderMarket failure Negative externalityImpact on the bystander is adverse Positive externalityImpact on the bystander is beneficial 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use
5、as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.3Externalities Negative externalitiesExhaust from automobilesBarking dogs Positive externalitiesRestored historic buildingsResearch into new technologies 2015 Cengag
6、e Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.4Externalities and Market Inefficiency Welfare economics:a
7、recapDemand curve:value to consumersPrices they are willing to paySupply curve:cost to suppliersEquilibrium quantity and priceEfficientMaximizes the sum of producer and consumer surplus 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for u
8、se as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.5Figure 16 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distribu
9、ted with a certain product or service or otherwise on a password-protected website for classroom use.The Market for AluminumPrice ofAluminumQuantity of Aluminum0Demand(private value)Supply(private cost)The demand curve reflects the value to buyers,and the supply curve reflects the costs of sellers.T
10、he equilibrium quantity,QMARKET,maximizes the total value to buyers minus the total costs of sellers.In the absence of externalities,therefore,the market equilibrium is efficient.QMARKETEquilibriumExternalities and Market Inefficiency Negative externalitiesCost to society(of producing a good)Larger
11、than the cost to the good producers 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.7“All I can
12、say is that if being a leading manufacturer means being a leading polluter,so be it.”Externalities and Market Inefficiency Negative externalitiesSocial costPrivate costs of the producers(supply)Plus the costs to those bystanders affected adversely by the negative externalitySocial cost curve is abov
13、e the supply curveTakes into account the external costs imposed on society 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
14、 website for classroom use.8Figure 29 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Pollution
15、and the Social OptimumPrice ofAluminumQuantity of Aluminum0Demand(private value)Supply(private cost)In the presence of a negative externality,such as pollution,the social cost of the good exceeds the private cost.The optimal quantity,QOPTIMUM,is therefore smaller than the equilibrium quantity,QMARKE
16、T.QMARKETOptimumSocial cost(private costand external cost)External Cost QOPTIMUMEquilibriumExternalities and Market Inefficiency Negative externalitiesOptimum quantity producedMaximize total welfareSmaller than market equilibrium quantity Government correct market failureInternalizing the externalit
17、yAltering incentives so that people take account of the external effects of their actions 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a pas
18、sword-protected website for classroom use.10Externalities and Market Inefficiency Positive externalitiesEducationBenefit of education is privateExternalities:better government,lower crime rates,higher productivity and wagesSocial value is greater than private valueSocial value curveAbove the demand
19、curve 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.11Figure 312 2015 Cengage Learning.All Rig
20、hts Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Education and the Social OptimumPrice ofEducationQuantity of Education0Demand
21、(private value)Supply(private cost)In the presence of a positive externality,the social value of the good exceeds the private value.The optimal quantity,QOPTIMUM,is therefore larger than the equilibrium quantity,QMARKET.QMARKETEquilibriumSocial value(privatevalue and external benefit)External Benefi
22、tQOPTIMUMOptimumExternalities and Market Inefficiency Positive externalitiesSocially optimal quantity is greater than market equilibrium quantityGovernment correct market failureInternalize the externalitySubsidy 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in wh
23、ole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.13Externalities and Market Inefficiency Negative externalitiesMarkets produce a larger quantity than is socially desirableGovernment:ta
24、x Positive externalitiesMarkets produce a smaller quantity than is socially desirableGovernment:subsidy 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or othe
25、rwise on a password-protected website for classroom use.14Technology spillovers,industrial policy,and patent protection Technology spillover=Positive externalityImpact of one firms research and production efforts on other firms access to technological advanceGovernment:internalize the externality Su
26、bsidy=value of the technology spillover15 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Techno
27、logy spillovers,industrial policy,and patent protection Industrial policyGovernment intervention in the economy that aims to promote technology-enhancing industries Patent lawProtect the rights of inventors by giving them exclusive use of their inventions for a period of time16 2015 Cengage Learning
