1、harcourt, inc. items and derived items copyright 2001 by harcourt, inc.externalitieschapter 10copyright 2001 by harcourt, inc.all rights reserved. requests for permission to make copies of any part of thework should be mailed to:permissions department, harcourt college publishers,6277 sea harbor dri

2、ve, orlando, florida 32887-6777.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.market efficiency - market failuresrecall that: adam smiths “invisible hand” of the marketplace leads self-interested buyers and sellers in a market to maximize the total benefit that society can d

3、erive from a market. but market failures can still happen.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.market failures: externalitiesuwhen a market outcome affects parties other than the buyers and sellers in the market, side-effects are created called externalities.uextern

4、alities cause markets to be inefficient, and thus fail to maximize total surplus.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.an externality arises. . . when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any

5、compensation for that effect.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.market failures: externalitiesuwhen the impact on the bystander is adverse, the externality is called a negative externality.uwhen the impact on the bystander is beneficial, the externality is called

6、a positive externality.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.uautomobile exhaustucigarette smokingubarking dogs (loud pets)uloud stereos in an apartment buildingexamples of negative externalitiesharcourt, inc. items and derived items copyright 2001 by harcourt, inc.u

7、immunizationsurestored historic buildingsuresearch into new technologiesexamples of positive externalitiesharcourt, inc. items and derived items copyright 2001 by harcourt, inc.the market for aluminum.quantity ofaluminum0price ofaluminumqmarketdemand(private value)supply(private cost)equilibriumharc

8、ourt, inc. items and derived items copyright 2001 by harcourt, inc.the market for aluminum and welfare economicsthe quantity produced and consumed in the market equilibrium is efficient in the sense that it maximizes the sum of producer and consumer surplus.harcourt, inc. items and derived items cop

9、yright 2001 by harcourt, inc.the market for aluminum and welfare economicsif the aluminum factories emit pollution (a negative externality), then the cost to society of producing aluminum is larger than the cost to aluminum producers.harcourt, inc. items and derived items copyright 2001 by harcourt,

10、 inc.the market for aluminum and welfare economicsfor each unit of aluminum produced, the social cost includes the private costs of the producers plus the cost to those bystanders adversely affected by the pollution.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.qmarketpollut

11、ion and the social optimum.quantity ofaluminum0price ofaluminumdemand(private value)supply(private cost)social costqoptimumcost ofpollutionequilibriumoptimumharcourt, inc. items and derived items copyright 2001 by harcourt, inc.negative externalities in productionthe intersection of the demand curve

12、 and the social-cost curve determines the optimal output level.uthe socially optimal output level is less than the market equilibrium quantity.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.achieving the socially optimal outputinternalizing an externality involves altering in

13、centives so that people take into account the external effects of their actions. harcourt, inc. items and derived items copyright 2001 by harcourt, inc.achieving the socially optimal outputthe government can internalize an externality by imposing a tax on the producer to reduce the equilibrium quant

14、ity to the socially desirable quantity. harcourt, inc. items and derived items copyright 2001 by harcourt, inc.positive externalities in productionwhen an externality benefits the bystanders, a positive externality exists.uthe social costs of production are less than the private cost to producers an

15、d consumers.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.positive externalities in productiona technology spillover is a type of positive externality that exists when a firms innovation or design not only benefits the firm, but enters societys pool of technological knowledg

16、e and benefits society as a whole.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.positive externalities in production.quantityof robots0priceof robotqoptimumdemand(private value)supply (private cost)social costqmarketvalue oftechnologyspilloverequilibriumoptimumharcourt, inc.

17、 items and derived items copyright 2001 by harcourt, inc.positive externalities in productionthe intersection of the demand curve and the social-cost curve determines the optimal output level.uthe optimal output level is more than the equilibrium quantity.uthe market produces a smaller quantity than

18、 is socially desirable. uthe social costs of production are less than the private cost to producers and consumers.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.internalizing externalities: subsidiesgovernment many times uses subsidies as the primary method for attempting to

19、internalize positive externalities.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.technology policygovernment intervention in the economy that aims to promote technology-enhancing industries is called technology policy.harcourt, inc. items and derived items copyright 2001 by

20、harcourt, inc.technology policyupatent laws are a form of technology policy that give the individual (or firm) with patent protection a property right over its invention. uthe patent is then said to internalize the externality.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.in

21、ternalizing production externalitiesutaxes are the primary tools used to internalize negative externalities.usubsidies are the primary tools used to internalize positive externalities.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.consumption externalities.quantity ofeducatio

