What did you study last time?

CRC Microeconomics

What did you study last time? • Trade—an exporting country • Trade—an importing country • Arguments against trade CRC Microeconomics

Do you know … • what an externality is? • what different types of externalities are? • why externalities lead to social inefficiency? • what social efficiency means? CRC Microeconomics

A. General concepts CRC Microeconomics

1. An externality • is the uncompensated (spillover) impact of one person's actions on the well-being of a bystander. • occurs when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that impact. • e.g. late night party, flu shot, etc. CRC Microeconomics

2. What are the different types of externalities? a. Negative externalities - create adverse (bad) impacts. - e.g. exhaust from automobiles, barking dogs, etc. b.Positive externalities - create beneficial (good) impacts. - e.g. restored historic building, research into new technologies, etc. CRC Microeconomics

3. Why do externalities lead to social inefficiency? • When there are externalities, the market equilibrium fails to maximize the total benefit to society as a whole. • The market becomes socially inefficient. CRC Microeconomics

4. What is social efficiency? • Social efficiency occurs at Qsoc where the total net benefit (TNB) to society is maximized. • Define: • T = total; N = net; M = marginal • S = social; P = private; E = external • B = benefit; C = cost • e.g. TSB = total social benefit, • MEC = marginal external cost, etc. CRC Microeconomics

4. What is social efficiency? • Social efficiency occurs at Qsoc where the total net benefit (TNB) to society is maximized. a. Total approach TSB = TPB + TEB TSC = TPC + TEC TNB = TSB – TSC To maximize TNB, society produces Q*soc. CRC Microeconomics

4. What is social efficiency? b. Marginal approach MSB = MPB + MEB MSC = MPC + MEC MNB = MSB – MSC Maximizing TNB requires that MNB = MSB – MSC = 0 i.e. society produces Qsoc where MSB = MSC. Notes: MSB = Dsoc and MSC = Ssoc MPB = D and MPC = S CRC Microeconomics

5. What are the effects of externalities on markets? Positive externalities Negative externalities production consumption production consumption research education pollution cigarettes, alcohol, etc. TSC < TPC TSB > TPB TSC > TPC TSB < TPB Qe < Qsoc Qe < Qsoc Qe > Qsoc Qe > Qsoc where Qe = market output; Q*soc = socially optimal output CRC Microeconomics

B. Graphs CRC Microeconomics

B. Graphs • Perfect competition a. General case b. With no externalities • Production externalities a. Negative b. Positive c. Summary CRC Microeconomics

B. Graphs 3. Consumption externalities a. Negative b. Positive c. Summary 4. Market-based solutions to externalities a. Pigovian taxes b. Pollution permits c. Summary CRC Microeconomics

1a. Perfect Competition Given a perfectly competitive market, where D = MPB and S = MPC. P Perfect competition leads to market efficiency because TS = max. S = MPC E Pe D = MPB Q CRC Microeconomics Qe = Qmarket

1b. Perfect Competition with no Externality Suppose that there is no externality, i.e. Dsoc = MSB = D and Ssoc = MSC = S. P Perfect Competition + No externality => Social Efficiency (Optimum) S = MPC = Ssoc = MSC E = Esoc Pe = Psoc D = MPB = Dsoc = MSB Q CRC Microeconomics Qe = Qmarket = Qsoc = Qoptimum

2a. Negative Production Externality Suppose that there is negative production externality, i.e. