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6.EXTERNALITIES

6.EXTERNALITIES. 6.1. Definition. Economic Activities Externalities Effect of activities of an individual or a firm upon others (individuals, firms and environment) whereby the source does not take into account the produced effect in its business decision. 6.2.Externalities and Environment.

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6.EXTERNALITIES

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  1. 6.EXTERNALITIES

  2. 6.1. Definition Economic Activities Externalities Effect of activities of an individual or a firm upon others (individuals, firms and environment) whereby the source does not take into account the produced effect in its business decision

  3. 6.2.Externalities and Environment • Economic activities • Externalities • Environment degradation • Solution?

  4. 6.3. The Problems of Externalities • Two Types of Externalities • Positive externalities  e.g. fresh air • by Kebun Raya Bogor • Negative externalities •  e.g. air pollution by • angkot • Problem over production of goods generating negative externalities • Problem  undersupply • of goods generating • positive externalities

  5. 6.4. Negative Externalities: Problem of Over Production of Goods Generating Negative Externalities Price Socially Optimum MSC Supply Curve Ps MPC Pm Demand Curve MB Qs Qm Note: Qm > Qs

  6. 6.5. Positive Externalities: Problem of Under Supplyof Goods Generating Positive Externalities Price Socially Optimum MSB MPB MPC Ps Pm Qm Qs Note: Qm < Qs

  7. 6.6. Alternative Solutions to Negative Externalities • Public Sector Solution • Private Sector Solutions • Internalization of externalities • Market Based Solutions • Assignment of Property Right (Coase Theorem) • Direct Regulation

  8. 6.7. Internalization of Negative Externalities • Forming a neighborhood association to make collective agreement and enforcement • For instance, • Case of a housing complex that wants to control pollution Potential Constraints • Transaction cost • Cost of making and enforcing agreement can be substantial • Free rider problem • Pollution-free environment has the character of public goods

  9. 6.8. The Coase Theorem: Assignment of Property Rights • The Root of Problem • Absence of property rights • See a case of air pollution by smokers • Assignment of property rights • If smokers is given the right to smoke, non-smokers would have to ‘bribe’ smokers to persuade them to reduce level of smoke that they release into air • If the right was granted to non- smokers, smokers have to ‘bribe’ to make them become willing to accept some degree of smoke Again, the ‘bribe’ becomes • a restraining factor for • smokers to smoke • For smokers, potential ‘bribe’ becomes the cost of releasing smoke • This cost becomes a restraining factor for them when smoking

  10. 6.9. The Coase Theorem: Limitations • Transaction cost • Free rider problem • Negotiation consumes time and efforts • Outcome has the character of public goods • If many involve, negotiation can be very costly or even too costly

  11. 6.10. Public Sector Solution to Negative Externalities • Market-based solutions • Direct regulation • Taxes • Subsidization of abatement technology • Marketable permits (not to be • discussed here) • Performance-based regulations • Input regulations

  12. 6.11. Taxation Solution to Negative Externalities Price Socially Optimum MSC Supply Curve Ps Tax MPC Pm Demand Curve MB Qs Qm • Impose tax such that so as MSC = MPC + tax • Production not at Qm, but at Qs Note: Qm > Qs

  13. 6.12. Pollution Abatement Subsidy Solution to Negative Externalities • Instead of taxing, government persuade a polluter to use abatement technology • to control level of • pollution that it dispose off MSCbs MB MSCas MPCbs MPCas • MSCbs = MSC before subsidy • MSCas = MSC after subsidy • MPCbs = MPC before subsidy • MPCas = MPC after subsidy • Q1 = efficient level with no subsidy • Q2 = efficient level with subsidy • Q3 = Output before subsidy • Q4 = Output after subsidy Q3 Q4 Q1 Q2 • Inefficiency is still persistent, but, at lower level

  14. 6.13. Direct Regulations • Input Regulation • Performance-based regulation • e.g. regulation on automobile pollution emission Taxed if exceeding the limit • Prohibited Uses of certain inputs e.g. smoking • Compulsory uses of certain inputs • e.g. Pollution abatement devices

  15. 6.14. Readings • Stiglitz, Joseph E. 2000. Economics of the Public Sector. New York, USA: W.W. Northon and Company. Chapter 9. • Mangkoesoebroto, Guritno. 1999.”Ekonomi Publik”. Yogjakarta: BPFE. Chapter 6

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