Chapter 11 | Externalities, Carbon Taxes, Free Riders and Public Goods Flashcards
Handcuffing the Invisible Hand: Market Failure with Externalities
When externalities exist, prices don’t reflect all social costs and benefits; markets fail to coordinate private smart choices with social smart choices.
Negative externalities (external costs)
costs to society from your private choice that affect others, but that you do not pay.
Positive externalities (external benefits)
benefits to society from your private choice that affect others, but that others do not pay you for.
Externalities occur when clear property rights are missing.
– Tragedy of the commons — the overuse and depletion of a resource that no one can be excluded from because of missing property rights.
– Free riders — those who consume products or services without paying.
When externalities exist, prices don’t reflect all social costs and benefits, and markets fail to produce efficient outcomes. Instead markets produce:
– too many products and services with negative externalities (second-hand smoke, pollution, traffic jams).
– too few products and services with positive externalities (vaccinations, education).
Why Radical Environmentalists Dislike Economists: Efficient Pollution
For an efficient market outcome when there are negative externalities, choose the quantity of output where marginal social cost equals marginal social benefit.
Efficient pollution” balances the additional environmental benefits of lower pollution with the additional opportunity costs of reduced living standards.
– The socially desirable amount of pollution is not zero; at some point the additional opportunity costs of reducing pollution are greater than the additional benefits of lower pollution.
The market quantity and price are determined at the intersection of the marginal private benefit and marginal private cost curves.
The market quantity and price are determined at the intersection of the marginal private benefit and marginal private cost curves.
For any product or service that generates an externality, the rule for a smart choice is: Choose the quantity of output where marginal social cost equals marginal social benefit.
– Marginal social cost
– Marginal external cost
- Marginal social benefit
– Marginal external benefit
– Marginal social cost
(MSC) = marginal private cost (MC) plus marginal external cost
– Marginal external cost
= price of preventing or cleaning up damage to others external to the original activity
– Marginal social benefit (MSB)
(MSB) = marginal private benefit (MB) plus marginal external benefit
Marginal external benefit
= price of the value or savings to others external to the original activity
Markets overproduce products and services with negative externalities; the price is too low because it does not incorporate external costs.
Markets overproduce products and services with negative externalities; the price is too low because it does not incorporate external costs.
Liberating the Invisible Hand: Policies to Internalize the Externality
If polluters are forced by government to pay the marginal external costs of their pollution, this internalizes the externalities/costs into private choices, creating smart social choices.