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Externalities - Chapter 4

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Ciaran Fitzpatrick

on 25 October 2012

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Transcript of Externalities - Chapter 4

Actions of the consumer or producer gives rise to positive/negative side-effects to a third party. Externalities Positive Externality
Negative Externality Positive Externalities are also known as spillover benefits. Negative Production
Externalities Negative Production Externalities:
Spillover costs created by Producers.
Enviromental pollution is an example. Correcting Negative Production Externalities If the Negative Production Externality could be corrected, the Qopt amount of jeans & dye would be produced.
At this point, there would be allocative efficiency If the effect on the third-party creates a benefit. Negative Externalities are also known as a Spillover Cost. If the action involves adverse or negative effects to a third party. The Demand Curve is thought of as "Marginal Private Benefit" or MPB.
Benefit the consumer derives from consuming the good. The Supply Curve reflects the firms cost of production. It represents the "Marginal Private Costs" If there is an Externality additional benefits & costs arise.
"Marginal Social Benefit": align with MPB
"Marginal Social Costs": align with MPC In our jean example from the previous class represented a Negative Externality in Production.

Why? Because:
Additional costs that spillover onto citizens.
Water pollution
Affects drinking water Supply curve represents "MPC"
Firms private cost of production "MSC" represents the cost to the citizens through pollution of the water. VERTICAL distance between "MSC" & "MPC"represents the spillover costs.
Costs associated with the Negative Externality. The free market gives rise to a quantity where "MPC"intersects "MPB"
Produce Quantity "m" Where "MSC"interests "MPC":
Represents the socially optimal production point. Several options exist to try an correct the overallocation of resources to the production of jeans. Legislation & Regulations
Limit the emission of pollutants
Limit the quantity of output produced by the firm
Require firms to implement new technologies to limit pollutants. Goal of Regulation & Legislation is to shift the "MPC"curve towards the "MSC"curve thus moving closer to the Socially optimal amount of production. Imposing taxes on the firm causing the Negative Production Externality As we know, taxes are a determinant of supply. This will shift the S (MPC) to the left and closer to the "MSC" Tradable Permits:
Permits issued by governments that permit firms to pollute.
They can be traded and sold.
Allowed to produce a certain amount of pollution. Negative Consumption Externalities Negative Consumption Externalities:
Spillover costs created by consumers Last class we talked about smoking being a Negative Consumption Externality.

Why? Spillover cost exists because when an individual smokes, there are spillover costs in the form of second-hand smoke. When there is a Consumption Externality:
MPB is either above or below the MSB. Negative Consumption Externality:
MSB is below the MPB
Vertical distance between MSB & MPB equal the spillover cost. Free Market Quantity produced:
Where MPB intersects MPC
This intersection is equal to the free market Quantity produced Socially Optimal Quantity:
Where MSB intersects MPC Exists and overallocation of resources to the consumption of cigarettes Can you think of any examples of Negative Consumption Externalities? Correcting Negative Consumption Externalities If a Negative Consumption Externality exists the goal is to decrease the MPB (demand) or decrease MPC (supply). Options include:
Advertising & persuasion
Try and persuade smokers to buy fewer smokes.
Goal is to decrease MPB (demand). Legislation & Regulations:
Aimed at preventing consumer activities.
Example: banning smoking in public places.
Looks to decrease MPB - moving it closer to MSB Imposing a tax on the firm producing the good:
Aim is to decrease the MPC (S) moving the curve to the left till it intersects with the socially optimal quantity for the good. Open Access Resources & their Overuse Open access resources:
Natural Resources that have no ownership & are subject to overuse.
Lack of ownership lies at the heart of the overallocation of resources to these goods. Examples:
Pastures, forests, water or the atmosphere.

Overuse of these goods represents a problem in sustainable development which we discussed in Chapter 1 Ways to address Open Access Resource Negative Externalities :
Legislation & Regulation
Advertising & Persuasion
Tradable Permits Extension of Property Rights:
Because no one owns these "goods", consumers and producers treat them as if they were free goods.
Zero opportunity cost
They are subject to scarcity & therefore have an opportunity cost. Examples of Property Rights:
Right to clean air
Right to smoke-free environment

Anyone who violates these rights is subject to pay for them.

The spillover cost would become a private cost
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