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Externalities

Externalities. Econ 10 Holmes. Test volume. Big Idea. So far: non-shareable goods only Hamburgers, T-shirts, etc. You are studying for big test and your roomie listens to “Hate Tank” by Method of Destruction. How much quality studying will you get done?. You get the idea.

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Externalities

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  1. Externalities Econ 10 Holmes Test volume

  2. Big Idea So far: non-shareable goods only Hamburgers, T-shirts, etc. You are studying for big test and your roomie listens to “Hate Tank” by Method of Destruction. How much quality studying will you get done? You get the idea...

  3. External economies When the consumption of a good affects people other than those consuming it, then we say that the good has “externalities” (or spillover effects). In this case, your roomie’s “music” affects your ability to study. (Compare with your roomie eating a hamburger-you are not affected). Note not necessarily negative: suppose neighbors like my roses.

  4. Key features • People do not incorporate the external costs (if negative) or external benefits (if positive) of the good. • Thus, social welfare is not maximized when individuals make their own decisions.

  5. Examples • Pollution: firms “make too much” [Gary] • Noise: w/out quiet hours, neighbors of MOD might never sleep • Cigarettes: I lose my voice when you smoke • etc.

  6. Public Goods Suppose you have a good that people cannot be prevented from enjoying consumption by one does not affect others’ consumption Nonexcludability Nondepletability Examples: public park, fireworks, concert in Central Park, etc. How much can seller get? (How much would you pay to watch the sunset?) A: nothing. These are called public goods. Circus with a tent: private (excludable) Circus without a tent: public (nonexcludable) [Wrigley Field]

  7. A continuum Most goods lie somewhere in between... Private Goods (all to consumer) Public Goods (benefit to all) National Defense Fire Department Hamburgers Massages Education Education: higher wage, enjoy learning (ha!) more educated populace, more productive

  8. Negative Externality Steel SC P MC But there is an external cost to society: pollution adds $10 to each unit $23 $20 Where will firms go? Where is society best? D DWL: loss due to overproduction 80 100 Q

  9. Practice Problem Compare and contrast DWL for monopoly and DWL for external economy.

  10. Table For steel... Suppose external cost is $30. Apply excise tax techniques. Market eq. (ME) will tend to $30, 300. SO is $50, 200.

  11. Graph of example Steel SC P MC But there is an external cost to society: pollution adds $30 to each unit SO $50 ME $30 Where will firms go? Where is society best? D DWL: loss due to overproduction 200 500 Q

  12. How can we get the ME to the SO? What does this graph look like? Suppose we imposed an excise tax of $30. Where would we end up? Practice Problem: Why do we impose an excise tax on cigarettes? What should the tax be if the external cost is $.50/pack? What form does the external cost take?

  13. What about a positive externality? Suppose I grow roses and you enjoy looking at them (even though you don’t pay). The social benefit is thus greater than the private benefit.

  14. Graph: positive P DWL MC Social benefit SB D (private benefit) Q DWL is loss due to underproduction.

  15. Table: Positive Education. Suppose education adds $30 in external benefit.. SB: Social Benefit At a SB of $40, $10 is private demand==> same D as at $10.

  16. Graph:Positive MC P SB has a higher Q for each P $40 $30 SB D 300 400 Q

  17. How do we convince private agents to act in public interest? We need to make the private agents internalize the external benefit. How to accomplish? How did we do this with negative externalities? Answer: Give subsidies. Examples: Student Loans Tax breaks for using natural gas in your car Awards for “best lawn”

  18. Practice Problems • Define externality. Give an example of negative (positive) externalities, clearly stating the external cost (benefit). • Define public good. What are the two key features of a public good? Why do government typically produce these? Discuss with examples. • Sketch a graph of a positive (negative) good. Show ME, SO, and DWL. Discuss what DWL means in each case. • Policy Relevance: Why do gov’ts offer cheap public transport?

  19. PP, continued Suppose we know that for cigarettes, the external cost per pack is $.75. 1. Find the ME, SO. 2. Sketch, including DWL. 3. Discuss DWL. 4. How can the gov’t make the SO the ME?

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