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Externalities

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by

Sven B

on 10 October 2012

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Transcript of Externalities

Externalities as a Market Failure Definitions Benefits or costs that affect someone who is not directly participating in the production or consumption of the good or service (Hubbard et al. 2011) Externality A situation in which the market fails to produce the efficient level of output (Hubbard et al. 2011) Market Failure Evaluation of the effects of externalities as market failures

Basic model of supply and demand Demand Quantity Price Demand (D) = Marginal Benefit (MB)
Assumption: ceteris paribus ('all else being equal')
Increasing price leads to a decrease of the quantity demanded Supply Quantity Price Supply (S) = Margina Cost (MC)
Assumption: ceteris paribus ('all else being equal')
Increasing price leads to an increase of the quantity supplied Market equilibrium Analysis - Demand/Supply Analysis - Demand/Supply P1/Q1 in equlibrium
Consumer surplus (area A) at its maximum (consumer net benefit)
Producer surplus (area B) at its maximum (producer net benefit)
Economic efficient (net benefit for society) Problem of externalities: discrepancy between social and private costs/benefits might be existent Analysis - Demand/Supply - Externalities Social/Private costs/benefits Social costs/benefits take additionally to the private costs/benefits external costs (externalities) for society into account

Might occur through production or consumption

Negative externalities crucial for the debate of global climate change

Concentration on negative externalities
Social costs > Private costs (Production Externalities)
Social benefits < Private benefits (Consumption Externalities) Internalisation Price S = MC D = MB Definitions Definitions Quantity D S P1 Q1 A B Quantity Price D S = MC P1 Q1 A B Analysis - Demand/Supply - Negative Externalities - Production P2 C D E F G H S = SC Q2 Negative production externalities cont. Policies force producer to internalise externalities
P2 > P1
Q2 <Q1
Equilibrium
Economic surplus
(A+B) > (A+B-H)
[Internalised] > [Not internalised]

No deadweight loss
Economic efficient Analysis - Demand/Supply - Negative Externalities - Production Social costs (SC) are higher than private costs (PC)
Social cost curve shifts to the left
Economic surplus (net benefit) changes from area
A+B+C+D+E+F+G
to
A+B+C+D+E+F+G - (C+D+E+F+G+H)
= A+B-H
Economic inefficient
Deadweight loss of H Quantity Price D S = PC P1 Q1 A B P2 C D E F G H S = SC Q2 Negative production externalities Examples Analysis - Demand/Supply - Negative Externalities - Production Negative production externalities cont. References References Hacket, Steven C. 2010. Enviromental and Natural Resources Economics- Theory, Policy, and the Substantial Society. 4th ed. M. E. Sharpe Inc.

Hubbard, Garnett, Lewis and O’Brien. 2011. Microeconomics. 2nd ed. Australia: Pearson.

Mankiw, N. Gregory. 2006. Principles of Microeconomics. 4th ed. Thompson South-Western. Pollution

Greenhouse gas emissions

Waste disposal Quantity Price D = PB S P1 Q1 A Analysis - Demand/Supply - Negative Externalities - Consumption P2 Q2 Negative consumption externalities Social benefits (SB) are lower than private benefits (PB)
Private benefit curve shifts to the left
Economic surplus changes from area
A+B+C+D+E+F+G+H
to
A+B+C+D+E+F +G +H
- (A+C+D+F+G+I)
= B+E+H-I
Economic inefficient
Deadweight loss of I B D = SB D E F G C H I Quantity Price D = PB S P1 Q1 A Analysis - Demand/Supply - Negative Externalities - Consumption P2 Q2 Negative consumption externalities Policies make consumers to internalise externalities
P2 < P1
Q2 < Q1
Economic surplus
B+E+H > B+E+H-I
[Internalised] > [Not Internalised]

No deadweight loss
Economic efficient B D = SB D E F G C H I Internalise Analysis - Demand/Supply - Negative Externalities - Consumption Examples Negative consumption externalities Fuel consumption

Alcohol consumption Analysis Summary Negative externalities cause deadweight loss
Production/consumption caused irrelevant
Economic inefficiency
Society is worse off without any internalisation
How to internalise?
Government intervention
Voluntary regulation
Full transcript