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Exercises

Exercises. Econ 304 Chapter 10. Do you know …. how externalities affect a market? why externalities cause social inefficiency? what governments do to deal with externalities?. Definitions. Market D = MPB S = MPC E = equilibrium point, where (MPB = D) = (MPC = S)

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Exercises

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  1. CRC Economics

  2. Exercises Econ 304 Chapter 10 CRC Economics

  3. Do you know … • how externalities affect a market? • why externalities cause social inefficiency? • what governments do to deal with externalities? CRC Economics

  4. Definitions • Market • D = MPB • S = MPC • E = equilibrium point, where (MPB = D) = (MPC = S) • Pe = market (equilibrium) price • Qe = market (equilibrium) output CRC Economics

  5. Definitions • Society • Dsoc = MSB = MPB + MEB = D + MEB • Ssoc = MSC = MPC + MEC = S + MEC • Esoc = social equilibrium point, where MSB = MSC • Psoc = social (equilibrium) price, or socially optimal price • Qsoc = social (equilibrium) output, or socially optimal output CRC Economics

  6. 1. How externalities affect a market? • No externalities • Negative production externalities • Positive production externalities • Negative consumption externalities • Positive consumption externalities • Exercises CRC Economics

  7. a. A market without externalities Suppose that originally the market looks like the graph below and that there are no externalities. P What is the market price? Market output? Socially optimal price? Socially optimal output? S = MPC = Ssoc = MSC E = Esoc Pe = Psoc = Dsoc = MSB D = MPB CRC Economics Q Qe = Qsoc

  8. No externalities, i.e. MEB = MEC = 0 • Dsoc = MSB = MPB + MEB = D + MEB = D • Ssoc = MSC = MPC + MEC = S + MEC = S • Esoc = E • Psoc = Pe • Qsoc = Qe • With no externalities, a free market is socially efficient. CRC Economics

  9. b. A market with externalities Suppose that originally the market looks like the graph below and that there are negative production externalities. P What is the market price? Market output? Socially optimal price? Socially optimal output? Ssoc = MSC S = MPC Esoc MEC Psoc E Pe = Dsoc = MSB D = MPB CRC Economics Q Qsoc Qe

  10. c. A market with externalities Suppose that originally the market looks like the graph below and that there are positive production externalities. P What is the market price? Market output? Socially optimal price? Socially optimal output? S = MPC MEB E Esoc Pe Ssoc = MSC Psoc = Dsoc = MSB D = MPB CRC Economics Q Qe Qsoc

  11. d. A market with externalities Suppose that originally the market looks like the graph below and that there are positive consumption externalities. P What is the market price? Market output? Socially optimal price? Socially optimal output? S = MPC Esoc = Ssoc = MSC Psoc E Pe Dsoc = MSB MEB D = MPB CRC Economics Q Qe Qsoc

  12. e. A market with externalities Suppose that originally the market looks like the graph below and that there are negative consumption externalities. P What is the market price? Market output? Socially optimal price? Socially optimal output? S = MPC = Ssoc = MSC E Esoc Pe Psoc MEC D = MPB Dsoc = MSB CRC Economics Q Qsoc Qe

  13. f. Exercises Suppose that originally the market looks like the graph below and that there are externalities. P Can you tell the type of externalities that affects this market? Qsoc < Qe => negative externalities Esoc on S => consumption S = MPC E Esoc Pe Psoc D = MPB CRC Economics Q Qsoc Qe

  14. f. Exercises Suppose that originally the market looks like the graph below and that there are externalities. P Can you tell the type of externalities that affects this market? Qsoc > Qe => positive externalities Esoc on D => production S = MPC E Esoc Pe Psoc D = MPB CRC Economics Q Qe Qsoc

  15. 2. Why do externalities cause social inefficiency? • Social efficiency occurs at Esoc, where (Dsoc = MSB) = (Ssoc = MSC) • At Esoc, society achieves socially optimal output Qsoc at socially optimal price Psoc. • The presence of externalities cause Qsoc to be different from Qe. CRC Economics

  16. With externalities, i.e. MEB <> 0 and/or MEC <> 0 • Dsoc = MSB = MPB + MEB = D + MEB <> D • Ssoc = MSC = MPC + MEC = S + MEC <> S • Esoc <> E • Psoc <> Pe • Qsoc <> Qe • With externalities, a free market is socially inefficient. CRC Economics

  17. 3. What governments do to deal with externalities? • Positive externalities => Qsoc > Qe, i.e. too little is being produced in markets. • Governments give subsidies to raise Qe. • Negative externalities => Qsoc < Qe, i.e. too much is being produced in markets • Governments impose taxes to reduce Qe. CRC Economics

  18. Summary Production externalities Consumption externalities Positive Negative Positive Negative MEB > 0 MEC > 0 MEB > 0 MEC > 0 Ssoc < S Ssoc > S Dsoc > D Dsoc < D Qsoc > Qe Qsoc < Qe Qsoc > Qe Qsoc < Qe Qe is too small Qe is too large Qe is too small Qe is too large Subsidies Taxes Subsidies Taxes CRC Economics

  19. See You! Take Care! CRC Economics

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