Lesson 10 - Externalities Flashcards
Externality
1) arises when someone engages in action that influences bystander’s well being + when no compensation is paid for that effect
2) Negative –> impact on bystander is adverse
3) Positive –> beneficial
Social Cost
1) Private cost + external cost
Ex of social cost effect on market
1) Steel production –> produces pollution
2) Supply curve BUT above that is the social cost that is pushed up by the external cost of pollution
3) New point P_optimum which is intersection of social + demand –> lesser than Q_Market bc of pollution effect
Tax effect on externality
1) Tax –> if accurately reflects external cost of pollution for example –> it would force both buyers + sellers to internalize externality
2) since it would shift same amount as social cost –> result in optimum amount produced
Positive Externality
1) Raises demand curve by external benefit
2) Because bystanders benefit –> more than just private value –> above demand curve
3) optimal quantity –> intersection of social-value curve + supply, Q_optimum is greater than Q_market
Government involvement positive externality
1) Issues subsidy to increase demand by positive benefit –> society reaches Q_Optimum
Summary: Govt intervention for externalities
1) Positive externality –> subsidy
2) Negative externality –> tax
Technology Spillover
1) Idea that new discoveries in a field help other companies further advance
2) Govt issues subsidies to fields with most tech spillover–> most development
3) problem = difficult to measure tech spillover AND interferes with property rights (patents)
Two types of responses to externalities
1) Command and control policies –> regulate behavior directly
2) Market-based policies –> provide incentives so that private decision makers choose to solve problem on their own
Command and control policy
1) Banning dumping of poisonous chemicals in lakes
2) Problem = Information needed to make these policies difficult to obtain –> private sector incentivized to not share info about side effects
Market Based Policy 1: Corrective taxes + subsidies
1) Adding corrective (Pigovian) taxes
2) better than regulations since cheaper to society
3) Incentivize changing behaviors (less polluting) while regulation means they only reduce to the level of regulation, not further
Market Based Policy 2: Tradable Permits
1) Selling right to pollute essentially
2) Ex, 2 factories both produce 300 tons of glop a year according to EPA policy. Factory A says it wants to increase emission to 400 tons. Factory B says it will reduce its emission to 200 tons in exchange for 5 million from Factory A
Tradable Permits vs Taxes
1) Both essentially have same outcome if demand is same
2) Tax –> perfectly elastic (horiz line) supply curve –> sets price
3) permit –> perfectly inelastic (vert line) supply curve –> sets quantity
How do policy makers ensure people make the right decisions regarding climate
1) Appeal to individuals’ sense of social responsibility –> unrealistic to expect most to act this way
2) use govt regulation to change decisions people make –> problem: creates tensions btwn product consumers want + products producers can sell
3) govt can put price on carbon emissions –> internalizes externalities
Private Solutions
1) Moral codes
2) Income tax deductions for charitable donations
3) Internalizing externalities by merging
(apple keeper + bee keeper both benefit from one another which is positive externality SO if they merge –> both benefit + remove externality)
4) Negotiating contract
Coase theorem
1) private economic actors can solve the problem of externalities among themselves.
2) Whatever the initial distribution of rights, the interested parties can reach a bargain in which everyone is better off and the outcome is efficient
Coase Theorem Limitations
1) only works when interested parties have no trouble reaching/enforcing agreement
2) examples of limitations include
- transaction costs
- bargaining break down
- too many involved parties
