Chapter 10: Externalities

Externality: the effect on the side when market affects each person rather than buyers and sellers of that market

  • Externality may cause markets to fail (ex. Failure in maximizing total surplus) -> become inefficient
  • The effect on the well-being an observer depending on certain actions
  • The total and the maximum benefit in the marketplace that buyers and sellers can develop from the market.
  • Market failures are always there in any situations

Welfare Economic: A Recap

  • Demand curve: the value to consumers measured by price of willingness to pay
  • Supply curve: the cost of producing the product
  • Qmarket: maximizes the total of consumer and producer surplus.

Negative Externalities

  • Unpaid costs that are entailed on individuals. The individuals who aren’t really involved in neither production nor consumption of goods
  • Producing and consuming goods generates the costs to other uncompensated people.
  • over producing the product than the product is actually desirable
  • Internalizing the externality: incentives that can be changed for buyers and sellers. The customers take the account from the external result.
    • Example: Automobile exhaust, cigarette smoking
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Positive Externalities

  • when externality benefits
  • Producing and consuming goods generates the costs to other paid people.
  • producing less amount of product than it is actually desirable
  • government subsidizes goods with positive externality
  • social value > private value,
    • therefore Qoptimum: is greater than equilibrium point.
    • Example: Immunizations, Restored historic buildings

Private Solutions to Externalities

  • Although externality causes market’s inefficiency, government service is not necessary to fix externalities.
  • Developing private solutions: -moral codes, -charitable organizations –incorporating variety of businesses –agreements between groups

Coase Theorem

: efficiency in economics of economic allocation, as well as solutions of externalities.
-when trade in externality, bargain is efficient.
-private bargaining may internalize outer effects.

Why Private Solutions do not always Work

  • In the real world, bargaining only works sometimes.
  • Transaction costs: cost earned during making economic exchange, in other words, through bargain.

Public Policies toward Externalities

command and control policy: Regulation

  • prohibit certain activities
    • Ex. Requirements on pollution production limitation by Environmental Protection Agency

  • require certain activities
    • Ex. All students should be immunized

Corrective Tax: taxing to decrease the amount of private decision makers with negative externality.

  • Government internalize externality by taxes and subsidies with social efficiency

Externality: the effect on the side when market affects each person rather than buyers and sellers of that market. It can change the market depending on whether it’s positive or negative. It causes market’s inefficiency. Government tries to eliminate them through policies like the command and control policy.

1. What can externality cause?
2. What are the two types of externalities?
3. Why can't coase theorem work?

1. Externalities may cause market failure and become inefficient
2. There are positive and negative externalities
3. Coase theorem might not work because private cost is too high