Externalities

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  • 1. Mankiw Short Quiz Chapter 101. What is one building in your neighborhood that you wish wasn’t there?2. Why does it bother you?
  • 2. Economist term:• Externalities are extra effects based on production• Outside the direct exchange• Can be positive or negative• Considered a failure of the market place
  • 3. Circular Flow Model again
  • 4. Examples of Negative Externalities• Air pollution from a factory• The neighbor’s barking dog• Late-night stereo blasting from the dorm room next to yours• Noise pollution from construction projects• Health risk to others from second-hand smoke• Talking on cell phone while driving makes the roads less safe for others
  • 5. Recap of Welfare Economics P The market for gasoline $5 The market eq’m maximizes consumer + producer surplus. 4 Supply curve shows private 3 cost, the costs directly$2.50 incurred by sellers. 2 Demand curve shows private value, the value to 1 buyers (the prices they are willing to pay). 0 0 10 20 25 30 Q (gallons)
  • 6. Analysis of a Negative Externality P The market for gasoline$5 Social cost = private + external cost4 external cost Supply (private cost)3 External cost = value of the negative2 impact on bystanders1 = $1 per gallon (value of harm0 from smog, 0 10 20 30 Q greenhouse gases) (gallons)
  • 7. Analysis of a Negative Externality P The market for gasoline The socially$5 Social optimal quantity cost is 20 gallons.4 S3 At any Q < 20, value of additional gas2 exceedsQ > 20,cost. At any social D social cost of the1 last gallon is greater than its value0 to society. 0 10 20 25 30 Q (gallons)
  • 8. Analysis of a Negative Externality P The market for gasoline$5 Social Market eq’m cost (Q = 25)4 S is greater than social optimum3 (Q = 20).2 One solution: D tax sellers1 $1/gallon, would shift0 S curve up $1. 0 10 20 25 30 Q (gallons)
  • 9. Examples of Positive Externalities• Being vaccinated against contagious diseases protects not only you, but people who visit the salad bar or produce section after you.• R&D creates knowledge others can use.• People going to college raise the population’s education level, Thank you for not contaminating which reduces crime and the fruit supply! improves government.
  • 10. Positive Externalities • In the presence of a positive externality, the social value of a good includes – private value – the direct value to buyers – external benefit – the value of the positive impact on bystanders • The socially optimal Q maximizes welfare: – At any lower Q, the social value of additional units exceeds their cost. – At any higher Q, the cost of the last unit exceeds its social value.EXTERNALITIES 12
  • 11. ACTIVE LEARNING 1 Analysis of a positive externality P The market for flu shots External benefit$ 50 = $10/shot 40  Draw the social value curve. S 30  Find the socially optimal Q. 20  What policy would internalize this 10 externality? D 0 Q 0 10 20 30
  • 12. ACTIVE LEARNING 1 Answers Socially optimal Q P The market for flu shots = 25 shots.$ 50 external To internalize the 40 benefit externality, use subsidy = $10/shot. S 30 Social value 20 = private value + $10 external benefit 10 D 0 Q 0 10 20 25 30 14
  • 13. Positive Externalities Brings customers to other businesses in Anaheim Solution?
  • 14. Positive Externalities Brings customers to Circle K and Eegees Also educates future workers
  • 15. Negative Externalities
  • 16. Negative Externalities
  • 17. Negative Externalities Brings traffic to Anaheim
  • 18. Negative Externalities
  • 19. Solving the Problem • Provide incentives to influence behavior• Formulate 5 ideas the government could promote positive externalities• Formulate 5 ideas the government could prevent negative externalities
  • 20. Positive Negative• Tax breaks • Fines• Subsidies • Prison• Direct payments • Banning• Private Property • Regulation Rights • Social Expectations
  • 21. AP Question1. If an industry ignores the external costs it generates in its production, which of the following will be true at the competitive market equilibrium output?a) Price will be greater than the marginal social cost.b) Price will be less than the marginal social cost.c) Price will be equal to the marginal social cost.d) Marginal private cost will be equal to marginal social cost.e) Marginal private cost will be greater than the marginal social cost.
  • 22. AP Question2. Positive externalities in the market place:a) assist non-involved partiesb) harm non-involved partiesc) have no effect on non-involved partiesd) only help workers in that industrye) do not exist
  • 23. AP Question3. Which of the following situations is the best example of a negative externality?a) An increase in the price of oil due to the imposition of environmental regulationsb) Declining restriction on the importation of foreign-made carsc) An increase in the price of oil due to action taken by the Organization of Petroleum Exporting Countriesd) A decline in oil stock prices as a result of bad managemente) Oil leakages from drilling platforms in the Gulf of Mexico
  • 24. ACTIVE LEARNING 2 A. Regulating lower SO2 emissions• Acme and US Electric run coal-burning power plants. Each emits 40 tons of sulfur dioxide per month, total emissions = 80 tons/month.• Goal: Reduce SO2 emissions 25%, to 60 tons/month• Cost of reducing emissions: $100/ton for Acme, $200/ton for USEPolicy option 1: Regulation Every firm must cut its emissions 25% (10 tons).Your task: Compute the cost to each firm and total cost of achieving goal using this policy.
  • 25. ACTIVE LEARNING 2A. Answers• Each firm must reduce emissions by 10 tons.• Cost of reducing emissions: $100/ton for Acme, $200/ton for USE.• Compute cost of achieving goal with this policy: Cost to Acme: (10 tons) x ($100/ton) = $1000 Cost to USE: (10 tons) x ($200/ton) = $2000 Total cost of achieving goal = $3000
  • 26. ACTIVE LEARNING 2B. Tradable pollution permits• Initially, Acme and USE each emit 40 tons SO2/month.• Goal: reduce SO2 emissions to 60 tons/month total.Policy option 2: Tradable pollution permits• Issue 60 permits, each allows one ton SO2 emissions. Give 30 permits to each firm. Establish market for trading permits.• Each firm may use all its permits to emit 30 tons, may emit < 30 tons and sell leftover permits, or may purchase extra permits to emit > 30 tons.Your task: Compute cost of achieving goal if Acme uses 20 permits and sells 10 to USE for $150 each.
  • 27. ACTIVE LEARNING 2 B. Answers• Goal: reduce emissions from 80 to 60 tons• Cost of reducing emissions: $100/ton for Acme, $200/ton for USE.Compute cost of achieving goal: Acme – sells 10 permits to USE for $150 each, gets $1500 – uses 20 permits, emits 20 tons SO2 – spends $2000 to reduce emissions by 20 tons – net cost to Acme: $2000 - $1500 = $500 continued…
  • 28. ACTIVE LEARNING 2 B. Answers, continued• Goal: reduce emissions from 80 to 60 tons• Cost of reducing emissions: $100/ton for Acme, $200/ton for USE. USE – buys 10 permits from Acme, spends $1500 – uses these 10 plus original 30 permits, emits 40 tons – net cost to USE = $1500 – spends nothing on abatement Total cost of achieving goal = $500 + $1500 = $2000 Using tradable permits, goal is achieved at lower total cost and lower cost to each firm than using regulation.