Step+10.+Externalities-+Lauren

=Externalities =

__**Brief Introduction**__ Wow! You're already on Step 10! Only 8 more to go! Now that you have learned about consumers and producers in the previous Chapter 7, in this chapter we will learn about how externality affect the economy. Here we go!

__**Key Terms**__ 1. Externality- the uncompensated impact of one person's actions on the well-being of a bystander. 2. Internalizing the externality- altering incentives so that people take account of the external effects of their actions. 3. Coase Theorem- the proposition that if private parties can bargain without the cost over the allocation of resources, they can solve the problem of externalities on their own. 4. Transaction cost- the costs that parties incur in the process of agreeing to and following though on a bargain. 5. Corrective tax- a tax designed to induce private decision makers to take account of the social costs that arise from a negative externality.

__**What We Will Learn**__ In this chapter, you'll learn that the principle of the invisible doesn't ALWAYS work. When externalities occur, the market fails and the government or private parties try their best to internalize the externalities. You'll also learn that externalities, regardless of positive or negative, are always inefficient, that is why people try to "internalize" them.

__**Introduction**__ The principle of the invisible hand that private interests lead the market to he best equilibrium doesn't ALWAYS work. Sadly, there are times when externalities cause the market to fail. This is where one of the Ten Principles of Economics come in: Governments can sometimes improve market outcomes. Externalities are always inefficient and therefore people internalize them. 1. Factory pumping out black smoke 2. Local fireworks event 3. Barking dogs next door 4. Restored historical opera house You wouldn't know quite which one's negative and which one's positive now right? But don't worry, you'll be able to make your examples by the end of this step!
 * Externality** is the uncompensated impact of one person's actions on the well-being of a bystander. Simply, it means that it's the effect of one's actions on a total stranger. There are two main kinds of externality: positive, which benefits others, and negative, which simply means that it harms others. Here are some examples of externalities:

 __**Topics**__ Externalities ALWAYS moves the graph off its equilibrium, which is when the market is at is most efficient point. Let's learn about the two externalities first.

I. NEGATIVE EXTERNALITY

In this case, we look at the movement of the supply curve. The supply cuurve is higher than the equilibrium, resulting in a higher quantity produced than quantity desired, which is the optimum quantity. Optimum is the point that you want to achieve: lower quantity, lower supply. A perfect example of a negative externality is pollution. For say, the world gets 10 billion grams of pollution a year, but the optimum would be less like 7 billion grams per year. The external cost is present as the quantity exceeds the quantity desired.

II. POSITIVE EXTERNALITY In this case, we look at the demand curve. Positive externality is something that has a lesser quantity than desired such as education or something good. That's why the optimum quantity, quantity desired, is more than the market quantity. The greater demand isn't being met so internalizing would produce more of the product. The social value is higher than private value in this case. A great example would be education, fireworks, and etc...

II. Internalizing Now that we've learned what they are, let's learn how to solve them! A. Private Internalization -this is simply when the government does not yet intervene with the solution. Private markets bargain with each other to solve the externality. According to the Coase theorem, the bargaining should always work unless the transaction cost is higher than the market's benefit. PRO:more efficient than the other method, which is public internalization, because it doesn't produce deadweight loss from government intervention. CON: however, the con is that it doesn't ALWAYS work like the public internalization.

B. Public Internalization -this is simply government intervention into the solution now. There are two methods to internalize a negative externality through public internalization: a. Permit- the government sets a specific limit on production. ex) a company can only produce 8 cans a day to limit on pollution b. Tax/Regulation- the government taxes every extra production. ex) a company has to pay 1 dollar for each additional can that they produce. It's inefficient in that it produces deadweight loss. (all taxes normally produce DWL) Both of the way above help control the production, and to decrease the quantity towards the optimum. There's also a way to solve positive externality through public internalization: a. subsidies- this alters the people's incentives to produce more of what's desired to raise the quantity to the optimum level. PRO: It always works and sometimes faster CON: Inefficient in that it always produces D.W.L. and not equitable that government forces people to follow.

__**Conclusion **__ The invisible hand does work many of the times but when externalities happen, government or private parties internalizes them. We could also just leave externalities without solving them but then it would never be solved right? : )

__**Quiz **__ 1. What are the three ways of handling externalities? A: do nothing, private internalization, public internalization 2. Which method of internalization is most efficient? a. private b. public c. monopoly d. do nothing

 __**Sources http://www.heart-valve-surgery.com/heart-surgery-blog/2008/03/21/smoking-children-and-open-heart-valve-surgery/ **__