1、,Externalities,Chapter 10,Copyright 2001 by Harcourt, Inc. All rights reserved. Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida 32887-6777.,Market Efficiency - Market Fail
2、ures,Recall that: Adam Smiths “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.,Market Failures: Externalities,When a market outcome affects parties other
3、 than the buyers and sellers in the market, side-effects are created called externalities. Externalities cause markets to be inefficient, and thus fail to maximize total surplus.,An externality arises.,. . . when a person engages in an activity that influences the well-being of a bystander and yet n
4、either pays nor receives any compensation for that effect.,Market Failures: Externalities,When the impact on the bystander is adverse, the externality is called a negative externality. When the impact on the bystander is beneficial, the externality is called a positive externality.,Automobile exhaus
5、t Cigarette smoking Barking dogs (loud pets) Loud stereos in an apartment building,Examples of Negative Externalities,Immunizations Restored historic buildings Research into new technologies,Examples of Positive Externalities,The Market for Aluminum.,Quantity of Aluminum,0,Demand (private value),Sup
6、ply (private cost),The Market for Aluminum and Welfare Economics,The quantity produced and consumed in the market equilibrium is efficient in the sense that it maximizes the sum of producer and consumer surplus.,The Market for Aluminum and Welfare Economics,If the aluminum factories emit pollution (
7、a negative externality), then the cost to society of producing aluminum is larger than the cost to aluminum producers.,The Market for Aluminum and Welfare Economics,For each unit of aluminum produced, the social cost includes the private costs of the producers plus the cost to those bystanders adver
8、sely affected by the pollution.,Pollution and the Social Optimum.,Quantity of,Aluminum,0,Demand,(private value),Supply,(private cost),Negative Externalities in Production,The intersection of the demand curve and the social-cost curve determines the optimal output level. The socially optimal output l
9、evel is less than the market equilibrium quantity.,Achieving the Socially Optimal Output,Internalizing an externality involves altering incentives so that people take into account the external effects of their actions.,Achieving the Socially Optimal Output,The government can internalize an externali
10、ty by imposing a tax on the producer to reduce the equilibrium quantity to the socially desirable quantity.,Positive Externalities in Production,When an externality benefits the bystanders, a positive externality exists. The social costs of production are less than the private cost to producers and
11、consumers.,Positive Externalities in Production,A technology spillover is a type of positive externality that exists when a firms innovation or design not only benefits the firm, but enters societys pool of technological knowledge and benefits society as a whole.,Positive Externalities in Production
12、.,Quantity,of Robots,0,Demand,(private value),Supply (private cost),Positive Externalities in Production,The intersection of the demand curve and the social-cost curve determines the optimal output level. The optimal output level is more than the equilibrium quantity. The market produces a smaller q
13、uantity than is socially desirable. The social costs of production are less than the private cost to producers and consumers.,Internalizing Externalities: Subsidies,Government many times uses subsidies as the primary method for attempting to internalize positive externalities.,Technology Policy,Gove
14、rnment intervention in the economy that aims to promote technology-enhancing industries is called technology policy.,Technology Policy,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
15、 internalize the externality.,Internalizing Production Externalities,Taxes are the primary tools used to internalize negative externalities. Subsidies are the primary tools used to internalize positive externalities.,Consumption Externalities.,Quantity of,Education,0,Price of,Education,Q,MARKET,Dema
16、nd,(private value),Social,value,Q,OPTIMUM,(b) Positive Consumption Externality,Supply,(private cost),Quantity,of Alcohol,0,Price,of Alcohol,Q,MARKET,Demand (private value),Supply,(private cost),Social value,Q,OPTIMUM,(a) Negative Consumption Externality,Externalities and Market Inefficiency,Negative
17、 externalities in production or consumption lead markets to produce a larger quantity than is socially desirable.Positive externalities in production or consumption lead markets to produce a larger quantity than is socially desirable.,Private Solutions to Externalities,Government action is not alway
18、s needed to solve the problem of externalities.,Types of Private Solutions to Externalities,Moral codes and social sanctions Charitable organizations Integrating different types of businesses Contracting between parties,The Coase Theorem,The Coase Theorem states that if private parties can bargain w
19、ithout cost over the allocation of resources, then the private market will always solve the problem of externalities on its own and allocate resources efficiently.,Transactions Costs,Transaction costs are the costs that parties incur in the process of agreeing to and following through on a bargain.,
20、Why Private Solutions Do Not Always Work,Sometimes the private solution approach fails because transaction costs can be so high that private agreement is not possible.,Public Policy Toward Externalities,When externalities are significant and private solutions are not found, government may attempt to
21、 solve the problem through . . . command-and-control policies. market-based policies.,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 leve
22、ls set by the Environmental Protection Agency (EPA).,Market-Based Policies,Government uses taxes and subsidies to align private incentives with social efficiency. Pigovian taxes are taxes enacted to correct the effects of a negative externality.,Examples of Regulation versus Pigovian tax,If the EPA
23、decides it wants to reduce the amount of pollution coming from a specific plant. The EPA could tell the firm to reduce its pollution by a specific amount (i.e. regulation). levy a tax of a given amount for each unit of pollution the firm emits (i.e. Pigovian tax).,Market-Based Policies,Tradable poll
24、ution 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.,The Equivalence of Pi
25、govian Taxes and Pollution Permits.,Quantity of,Pollution,0,Price of,Pollution,P,Q,Demand for,pollution rights,Pigovian,tax,(a) Pigovian Tax,2. .which, together with the demand curve, determines the quantity of pollution.,1. A Pigovian tax sets the price of pollution.,Quantity of,Pollution,0,Q,Deman
26、d for,pollution rights,Supply of,pollution permits,(b) Pollution Permits,Price of,Pollution,P,2. .which, together with the demand curve, determines the price of pollution.,1. Pollution permits set the quantity of pollution.,Summary,When a transaction between a buyer and a seller directly affects a t
27、hird 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,Those affected
28、 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.,Summary,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.,The Market for Aluminum.,Pollution and the Social Optimum.,Positive Externalities in Production.,Consumption Externalities.,The Equivalence of Pigovian Taxes and Pollution Permits.,