22、n0price ofeducationqmarketdemand(private value)socialvalueqoptimum(b) positive consumption externalitysupply(private cost)quantityof alcohol0priceof alcoholqmarketdemand (private value)supply(private cost)social valueqoptimum(a) negative consumption externalityharcourt, inc. items and derived items

23、copyright 2001 by harcourt, inc.externalities and market inefficiencyu negative externalities in production or consumption lead markets to produce a larger quantity than is socially desirable.u positive externalities in production or consumption lead markets to produce a larger quantity than is soci

24、ally desirable.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.private solutions to externalitiesgovernment action is not always needed to solve the problem of externalities.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.types of private solutions to ex

25、ternalitiesumoral codes and social sanctionsucharitable organizationsuintegrating different types of businessesucontracting between partiesharcourt, inc. items and derived items copyright 2001 by harcourt, inc.the coase theoremthe coase theorem states that if private parties can bargain without cost

26、 over the allocation of resources, then the private market will always solve the problem of externalities on its own and allocate resources efficiently.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.transactions coststransaction costs are the costs that parties incur in the p

27、rocess of agreeing to and following through on a bargain.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.why private solutions do not always worksometimes the private solution approach fails because transaction costs can be so high that private agreement is not possible.harcou

28、rt, inc. items and derived items copyright 2001 by harcourt, inc.public policy toward externalitieswhen externalities are significant and private solutions are not found, government may attempt to solve the problem through . . .command-and-control policies.market-based policies.harcourt, inc. items

29、and derived items copyright 2001 by harcourt, inc.command-and-control policiesuusually take the form of regulations: uforbid certain behaviors.urequire certain behaviors.uexamples:urequirements that all students be immunized.ustipulations on pollution emission levels set by the environmental protect

30、ion agency (epa).harcourt, inc. items and derived items copyright 2001 by harcourt, inc.market-based policiesugovernment uses taxes and subsidies to align private incentives with social efficiency.upigovian taxes are taxes enacted to correct the effects of a negative externality.harcourt, inc. items

31、 and derived items copyright 2001 by harcourt, inc.examples of regulation versus pigovian taxif the epa decides it wants to reduce the amount of pollution coming from a specific plant. the epa couldtell the firm to reduce its pollution by a specific amount (i.e. regulation).levy a tax of a given amo

32、unt for each unit of pollution the firm emits (i.e. pigovian tax).harcourt, inc. items and derived items copyright 2001 by harcourt, inc.market-based policiesutradable pollution permits allow the voluntary transfer of the right to pollute from one firm to another. ua market for these permits will ev

33、entually develop.ua firm that can reduce pollution at a low cost may prefer to sell its permit to a firm that can reduce pollution only at a high cost. harcourt, inc. items and derived items copyright 2001 by harcourt, inc.the equivalence of pigovian taxes and pollution permits.quantity ofpollution0

34、price ofpollutionpqdemand forpollution rightspigoviantax(a) pigovian tax2. .which, togetherwith the demand curve,determines the quantityof pollution.1. a pigoviantax sets theprice ofpollution.quantity ofpollution0qdemand forpollution rightssupply ofpollution permits(b) pollution permitsprice ofpollu

35、tionp2. .which, togetherwith the demand curve,determines the priceof pollution.1. pollutionpermits setthe quantityof pollution.harcourt, inc. items and derived items copyright 2001 by harcourt, inc.summaryuwhen a transaction between a buyer and a seller directly affects a third party, the effect is

36、called an externality.unegative externalities cause the socially optimal quantity in a market to be less than the equilibrium quantity.upositive externalities cause the socially optimal quantity in a market to be greater than the equilibrium quantity.harcourt, inc. items and derived items copyright

37、2001 by harcourt, inc.summaryuthose affected by externalities can sometimes solve the problem privately.uthe coase theorem states that if people can bargain without a cost, then they can always reach an agreement in which resources are allocated efficiently.harcourt, inc. items and derived items cop

38、yright 2001 by harcourt, inc.summaryuwhen private parties cannot adequately deal with externalities, then the government steps in.uthe government can either regulate behavior or internalize the externality by using pigovian taxes.harcourt, inc. items and derived items copyright 2001 by harcourt, inc

39、.graphical reviewharcourt, inc. items and derived items copyright 2001 by harcourt, inc.the market for aluminum.quantity ofaluminum0price ofaluminumqmarketdemand(private value)supply(private cost)equilibriumharcourt, inc. items and derived items copyright 2001 by harcourt, inc.pollution and the social optimum.qmarketquantity ofaluminum0price ofa