Your SlideShare is downloading. ×
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Session 8 externalities
Upcoming SlideShare
Loading in...5
×

Thanks for flagging this SlideShare!

Oops! An error has occurred.

×
Saving this for later? Get the SlideShare app to save on your phone or tablet. Read anywhere, anytime – even offline.
Text the download link to your phone
Standard text messaging rates apply

Session 8 externalities

2,501

Published on

0 Comments
1 Like
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total Views
2,501
On Slideshare
0
From Embeds
0
Number of Embeds
0
Actions
Shares
0
Downloads
85
Comments
0
Likes
1
Embeds 0
No embeds

Report content
Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
No notes for slide

Transcript

  • 1. Session 8 Externalities © 2002 by Nelson, a division of Thomson Canada Limited Lectured by Prof. Dr. Ferdinand D. Saragih, MA
  • 2.
    • Learn the nature of an externality.
    • See why externalities can make market outcomes inefficient.
    • Examine how people can sometimes solve the problem of externalities on their own.
    • Consider why private solutions to externalities sometimes do not work.
    • Examine the various government policies aimed at solving the problem of externalities.
    In this chapter you will… Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 3.
    • Recall: Adam Smith’s “invisible hand” of the marketplace leads self-interested buyers and sellers in a market to maximize the total benefit that society can derive from a market.
    • But market failures can still happen!
    EXTERNALITIES Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 4.
    • If a market system affects individuals other than buyers and sellers of that market, side-effects are created called Externalities .
      • Externalities cause markets to be inefficient, and thus fail.
    EXTERNALITIES Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 5.
    • An externality refers to the uncompensated impact of one person’s actions on the well-being of a bystander.
    • Externalities cause markets to be inefficient, and thus fail to maximize total surplus.
    EXTERNALITIES Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 6.
    • In the presence of externalities, society’s interest in a market outcome extends beyond the well-being of buyers and sellers in the market. . .
    • … the well-being of third parties are considered .
    EXTERNALITIES Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 7.
    • Positive Externality
      • The uncompensated benefits that are received by individuals who are not directly involved in the production or consumption of goods.
      • The act of producing or consuming goods sometimes generates benefits to others who do not have to pay for them.
    EXTERNALITIES Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 8.
    • Negative Externality
      • The uncompensated costs that are imposed upon individuals who are not directly involved in the production or consumption of goods.
      • The act of producing or consuming goods sometimes generates costs to others who are not paid to endure them.
    EXTERNALITIES Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 9.
    • Negative Externality
    • Automobile exhaust
    • Cigarette smoking
    • Positive Externality
    • Immunizations
    • Restored historic buildings
    EXTERNALITIES Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 10.
    • The Market for Aluminum
      • The demand curve for aluminum reflects the value to consumers of aluminum as measured by the prices they are willing to pay.
      • The supply curve for aluminum reflects the costs of producing aluminum.
      • Q market : the quantity produced and consumed in the market equilibrium is efficient in the sense that it maximizes the sum of producer and consumer surplus.
    Welfare Economics: A Recap Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 11. Figure 10-1: The Market for Aluminium Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page 0 Quantity of Aluminium Price of Aluminium Demand (private value) Supply (private costs) Equilibrium Q market
  • 12.
    • The Market for Aluminum (cont’d)
      • If the aluminum factories emit pollution (a negative externality), then the cost to society of producing aluminum is larger than the cost to aluminum producers.
    Welfare Economics: A Recap Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 13.
    • The Market for Aluminum (cont’d)
      • For each unit of aluminum produced, the social cost includes the private costs of the producers plus the cost to those bystanders adversely affected by the pollution.
    Negative Externalities in Production Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 14.
    • The Market for Aluminum (cont’d)
      • What quantity of aluminum should be produced?
        • Where the demand curve crosses the social-cost curve.
        • Below Q optimum the value of the aluminum to consumers exceeds social cost of producing it.
        • Above Q optimum the social cost of producing additional aluminum exceeds the value to consumers.
    Negative Externalities in Production Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 15. Figure 10-2: Pollution and the Social Optimum Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page Supply (private costs) 0 Quantity of Aluminium Price of Aluminium Demand (private value) Equilibrium Q market Social costs Q optimum Cost of pollution Optimum
  • 16.
    • The Market for Aluminum (cont’d)
      • Reducing aluminum production and consumption below the market equilibrium level raises total economic well-being.
    Negative Externalities in Production Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 17. Figure 10-3: Deadweight Loss of a Negative Production Externality Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page 0 Quantity of Aluminium Price of Aluminium Social costs Demand (private value) H D + A + E D + A + E - H A + B + C + H A + E E - (B + C + H) - (A + B + C) D A + B + C + D P optimum Q optimum P market Q market a b Total surplus Producer surplus Consumer surplus Change At Q Optimum At Q Market D A B C E F G H
  • 18.
    • The Market for Aluminum (cont’d)
      • How the can social optimum of aluminum production be achieved?
        • Tax the producers of aluminum thus shifting the private supply curve up by the amount of the tax so that it coincides with the social-cost curve.
      • Internalizing an externality involves altering incentives so that people take account of the external effects of their actions.
      • Pigovian taxes are taxes enacted to correct the effects of negative externalities.
      • In Figure 10-3, the Pigovian tax is equal to the distance ab .
    Negative Externalities in Production Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 19.
    • When an externality benefits the bystanders, a positive externality exists.
      • The social value of the good exceeds the private value.
    • Example:
    • A technology spillover is a type of positive externality that exists when a firm’s innovation or design not only benefits the firm, but enters society’s pool of technological knowledge and benefits society as a whole.
