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AP Economics

AP Economics. Mr. Bernstein Module 75: Externalities and Public Policy January 15, 2014. AP Economics Mr. Bernstein. Externalities and Public Policy External benefits and costs can cause inefficiencies in the market

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AP Economics

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  1. AP Economics Mr. Bernstein Module 75: Externalities and Public Policy January 15, 2014

  2. AP EconomicsMr. Bernstein Externalities and Public Policy • External benefits and costs can cause inefficiencies in the market • Deadweight loss occurs when a market does not recognize the externality in equilibrium pricing and supplies too little or too much of a good • Some government policies to deal with externalities, such as emissions taxes, tradable emissions permits, and Pigouvian subsidies, are efficient • Other government policies, including environmental standards, are not

  3. AP EconomicsMr. Bernstein Policies Toward Pollution • Auto Emission Standards • Limits amount of crud going into the air • Tradable Pollution Permits (ie Cap and Trade) • Those who can efficiently reduce emissions sell permits to those who are less efficient at reductions • An equilibrium permit price is found when there are no more mutually beneficial transactions to be made • Same limit on amount of crud going into the air • Emissions taxes

  4. AP EconomicsMr. Bernstein S Popt Positive Externalities: Home Upgrades • Improves property values • MSB = MPB + MEB (Marginal Private plus External Benefits) • Equil: S crosses MPB • But society sees External Benefits and would pay Poptimal(MSB=MSC) Pmkt Subsidy Pcons MSB Price, MSB MPB Qmkt Qopt Qty, home improvements

  5. AP EconomicsMr. Bernstein S Popt Positive Externalities: Home Upgrades • Market underproduces vs. socially optimal outcome • Deadweight loss • Policy to eliminate: Pigouvian subsidy on each unit of home upgrade demanded pushes Q up Pmkt Subsidy Pcons MSB Price, MSB MPB Qmkt Qopt Qty, home improvements

  6. AP EconomicsMr. Bernstein MSC MPC Negative Externalities: Electricity • Electricity creates pollution • MSC = MPC + MEC • Equil: D crosses MPC • But society would actually pay higher MSC at Qmkt! • Socially optimal result is where D crosses MSC Popt Tax Pmkt Pfirm Price, MSC D Qopt Qmkt Electricity

  7. AP EconomicsMr. Bernstein MSC MPC Negative Externalities: Electricity • Market overproduces vs. socially optimal outcome • Deadweight loss • Policy to eliminate: Pigouvian tax on each unit of electricity demanded pushes Q up Popt Tax Pmkt Pfirm Price, MSC D Qopt Qmkt Electricity

  8. AP EconomicsMr. Bernstein Network Externalities • Value of a product depends on how many others use product • Example: Facebook

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