Chapter+10+Externalities

An **externality **refers to the uncompensated impact of one person's actions on the well-being of a bystander. 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.
 * internalizing an externality ** involves altering incentives so that people take account of the external effects of their actions
 * Transaction costs **are the costs that parties incur in the process of agreeing to and following through on a bargain.
 * Corrective taxes **are taxes enacted to correct the effects of a negative externality, also called as Pigovian taxes.

=**EXTERNALITIES AND MARKET INEFFICIENCY**= How Market Fail: Positive and Negative Externalities media type="youtube" key="Jax-ZyL7DkI" height="344" width="425" http://kr.youtube.com/watch?v=Jax-ZyL7DkI

**Negative Externalities**
ex) The exhaust from automobiles, barking dogs http://upload.wikimedia.org/wikipedia/en/thumb/e/ef/Negative_externality.jpg/300px-Negative_externality.jpg
 * Because of the externality, the cost to society of product is larger than the cost to that of the producers. For each unit of product produced, the social cost includes the private costs of the product producers plus the costs to those bystanders affected adversely by the effect. The social cost of the good exceeds the private cost because it takes into account the external costs imposed on society by the product's producers.


 * The optimal quantity, Qs, is smaller than the equilibrium quantity, Qr.The reason for this inefficiency is that the market equilibrium reflects only the private costs of production. In the market equilibrium, the marginal consuemr values product at less than the social cost of producing it. That is, at Qr, the demand curve lies below the social cost curve. Thus, reduicng product production and consumption below the market equilibrium level raises total economic well-being.


 * The producer wants to maximize the total surplus derived from the market - the value to consumers of the product minus the cost of producing the product. Yet, the producer understands that the cost of producing the product includes the external costs of the effect.The producer would choose the level of product production at which the demand curve crosses the social-cost curve. This intersection determines the optimal amount of aluminum from the standpoint of society as a whole. Below this level of production, the value of teh aluminum to consumers (as measured by the height of the demand curve) exceeds the social cost of producing it (as measured by the height of the social-cost curve). The planner does not produce more than this level because the social cost of producing additonal product exceeds the value to consumers.


 * Internalizing the externality is one way to achieve the optimal outcome. The tax would shift the supply curve for product upward by the size of the tax. If the tax accurately reflected the social cost of smoke released into the atmosphere, the new supply curve would coincide with the social=cost curve. In the new market equilibrium, producers would produce the socially optimal quantity of the product. Internalizing the externality gives buyers and sellers in the market an incentive to take account of the external effects of their actions. Procers would take the costs of the externality into accout when deciding how much product to supply because th tax would make them pay for these external costs. And because the market price would reflect the takx on producers, consumers of the product would have an incentive to use smaller quanity.

**Positive Externalities**
ex) restored historic buildings, research into new technologies http://bp1.blogger.com/_vhGdX1v17Ic/ReXLWNJGuOI/AAAAAAAAAAY/rajna6FkNI0/s320/positive%2Bexternaity.jpg
 * The demand curve does not reflect the value to society of good. Because the social value is great than the private value, the social-value curve lies above the demand. The optimal quantity is found where the social-value curve and the supply curve (which represents costs) intersect. Hence, the socially optimal quantity is greater than the quantity determined by the private market.


 * The government can correct the market failure by inducign market participants to internalize the xternality. The apporpriate response in this case of positive externalities is exactly the oppostie to the case of negative externalities. To move the market equliibrium closer to the social optimum, a positive externaltiy rquires a subsidy.

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

=**PRIVATE SOLUTIONS TO EXTERNALITIES**=

**The Types of Private Solutions**

 * 1) Sometimes the problem of externalities is solved with moral codes and social sanctions
 * 2) Another private solution to externalities, is charities, many of which are established to deal with externalities.
 * 3) The private market can often solve the problem of externalities by relying on the self-interest of the relevant parties.
 * 4) Another way for the private market to deal with external effects is for the interested parties to enter into a contract.

**The Coase Theorem**
The Coase theorem says taht private economic actors can solve the problem of externalities among themsleves. Whatever the initial distribution of rights, the interseted parties can always reach a bargain in which everyone is better off and the outcome is efficient.