    Positive Externalities in Production Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 20. Figure 10-4: Technology Spillovers and the Social Optimum Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page 0 Quantity of Robots Price of Robots Demand (private value) Supply (private costs) Optimum Social costs a b Q optimum P optimum Q market P market Equilibrium Value of technology spillover Deadweight loss
  • 21.
    • The intersection of the supply curve and the social-value curve determines the optimal output level.
      • The optimal output level is more than the equilibrium quantity.
      • The market produces a smaller quantity than is socially desirable.
      • The social value of the good exceeds the private value of the good.
    Positive Externalities in Production Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 22.
    • Internalizing Externalities: Subsidies
      • Used as the primary method for attempting to internalize positive externalities.
    Positive Externalities in Production Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 23.
      • Government intervention in the economy that aims to promote technology-enhancing industries
        • Patent laws are a form of technology policy that give the individual (or firm) with patent protection a property right over its invention.
        • The patent is then said to internalize the externality.
        • The patent system gives firms a greater incentive to engage in research and other activities that advance technology.
    CASE STUDY: The Debate Over Technology Policy Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 24.
    • Some externalities are associated with consumption.
    • Figure 10-5 (a) shows a market with a negative consumption externality such as the market for alcoholic beverages.
    • Figure 10-5 (b) shows a market with a positive consumption externality such as the market for education.
    Externalities in Consumption Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 25. Figure 10-5: Consumption Externalities Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page (a) Negative Consumption Externalities (b) Positive Consumption Externalities Price of Alcohol Quantity of Alcohol 0 0 Social value Demand (private value) Supply (private cost) Quantity of Education Price of Education Social value Demand (private value) Supply (private cost) Q market Q optimum Q optimum Q market
  • 26.
    • Government action is not always needed to solve the problem of externalities, which cause markets to be inefficient.
    • People can develop private solutions.
      • Moral codes and social sanctions
      • Charitable organizations
      • Integrating different types of businesses
      • Contracting between parties
    PRIVATE SOLUTIONS TO EXTERNALITIES Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 27.
    • The Coase Theorem is a proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own.
    • Private bargaining can internalize the external effects, resulting in efficient solutions.
    The Coase Theorem Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 28.
    • In the real world bargaining does not always work.
      • Transactions Costs
        • Transaction costs are the costs that parties incur in the process of agreeing to and following through on a bargain.
      • Bargaining breaks down.
    Why Private Solutions Do Not Always Work Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 29.
    • When externalities are significant and private solutions are not found, government may attempt to solve the problem through . . .
      • Command-and-control policies that regulate behaviour directly.
      • Market-based policies that provide incentives so that private decisions makers will choose to solve the problem on their own.
    PUBLIC POLICIES TOWARDS EXTERNALITIES Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 30.
    • Command-and-Control Policies
      • Usually take the form of regulations:
        • Forbid certain behaviors.
        • Require certain behaviors.
      • Examples:
        • Requirements that all students be immunized.
        • Stipulations on pollution emission levels set by the Environmental Protection Agency (EPA).
    PUBLIC POLICIES TOWARDS EXTERNALITIES Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 31.
    • Market-Based Policies
      • Government can internalize an externality by using taxes and subsidies to align private incentives with social efficiency.
      • Pigovian taxes are taxes enacted to correct the effects of a negative externality.
    PUBLIC POLICIES TOWARDS EXTERNALITIES Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 32.
    • Why are gasoline taxes so common?
    • They are a Pigovian tax aimed at correcting three negative externalities:
      • Congestion
      • Accidents
      • Pollution
    • The tax makes the economy work better.
    CASE STUDY: Why Is Gasoline Taxed So Heavily? Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 33.
    • Market-Based Policies
      • Tradable pollution permits allow the voluntary transfer of the right to pollute from one firm to another.
      • A market for these permits will eventually develop.
      • A firm that can reduce pollution at a low cost may prefer to sell its permit to a firm that can reduce pollution only at a high cost.
    PUBLIC POLICIES TOWARDS EXTERNALITIES Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 34.
    • Market-Based Policies
      • Reducing pollution using permits is quite similar to imposing a Pigovian tax.
      • In both cases it is the firm who pays its pollution.
      • With Pigovian taxes, polluting firms must pay the government.
      • With pollution permits, polluting firm must pay to buy the permit.
      • See Figure 10-6 for an illustration of the similarities.
    PUBLIC POLICIES TOWARDS EXTERNALITIES Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 35. Figure 10-6: The Equivalence of Pigovian Taxes and Pollution Permits. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page (a) Pigovian Tax (b) Pollution Permits Price of Pollution Quantity of Pollution 0 Quantity of Pollution 0 Pigovian Tax P 1. A Pigovian sets the price of pollution… 2. … which together with the demand curve, determines the quantity of pollution… Demand for pollution rights Q Supply of pollution permits 1. … Pollution permits set the quantity of pollution… Q 2. … which together with the demand curve, determines the price of pollution… Demand for pollution rights P
  • 36.
    • When a transaction between a buyer and a seller directly affects a third party, the effect is called an externality.
    • Negative externalities cause the socially optimal quantity in a market to be less than the equilibrium quantity.
    • Positive externalities cause the socially optimal quantity in a market to be greater than the equilibrium quantity.
    Summary Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 37.
    • Those affected by externalities can sometimes solve the problem privately.
    • The Coase theorem states that if people can bargain without a cost, then they can always reach an agreement in which resources are allocated efficiently.
    • When private parties cannot adequately deal with externalities, then the government steps in.
    • The government can either regulate behavior or internalize the externality by using Pigovian taxes or by issuing pollution permits.
    Summary Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page
  • 38. The End Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 10: page

×