What externalities are and why they can lead to inefficiency and.docxphilipnelson29183
What externalities are and why they can lead to inefficiency and government intervention in the market
The difference among negative, positive, and network externalities
The importance of the Coase theorem, which explains how private individuals can sometimes remedy externalities
Why some government policies to deal with externalities, like emissions taxes, tradable emissionspermits, or Pigouviansubsidies, are efficient, and others, like environmental standards, are not
What makes network externalities an important feature of high–tech industries
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Active Learning
What you will learn in this chapter
1
EXTERNALITIES
Externalities (spillovers): the impact on third parties of a transaction between others.
If fracking pollutes drinking water sources, it is an external cost (“negative externality”).
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2
Image credit: Associated Press, MCT via Getty Images
The extra safety your neighbor might have because everyone else in the area has purchased burglar alarms is a(n):
private cost.
external cost.
private benefit.
external benefit.
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LEARN BY DOING: PRACTICE QUESTION
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3
EXTERNALITIES
Examples of external costs:
air and water pollution
texting while driving
chemical runoff that affects fish stocks
Examples of external benefits:
education
beehives next to almond orchards
preserved farmland
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All image credits courtesy of Morgue File and/or FreeImages.com unless otherwise specified
4
FOR INQUIRING MINDS: TEXTING
1 in 4 accidents (250,000 per year) are caused by cell phone use (National Safety Council, 2012)
43 states have banned it… because of the negative (fatal) externalities.
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Image: Steve Debenport/Getty Images
5
IS THE MARKET ALWAYS EFFICIENT?
Market failure: free-market equilibrium not providing the socially optimal amount of a good.
Left to itself, a market economy will typically generate too much pollution because polluters have no incentive to take into account the costs they impose on others.
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All image credits courtesy of Morgue File and/or FreeImages.com unless otherwise specified
6
COSTS AND BENEFITS OF POLLUTION
The marginal social cost of pollution is the additional cost imposed on society as a whole by an additional unit of pollution.
Acid rain, smog, contaminated water, etc.
The marginal social benefit of pollution is the additional gain to society as a whole from an additional unit of pollution.
Goods and services, jobs, etc.
The socially optimal quantity of pollution is the quantity society would choose if all costs and benefits were fully accounted for.
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7
SO HOW DO YOU MEASURE THE MARGINAL SOCIAL COST OF POLLUTION?
It’s the sum of the willingness to pay among all members of society to avoid that unit of pollution.
It may be hard to estimate, so society often underestimates it.
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