**Why Private Solutions Do Not Always Work**

 * 1) Sometimes the interested parties fail to solve an externality problem because of transaction costs.
 * 2) At other times, bargaining simply breaks down.
 * 3) Reaching an efficient bargain is especially difficult when the number of interested parties is large because coordinating everyone is costly.

Okay this is a student produced video that thoroughly demonstrates NEGATIVE externality and the COASE THEOREM. media type="youtube" key="7jdvnSm48nY" height="295" width="480" Credits to [|jameschen7]

Financial Intervention to Overcome Market Failure media type="youtube" key="Unh9uJggjRg" height="344" width="425" http://kr.youtube.com/watch?v=Unh9uJggjRg
 * PUBLIC POLICIES TOWARD EXTERNALITIES**

Command-and-Control policies regulate behavior directly. Market-based policies provide incentive so that private decision makers will choose to solve the problem o their own.

**Command-and-Control Policies: Regulation**
The government can remedy an externality by making certain behaviors either required or forbidden. In all cases, to design good rules, the government regulators need to know the details about specific industries and aout the alternative technologies that those industries could adopt. This information is often difficult for government regulators to obtain.

**Market-Based Policy 1: Corrective Taxes and Subsidies**
The government can internalize the externality by taxking activities that have negative externalities and subsidizing activities that have positive externalities. An ideal corrective tax would equal the external cost from an activity with negative externalities, and an ideal corrective subsidy would equal the external benefit from an acitivty with positive externalities. Economists usually prefer corrective taxes to regulations as a way to deal with pollution becaue they can reduce pollution at a lower cost to society. The regulation would dictate a level of pollution, whereas the tax would give facotry owners an economic incentive to reduce pollution. Most economists would prefer the tax. They would first point out that a tax is just as effective as a regulation in reducing the overall level of pollution. Ther eason economists would prefer the atax is that it redces the pollution mor efficiently. The regulation requires each factory to reduce pollution by the same amount, but an equal recution is not necessarily the least expensive way to clean up the water. In essence, the corrective tax places a price on the right to pollute. Just as markets allocate goods to those buyers who value them most highly, a correctiv tax allocates pollutions to those factories that face the highest cost of reducing it. Economists also argue that corrective taxes are better for the environment. The tax gives the factories an incentive to develop cleaner technologies because a clearn technoogy would reduce the amoutn of tax the facotry has to pay.

Most taces distort incentives and move the allocation of resources away from the social optimum. The recution in economic well-being - that is, in consumer and producer surplus - exceeds the amoutn of revenue the government raises, resulting in a dadweight loss. By contrast, when externalities are present, society also cares aobut the well-being of the bystanders who are affected. Corrective taxes alter incentives to account for the presnece of externalties, and therby move the allocation of resources closer to the social optimum. Thus while corrective taxes raise revenue for the government, they also enhance economic efficiency.

**Market-Based Policy 2: Tradable Pollution Permits**
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 cast may prefer to sell its permit to a firm that can reduce pollution only at a high cost.

Corrective Tax: A corrective tax sets the price of pollution which, together with the demand curve, determines the quantity of pollution. Pollution Permits: http://welkerswikinomics.com/blog/wp-content/uploads/2008/01/pollution-permits_1.jpeg Pollution permits set the quantity of pollution which, together with the demand curve, determines the price of pollution.

Questions: 1. In the absence of externalities, the "invisible hand" leads a market to maximize a. producer profit from that market b. total benefit to society from the market c. both equity and efficiency in the market d. output of good or services in the market.

2. An externality exists whenever a. the economy can benefit from government intervention b. markets are not able to reach equilibrium c. a frim sells its product in a foregin market d. a person engages in an activity that influences the well-being of a bystander and yet heither pays nor recievs payment for that effect

Answers for Chapter 10 Jenn

=BRIEF SUMMARY= Externality is when the interaction between two people affect the THIRD party. Positive externality is when socially optimal quantity is greater than the equilibrium Q. However, when the externality is negative, then socially optimal quantity is less than the equilibrium Q. These externalities can be solved privately, according to Coase Theorem. However, Coase theorms doesn't always work because of high personal costs. (e.g. hiring a lawyer) When these externalities can't be controlled personally, government steps in and sets a quantity regulation or tax (pigouvian tax) to regulate and limit the externalities. They even subsidize for positive externalities to reach the socially optimal Q. = =