Chapter+10-+Externalities

 We are going to talk about the externalities in this chapter.**Externalities** in economics are basically the unintended impact of one person's action to the market. We can catergorize the externalities into two types: Positive and Negative externality. When negative externalities happen, the government use a tax to internalize the externality because it gives buyers and sellers in the market an incentive for external effects of their actions. We can internalize the externality through private or public solutions. 

Coase Theorem: If private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own. Corrective Tax: A tax designed to induce private decision makers to take account of resources, they can solve the problem of externalities on their own. Externallity: The uncompensated impact of one person's actions on the well-being of a bystander. Internalizing the externality: Altering incentives so that people take account of the external effects of their actions. Transaction costs: The costs that parties incur in the process of agreeing to and following through on a bargain.
 * Words to keep in mind: **

= How Markets Fail: Positive & Negative Externalities = media type="youtube" key="Jax-ZyL7DkI" height="294" width="361"  ** Negative Externalities **
 * Externalities: **

We all know that the aluminum factories emit pollution. Therefore, we consider the aluminum factories as a **negative externality** because the smoke creates a health risk to us. The graph shows the social cost of producing aluminum. The social cost includes the private cost and the costs to the bystanders. You can discover that the social cost curve is above the supply curve because of the external costs imposed on society by aluminum producers, which means that the cost to society of producing the good is larger than the cost to the producers.

See how the equilibrium quantity of aluminum(Q Market) is larger than the socially optimal quantity(Q Optimum). The optimum represents the ideal equilibrium, which reflects the social costs. The optimum determines the amount of good that the society have to produce.

The main reason that the **negative externalities are inefficient** is because the market equilibrium only reflects the private costs of production. When externalities take place, the government can correct the market failure. The government **internalizes the externality** because it gives buyers and sellers an incentive to take for their actions.

** Positive Externalities ** 

Although some activities cause negative externalities, there are activities that yield benefits. These actions are referred to as **positive externalities**. The most common example of positive externality is education. Education leads to a more educated population, which results in more informed voters. Therefore, the country will have a better government for the citizens. Another benefit is that educated population tends to lower the crime rates. Moreover, the more educated population we have, there are more potential for the productivity and wages to increase.

**Negative/ Positive Externalities, Internalizing The Externalities** 

Negative externalities lead markets to produce a larger quantity than is socially desirable. Positive externalities lead markets to produce a smaller quantity than is socially desirable. To remedy the problem, the government can internalize the externality by taxing goods that have negative externalities and subsidizing goods that have positive externalities.

** Private Solutions To Externalities ** **The Types of Private Solutions:** 1. Moral codes and social sanctions 2. Charities 3. Relying on the self interest of the relevant parties 4. Contract 5. **Coase Theorem** : if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own.

The **coase theorem** basically says that private economic actors can solve the problem of externalities among themselves. The interested parties can always reach a bargain in better and efficient environment **. **

**Video demonstrating an example of negative externalities and the Coase Theorem.** media type="youtube" key="7jdvnSm48nY" height="246" width="402" align="right"

**Why Private Solutions Do Not Always Work**  Private solutions do not always work. This is because interested parties have failed to remedy the externality problem due to transaction costs. When the bargain breaks down, it is very difficult to reach an efficient bargain because the number of interested parties is too large. When private bargaining does not work, the government can sometimes play a role like acting on behalf of the fishermen.
 * Transaction costs** is the costs that parties incur in the process of agreeing to and following through on a bargain.

**Public Policies Toward Externalities** There are two ways the government can respond to the externalities. Command and control policies regulate behavior directly. Market based policies provide incentives so that private decision makers will choose to solve the problem on their own. <span style="color: #f04d0a; font-family: Verdana,Geneva,sans-serif; font-size: 117%;">Command-and Control Policies: Regulation ** The government can remedy an externality by making certain behaviors either required or forbidden. Although it sounds simple, it is not. It is impossible to prohibit all polluting activity. Therefore, society should weigh the costs and benefits to decide the kinds and quantities of pollution instead of eradicating entire pollution.

<span style="color: #f04d0a; font-family: Verdana,Geneva,sans-serif; font-size: 90%;">** Market-Based Policy 1: Corrective Taxes and Subsidies ** <span style="font-family: Verdana,Geneva,sans-serif;">The government can use market based policies for private incentives with social efficiency. Tax designed to deal with the effects of negative externalities are called **corrective taxes**. Corrective taxes are also called as //Pigovian// taxes. In case of pollution, most economists would prefer tax because it reduces pollution more efficiently. However, some economists think that corrective taxes are better for the environment. Corrective taxes alter incentives to account for the externalities and move the allocation of resources closer to the social optimum. Therefore, corrective taxes raise revenue for the government and enhance economic efficiency. <span style="color: #f04d0a; font-family: Verdana,Geneva,sans-serif; font-size: 90%;">
 * Market-Based Policy 2: Tradable Pollution Permits **

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Tradable pollution permits allow any voluntary transfer of the right to pollute from one firm to another. The good thing is that the initial allocation of pollution permits among firms doesn't matter in terms of efficiency. The EPA limits the quantity of pollution by limiting the numver of pollution permits and the demand curve determines the price of pollution.

<span style="display: block; font-family: Verdana,Geneva,sans-serif; text-align: center;"> In this chapter, we learned about the types of externalities and how the government internalize the externalities. In some cases, people can solve the problem of externalities on their own. The coase theorem suggests that the parties can bargain among themselves for efficient solution. If people can't solve the problem privately, the government comes in and internalizes in externality using corrective taxes or regulating behavior.

1. In negative externalities, why is it inefficient when the equilibrium quantity of good is larger than the socially optimal quantity? 2. How happens when private parties cannot adequately deal with external effects?
 * Questions:**

1. This is because the market equilibrium only reflects the private costs of production. The marginal consumer values the good at less than the social cost of producing it. Thus, reducing the production and consumption below the market equilibrium level raises total economic well-being. 2. When private parties cannot adequately deal with external effects, the government steps in. They prevent socially inefficient activity through regulations. Or sometimes, it internalizes an externality using corrective taxes and issuing permits.
 * Answers:**


 * <span style="color: #f04d0a; font-family: Verdana,Geneva,sans-serif;">Bibliography 10 **