Short Quiz
1. What is one building in your neighborhood that
you wish wasn’t there?
2. Why does it bother you?
Mankiw
Chap...
Economist term:
• Externalities are extra effects based on production
• Outside the direct exchange
• Can be positive or n...
Circular Flow Model again
Examples of Negative Externalities
• Air pollution from a factory
• The neighbor’s barking dog
• Late-night stereo blastin...
0
1
2
3
4
5
0 10 20 30 Q
(gallons)
P
$
The market for gasoline
Recap of Welfare Economics
Demand curve shows
private value...
0
1
2
3
4
5
0 10 20 30 Q
(gallons)
P
$
The market for gasoline
Analysis of a Negative Externality
Supply (private cost)
Ex...
0
1
2
3
4
5
0 10 20 30 Q
(gallons)
P
$
The market for gasoline
Analysis of a Negative Externality
D
S
Social
cost
The soci...
0
1
2
3
4
5
0 10 20 30 Q
(gallons)
P
$
The market for gasoline
Analysis of a Negative Externality
D
S
Social
cost
Market e...
Examples of Positive Externalities
• Being vaccinated against
contagious diseases protects
not only you, but people who
vi...
EXTERNALITIES 12
Positive Externalities
• In the presence of a positive externality,
the social value of a good includes
–...
A C T I V E L E A R N I N G 1
Analysis of a positive externality
The market for flu shots
D
S
0
10
20
30
40
50
0 10 20 30
...
A C T I V E L E A R N I N G 1
Answers
14
Socially optimal Q
= 25 shots.
To internalize the
externality, use
subsidy = $10/...
Positive Externalities
Brings customers to other businesses in Anaheim
Solution?
Positive Externalities
Brings customers to Circle K and Eegees
Also educates future workers
Negative Externalities
Negative Externalities
Negative Externalities
Brings traffic to Anaheim
Negative Externalities
Solving the Problem
• Provide incentives to
influence behavior
• Formulate 5 ideas
the government
could promote
positive e...
Positive Negative
• Tax breaks
• Subsidies
• Direct payments
• Private Property
Rights
• Fines
• Prison
• Banning
• Regula...
AP Question
1. If an industry ignores the external costs it generates in its
production, which of the following will be tr...
AP Question
2. Positive externalities in the market place:
a) assist non-involved parties
b) harm non-involved parties
c) ...
AP Question
3. Which of the following situations is the best example of a
negative externality?
a) An increase in the pric...
• Acme and US Electric run coal-burning power plants. Each
emits 40 tons of sulfur dioxide per month,
total emissions = 80...
• Each firm must reduce emissions by 10 tons.
• Cost of reducing emissions:
$100/ton for Acme, $200/ton for USE.
• Compute...
• Initially, Acme and USE each emit 40 tons SO2/month.
• Goal: reduce SO2 emissions to 60 tons/month total.
Policy option ...
• Goal: reduce emissions from 80 to 60 tons
• Cost of reducing emissions:
$100/ton for Acme, $200/ton for USE.
Compute cos...
• Goal: reduce emissions from 80 to 60 tons
• Cost of reducing emissions:
$100/ton for Acme, $200/ton for USE.
USE
– buys ...
Externalities
Externalities
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Externalities

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Externalities

  1. 1. Short Quiz 1. What is one building in your neighborhood that you wish wasn’t there? 2. Why does it bother you? Mankiw Chapter 10
  2. 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. 3. Circular Flow Model again
  4. 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. 5. 0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Recap of Welfare Economics Demand curve shows private value, the value to buyers (the prices they are willing to pay). Supply curve shows private cost, the costs directly incurred by sellers. The market eq’m maximizes consumer + producer surplus. $2.50 25
  6. 6. 0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Analysis of a Negative Externality Supply (private cost) External cost = value of the negative impact on bystanders = $1 per gallon (value of harm from smog, greenhouse gases) Social cost = private + external cost external cost
  7. 7. 0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Analysis of a Negative Externality D S Social cost The socially optimal quantity is 20 gallons. At any Q < 20, value of additional gas exceeds social cost.At any Q > 20, social cost of the last gallon is greater than its value to society. 25
  8. 8. 0 1 2 3 4 5 0 10 20 30 Q (gallons) P $ The market for gasoline Analysis of a Negative Externality D S Social cost Market eq’m (Q = 25) is greater than social optimum (Q = 20). 25 One solution: tax sellers $1/gallon, would shift S curve up $1.
  9. 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, which reduces crime and improves government. Thank you for not contaminating the fruit supply!
  10. 10. EXTERNALITIES 12 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.
  11. 11. A C T I V E L E A R N I N G 1 Analysis of a positive externality The market for flu shots D S 0 10 20 30 40 50 0 10 20 30 P Q $ External benefit = $10/shot  Draw the social value curve.  Find the socially optimal Q.  What policy would internalize this externality?
  12. 12. A C T I V E L E A R N I N G 1 Answers 14 Socially optimal Q = 25 shots. To internalize the externality, use subsidy = $10/shot. The market for flu shots D S Social value = private value + $10 external benefit 0 10 20 30 40 50 0 10 20 30 P Q $ external benefit 25
  13. 13. Positive Externalities Brings customers to other businesses in Anaheim Solution?
  14. 14. Positive Externalities Brings customers to Circle K and Eegees Also educates future workers
  15. 15. Negative Externalities
  16. 16. Negative Externalities
  17. 17. Negative Externalities Brings traffic to Anaheim
  18. 18. Negative Externalities
  19. 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. 20. Positive Negative • Tax breaks • Subsidies • Direct payments • Private Property Rights • Fines • Prison • Banning • Regulation • Social Expectations
  21. 21. AP Question 1. 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. 22. AP Question 2. Positive externalities in the market place: a) assist non-involved parties b) harm non-involved parties c) have no effect on non-involved parties d) only help workers in that industry e) do not exist
  23. 23. AP Question 3. 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 regulations b) Declining restriction on the importation of foreign-made cars c) An increase in the price of oil due to action taken by the Organization of Petroleum Exporting Countries d) A decline in oil stock prices as a result of bad management e) Oil leakages from drilling platforms in the Gulf of Mexico
  24. 24. • 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 USE Policy 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. A C T I V E L E A R N I N G 2 A. Regulating lower SO2 emissions
  25. 25. • 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 A C T I V E L E A R N I N G 2 A. Answers
  26. 26. • 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. A C T I V E L E A R N I N G 2 B. Tradable pollution permits
  27. 27. • 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… A C T I V E L E A R N I N G 2 B. Answers
  28. 28. • 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. A C T I V E L E A R N I N G 2 B. Answers, continued
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