Chapter10+JDEM





==== //Markets normally do well and take care of themselves, but what happens when they don’t do well? One of the 10 Principles of Economics that will apply to this chapter is how government can sometimes improve market outcomes. Topics we will cover include why markets sometimes fail to allocate resources efficiently, how government can intervene by using policies to change the market, and what types of policies work the best.// ====

Before we get into the technical points of this chapter, let’s start off with the basics. First of all we have to know the definition of the word externality. It is, after all, the topic of today’s episode. An externality is the impact of a person’s actions on the well-being of a bystander, that was not made up for. It is also when a third party is affected directly by a buyer and seller. If the impact was harmful or disturbing for the bystander then it’s a negative externality. If the impact was beneficial for the bystander then it’s a positive externality. Sometimes buyers and sellers ignore the impacts of their actions when making decisions on supply and demand, which is why market equilibrium is not efficient when surrounded by externalities. This is why externalities are serious business; they can produce problems in the market when people are oblivious to how they act around one another.

Examples of externalities can be seen anywhere in real life. For example, when people drive cars it creates air pollution from the Carbon Dioxide gas emissions. This is an example of a negative externality because it pollutes the air that people breathe. An example of a positive externality would be new developments in technology because it improves knowledge for people and efficiency for the modern world.

Let’s go deeper with the two types of externalities. First off is the negative externality. See the chart below:



Referring to the chart, pollution when a negative externality is involved the good’s social cost is higher than the private cost. Optimal quantity (Q Optimum) < equilibrium quantity (Q Market). Negative externalities lead markets to create larger quantities of goods than is needed.

Next is the positive externality. See the chart below:

Notice that this chart is similar to the negative externality chart, basically everything is reversed. Referring to the chart, education when a positive externality is involved the good’s social value is higher than the private value. Optimal quantity (Q Optimum) > equilibrium quantity (Q Market). Positive externalities lead markets to create smaller quantities of goods than is needed.

Recap: Negative externalities lead markets to create larger quantities of goods than is needed. Positive externalities lead markets to create smaller quantities of goods than is needed. This is a problem! In order to fix this problem government can internalize the externality. Goods with negative externalities will be taxed and goods with positive externalities will be subsidized.

Now that we know how to spot externalities and how their more specific types are different/alike, let’s discuss how we can actually solve the problems.

There are two ways to solve market inefficiency: through private or public solutions.

Ordinary people can solve issues on their own, hence the name “private solution”. People can basically be trusted because most of us have been taught good morals at an early age. Such as being considerate of others by being responsible for our actions. In this way we can say that people can solve problems on their own without government help because we know how to take action. According to The Coase Theorem, the problem can be solved by all private parties if they can bargain without cost over the allocation of resources. Here is an example of how the The Coase Theorem applies to this chapter, but first watch the video!
 * PRIVATE SOLUTIONS:**

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//Scenario Analysis with the two boys:// In the Youtube video that was posted, the actors present a real-life scenario relating to The Coase Theorem. The blue shirt boy really wants to study, but can’t because of his obnoxious roommate, who loves to party and socialize. The examples of negative externalities in this video include having an obnoxious roommate who is not considerate of the other person’s studying, waking up his roommate at 3:39 am, and having a messing room. The roommate who wanted to study was affected heavily. He couldn’t study well for his test and didn’t get enough sleep for being woken up, therefore he failed his test in the end.

//Applying The Coase Theorem:// The blue shirt roommate decided to talk to his roommate about the issues that they could work out. In the end, their bargain was to have a hamper for the party boy roommate to put his stuff away. He also agreed to keep his partying level down when the other guy wanted to study or sleep in the room. For the blue shirt roommate, he agreed to go to the library once in a while to let the guy party in their room if he wanted to. In the end, both of them made a reasonable bargain with each other, without having to make it all too complicated and both sides win.

However, even though it may seem like private solutions are perfect for all solutions, they are not. Even the idea of The Coase Theorem can backfire and that is because private individuals often fail to resolve these conflicts on their own. Some parties do not pay transaction costs, which are costs that they must pay going through the process of the bargain and following through with it. For example, if the party boy from the video sees that giving up some of his party time for his roommate isn’t worth it, then he’ll just keep doing what he’s doing. Resolving these issues and reaching a bargain is difficult also if the parties involved are too large. It’s harder to cooperate and come to an agreement with everyone when too many parties are involved.