28、.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Public Policies Toward Externalities Command-and-control policiesRegu
29、late behavior directlyRegulation Market-based policies Provide incentives so that private decision makers will choose to solve the problem on their ownCorrective taxes and subsidiesTradable pollution permits 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole o
30、r in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.17Public Policies Toward Externalities Regulation Regulate behavior directly:making certain behaviors either required or forbiddenCannot era
31、dicate pollutionEnvironmental Protection Agency(EPA)Develop and enforce regulationsDictates maximum level of pollution Requires that firms adopt a particular technology to reduce emissions 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except fo
32、r use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.18Public Policies Toward Externalities Corrective taxes and subsidiesCorrective taxes(Pigovian taxes)Induce private decision makers to take account of the soci
33、al costs that arise from a negative externalityPlaces a price on the right to polluteReduce pollution at a lower cost to societyRaise revenue for the governmentEnhance economic efficiency 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for
34、 use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.19Why is gasoline taxed so heavily?Negative externalities associated with drivingCongestion,accidents,pollution20 2015 Cengage Learning.All Rights Reserved.May
35、not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Why is gasoline taxed so heavily?The gas tax=corrective taxDoesnt cause deadweight lossesMakes
36、 the economy work better Less traffic congestion Safer roads Cleaner environment21 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-p
37、rotected website for classroom use.Why is gasoline taxed so heavily?How high should the tax on gasoline be?Most European countries Higher gasoline tax than in the U.S.2007,Journal of Economic LiteratureOptimal corrective tax on gasoline$2.28 per gallon in 2005 dollars$2.70 per gallon in 2012 dollars
38、 Actual tax in the U.S.in 2012:50 cents per gallon22 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom
39、 use.Why is gasoline taxed so heavily?Tax revenue from a gasoline taxUsed to lower taxes that distort incentives and cause deadweight lossesSome government regulations Production of fuel-efficient cars unnecessary23 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in
40、 whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Public Policies Toward Externalities Tradable pollution permitsVoluntary transfer of the right to pollute from one firm to anotherNe
41、w scarce resource:pollution permitsMarket to trade permitsFirms willingness to payDepend on its cost of reducing pollution 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product
42、 or service or otherwise on a password-protected website for classroom use.24Public Policies Toward Externalities Advantage of free market for pollution permitsInitial allocation of pollution permits doesnt matterIf firms can reduce pollution at a low cost:Sell whatever permits they getIf firms can
43、reduce pollution only at a high cost:buy whatever permits they needEfficient final allocation 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a
44、 password-protected website for classroom use.25Public Policies Toward Externalities Reducing pollution using pollution permits or corrective taxesFirms pay for their pollutionCorrective taxes:pay to the governmentPollution permits:pay to buy permitsInternalize the externality of pollution 2015 Ceng
45、age Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.26Figure 427 2015 Cengage Learning.All Rights Reserved.Ma
46、y not be copied,scanned,or duplicated,in whole or in part,except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.The Equivalence of Corrective Taxes and Pollution PermitsPrice ofpollutionIn panel(a),the EP
47、A sets a price on pollution by levying a corrective tax,and the demand curve determines the quantity of pollution.In panel(b),the EPA limits the quantity of pollution by limiting the number of pollution permits,and the demand curve determines the price of pollution.The price and quantity of pollutio
48、n are the same in the two cases.0Quantity ofpollution(a)Corrective Tax(b)Pollution PermitsDemand forpollution rightsQPCorrective tax1.A corrective tax sets the price of pollution.2.which,together with the demand curve,determines the quantity of pollution.Price ofpollution0Quantity ofpollutionDemand
49、forpollution rightsPQSupply of pollution permits1.Pollution permits set the quantity of pollution.2.which,together with the demand curve,determines the price of pollution.Public Policies Toward Externalities Objections to the economic analysis of pollution“We cannot give anyone the option of polluti
50、ng for a fee.”-by late Senator Edmund Muskie People face trade-offsEliminating all pollution is impossible Clean water and clean air opportunity costLower standard of living 2015 Cengage Learning.All Rights Reserved.May not be copied,scanned,or duplicated,in whole or in part,except for use as permit
