Chapter 10: Externalities - PowerPoint Presentation

1. Chapter 10: ExternalitiesLaura Jackson Young

2. Market Efficiency‘Markets are usually a good way to organize economic activity’In absence of market failures, the competitive market outcome is efficientMaximizes total surplusPublic Intervention: How can the government intervene to alleviate externalities?

3. Externalities and EfficiencyExternality: The uncompensated impact of one person’s actions on the well-being of a bystanderOne type of market failureExternal cost = Negative externality: Hurts the bystanderExternal benefit = Positive externality: Benefits the bystander

4. Negative ExternalitiesWhat are some examples of scenarios in which a transaction may harm the bystander?

5. Market for gasoline0123450102030Q (gallons)P $$2.5025S D

6. Effects of Negative Externalities0123450102030Q (gallons)P $Supply (private cost)Social cost = private + $1 external costExternal cost Overproduction of GasolineD

7. Negative Externalities: Use Taxes!0123450102030Q (gallons)P $Supply (private cost)private + $1 taxImpose tax = external cost Internalize Externality  Produce Qtax =20D

8. Positive ExternalitiesWhat are some examples of scenarios in which a transaction may benefit the bystander?

9. Market for Electric VehiclesDS010,00020,00030,00040,000$50,0000102030PQ (in thousands)

10. Effects of Positive ExternalitiesDSSocial value = private benefit + $10,000 external benefit010,00020,00030,00040,000$50,0000102030PQ (in thousands)External benefit25Underconsumption of EVs

11. Positive Externalities: Use Subsidies!D (private benefit)Sprivate+ $10,000 subsidy010,00020,00030,00040,000$50,0000102030PQ (in thousands)Impose subsidy = external benefit25Internalize Externality  Produce Qsubsidy =25

12. Global Pandemics Create Negative ExternalitiesThe marginal external cost associated with risky behavior during a pandemic are larger the more infectious and fatal the disease because you are likely to make more people sickThe infectiousness of a disease is estimated by R or its ‘reproduction rate’A higher R means, on average, someone with the disease infects more peopleWhat solutions can be used to internalize this negative externality?PriceQuantityMarginal private costof contracting illnessDemandMarginal social costof contracting illnessMarginal external cost of infecting othersOverproduction of leisure travelMarket for Leisure Trips

13. Efforts to Combat Global Pandemics Create Positive ExternalitiesSimilarly, the marginal external benefit associated with social distancing and mask-wearing during a pandemic are larger the more potential infections and fatalities averted since your actions can save more livesWhat solutions can be used to internalize this positive externality?PriceQuantitySupplyMarginal private benefit of mask wearingMarginal social benefitof masksMarginal external benefit of preventing spreadUnderproduction of masksMarket for Masks

14. Other Methods to Fix ExternalitiesIndustrial policy  patents can encourage investmentMoral codes  cultural norms can incentive behaviorsCharities  if private parties won’t spend what’s necessaryPrivate Markets  Coase Theorem

15. Coase TheoremIf private parties can bargain without cost over the allocation of resources  Can solve the problem of externalities on their ownNecessary Assumptions:Property rights must be defined in some wayBargaining must be costlessThe decision makers in the bargaining must be economically “rational”

16. Example: Health impact of pollutionConsider a community where parents may have to pay higher health-care costs related to pollution-induced asthma among their children because of increased industrial activity in their neighborhoodProducers do not consider those costs to others in their decisionsThey produce more goods with negative externalities than is efficientLeads to more environmental degradation than is socially desirableUsing the Coase theorem, is there a way that the firms generating the pollution and the parents could negotiate a solution to the externalities without government intervention?

17. The Wicked Problem of Water Quality in the Mississippi River WatershedUnfortunately, the Coase theorem’s fundamental assumption of costless negotiation often falls short  not commonly applicable as a real-world solutionCoase theorem is an important reminder that, even in the case of complex environmental problems, there may be room for mutually beneficial compromisesAs we work through this application, keep in mind the assumptions behind the private market outcome via the Coase Theorem and potential government intervention