 * PUBLIC SOLUTIONS:**

This is where the government steps in when a private solution can’t be reached. One method under to the public solutions would be to use the Command-and-Control Policies. These policies are supposed to regulate behavior directly. The other way is through using Market-Based Policies. These policies give incentives to the private decision makers who hopefully will make the right decisions independently.

Command-and-Control Policies

The government uses these policies to regulate actions by allowing some, but banning some as well. Let’s say that some fishermen are sharking finning out in the ocean. This is banned by certain countries today in order to protect the shark population and environment. A government can try to prevent certain types of harmful fishing by setting up command-and-control policies. This way, less fishermen will hunt sharks and more sharks will survive. However, this policy will not always work even though it may appear to be so simple. Some fishermen will continue to hunt sharks even though the government banned it because it’s a way of life for them. People especially in Asia like to eat shark fin meaning it will continue to be in demand. The fishermen would see it as a waste to stop because they would not earn money by doing that. Also, the government cannot ban all types of fishing because not all of it is bad. They weigh the costs and benefits in order to decide what kinds and how much of fishing they want to allow.

Market-Based Policy 1: Corrective Taxes and Subsidies

An externality can be dealt with when these policies provide incentives to society. Negative ext. can be taxed while positive ext. can be subsidized. Corrective taxes are taxes that induce private decision makers to take responsibility for the social costs of the negative externality. Let’s say that a factory is polluting the river right next to it by dumping their toxics waste products there. The government could either a) regulate the action by telling the factory to decrease the amount of toxic waste products they dump. Or b) they could impose a tax on the factory, making them pay a certain amount for every ton they dump. Which one sounds better? Choice “b” is preferred by economists because the factory will have to listen since they are being taxed for every ton of goo they dump. They would see that they can still produce their goods with minimal pollution. As long as they avoid the tax they are also satisfied. Corrective taxes move the allocation of resources closer to the social optimum when the private decision makers are given incentives to fix their actions. These taxes raise revenue for the government and at the same time create economic efficiency.

Market-Based Policy 2: Tradable Pollution Permits

Pollution permits are an advantage when allowed into the market because it doesn’t matter where or how these permits are distributed among firms; it doesn’t mess with the economic efficiency. Firms, for example factories that are polluting the environment, can use these pollution firms. Firms that are able to lower their pollution at a low cost will sell the pollution permits they get. The firms that lower their pollution at high costs will buys permits that they need. There has to be a free market for this to work, with the last allocation being efficient, due to the starting allocation.

Conclusion

==== //When society fails to allocate resources efficiently, there are external effects that can happen. One way to fix those problems is through private methods. The Coase Theorem is the concept of how arguing parties can make a bargain between themselves and come to an agreement. The public method of solving the problem would be through the government. They stpe in when parties cannot handle the situations on their own. One way they solve the problem is by making decision makers choose what is best, in which they take responsibility for their actions. They can regulate certain behaviors or impose taxes. Each way the government can do it is done in a different approach. In the end it turns out that market forces are the best way to fix market failure if set in the right path.// ====

a. foreign competition. b. externalities. c. low consumer demand. d. government intervention.
 * 1. Market failure can be caused by**

a. fail to allocate resources efficiently. b. cause price to be different than the equilibrium price. c. benefit producers at the expense of consumers. d. cause markets to operate more equitably.
 * 2. Externalities cause markets to**

a. is an bad impact on a bystander. b. causes the product in a market to be under-produced. c. is an bad impact on market participants. d. is present in markets in which the good or service is undesirable for society.
 * 3. A negative externality**

a. are directly affected and market bystanders are indirectly affected. b. and market bystanders are both directly affected. c. and market bystanders are both indirectly affected. d. are indirectly affected and market bystanders are directly affected.
 * 4. When externalities are present in a market, the well-being of market participants**

a. causes the product to be overproduced. b. provides an additional benefit to market participants. c. benefits consumers because it results in a lower equilibrium price. d. is a benefit to a market bystander. click here to check your answers
 * 5. A positive externality**

=**Glossary:**=

Externality- the impact of a person’s actions on the well-being of a bystander, that was not made up for. It is also when a third party is affected directly by a buyer and seller. Negative Externality- If the impact was harmful or disturbing for the bystander. Positive Externality- If the impact was beneficial for the bystander. The Coase Theorem- the problem can be solved by all private parties if they can bargain without cost over the allocation of resources.