CHAPTER+10+.+EXTERNALITIES+;)

=Chapter 10: Externalities = = =  =INTRODUCTION: = = = In this chapter we will learn how externalities affect economic well being. So first, one must understand what an externality is.

In short, an **externality** is an effect against a third party that neither pays or recieves compensation for that effect.

Examples include:

**Positive Externalities:**
 Rebuilt landmarks are positive externalities because owners of these buildings do not receive a benefit of restoring the landmark yet, others who walk near them can enjoy the beauty of the buildings

**Negative Externalities:**
 Cars create negative externalities, for thought it does not affect the driver, it creates smog that other people are affected by.

 Now, we need to learn how to change these externalities to the social optimum. Simply put, one needs to internalize the externality. **Internalizing an externality** means that one is altering incentives so that people take account of the external effects of their actions, basically adding incentives to act a certain way.

Obviously to reach a social optimum, one wants to lower a negative externality. A negative externality always has a bigger social cost than a the private cost. Thus, to lower it to an optimum, one must add an external cost, to make it so that the socially optimum is reached. For a positive externality, one wants to raise it to a social optimum. To reach that higher social option, one must add an external benefit to encourage others to react a certain way. If its done, both the supply and the price rises, into a socially optimum state, as shown in the 2 charts below But of course, we need to know how to internalize an externality. There are 2 main different solutions to externalities. The first being **private solutions**, and the second being **public solutions**

=**Private Solutions:** = = =  Now private solutions are exactly like they sound, they are solutions created by the private parties. They are divided into 3 main groups: **moral codes, charities, and contracts.**


 * Moral Codes** basically keeps one from acting in certain behaviors or doing certain activities. Such as how many people do not tend to litter. Thought its not strictly enforced, people do not litter because of the fact that, it just is not morally right or they feel compelled not to. This compulsion to act and not act a certain way is no different than internalizing externalities.
 * Charities** are a different case, where a private companies are established to deal with a certain externality. Charities take privately gained finances and spend it in a variety of places, such as the well-being of natural monuments, to school donations.


 * Contracts** are what takes the biggest part of the private solutions. A contract "haggles" the options possible to make both parties better off. It comes up with a solution so that both parties are somewhat happy and reduces the externalities at the same time.

But one must wonder how effective all of these private methods are. One way to describe how effective they are would be by describing the Coase Theorem


 * The Coase Theorem** is the proposition that if private parties can bargain without cost over the allocation of resourses, they can solve the problems of externalities on their own. Logically speaking, this theorem works, where both parties negotiate to allocate the resources equally and efficiently. However, it is not without faults.

Private solutions have faults that negate the Coase Theorem completely. First of all, people experience transaction costs. These are the costs that parties incur during the process of agreeeing and reaching a decision. This could range from lawyer fees, to translations, and etc... However, the main problem with Private solutions is that, negotiations often break down. With 2 sides looking to make themselves better off, there are times where neither sides are looking to negotiate and no conclusion is reached.

=**Public Solutions:** = = = <span style="font-family: 'Comic Sans MS',cursive;"> Thus, to prevent these faults of private solutions, public solutions exist. Public solutions are basically solutions created for the public and are usually enforced by the government. The government uses regulation to enforce certain behaviors to change the externalities. For instance, it can make certain things crime, such as killing people and dumping waste into water.

For positive externalities, the government will most likely enforce a subsidy on that certain behavior or good. A subsidy encourages people to act a certain way, such as increased school funding will create better and more informed future citizens.

However, the government does not necessarily have to create a regulation or a law that restricts behavior completely. Instead, there are 2 different actions that they can take.

<span style="font-family: 'Comic Sans MS',cursive; font-size: 200%;">1 <span style="font-family: 'Comic Sans MS',cursive;">, there are **corrective taxes.** These basically restrict a certain behavior by adding a tax regarding the behavior. For instence, instead of just banning dump of waste into waters completely, it could ask for 30,000 dollars for ever ton dumped into the water. This not only helps the governement with tax money, but it also creates an incentive for companies to behave a certain way. For instance, a company might create greener machines to help lower their tax rate, thus creating less pollution. This can not work with regulation for no one has anything to gain once they reach the regulation limits.

<span style="font-family: 'Comic Sans MS',cursive; font-size: 200%;"> 2 <span style="font-family: 'Comic Sans MS',cursive;">, there is the option of **trade-able pollution permits**. It is exactly as the name says, it is pollution permits that are tradeable amongst other companies. This allows smaller companies to sell off their permits to bigger companies that need them. Thus, these permits will land into the hands that value them more and create an efficiency in the market.



=<span style="font-family: 'Comic Sans MS',cursive;"> Key Terms/Concepts that you need to know = <span style="font-family: 'Comic Sans MS',cursive;"> **-Externality:** 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
 * -Coase Theorem:** the proposition that if private parties can barain without cost over the allocation of resources, they can solve the problem on their own
 * -Transaction Costs:** the costs that parties incur in the process of agreeing to and following through on a bargain
 * -Corrective Tax** : a tax designed to induce private decision makers to take account of the social costs that arise from a negative externality

=<span style="font-family: 'Comic Sans MS',cursive;">**Conclusion** = =<span style="font-family: 'Comic Sans MS',cursive;"> = <span style="font-family: 'Comic Sans MS',cursive;"> So overall, we learn that externalities prove that the invisible hand can not allocate resources perfectly. Thus, we require the use of private and public solutions. Private solutions are first attempted to create a quick and easy solution to the problem at hand. If it fails to work due to varying reasons, the government steps in and starts to create different policies. These 2 different solutions begin to internalize the externality to create a more socially optimum world.

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