Externalities

1. Externalities Environmental Economics Honors C.A.D.

2. Objectives • Define and give examples describing the concept of an “externality” • Describe how taxes can be used to discourage negative and encourage positive externalities

3. Review • What is environmental economics? • Cost/benefit analysis • “Tragedy of the Commons” • The dilemma of ownership

4. What’s the Similarity? • A farm uses a pesticide that contaminates the groundwater, forcing the neighboring farm to install water purifiers. • A factory dumps waste into a river, killing off fish stocks and destroying the income of fishermen. • A beekeeper keeps bees for honey, and the flowers and plants in his neighbor’s garden thrive. • Children go to school, and because they are there and not on the streets, crime is lower.

5. The Answer • These are all EXTERNALITIES. • An externality is an unintentional side effect of an activity affecting people that aren’t directly involved. • Positive – means it beneficial • Negative – means it was harmful • In all the previously examples, there was a “third party” that was affected in some way that had nothing to do with the original situation.

6. Countering Externalities • Free rider – someone who gains benefits without paying the cost. • Pigouvian taxes – taxes to discourage harmful externalities and subsidies to encourage good ones • When you think of carbon taxes and subsidies for more efficient cars, think here • Coase’s Theorem – allow people to bargain to get rid of externalities

7. Negative Externalities • Two ways of combating negative externalities: cap and trade and individual transferable quotas (ITQ’s) • Cap and trade – “trade your pollution” • ITQ – similar to cap and trade, but for things like fisheries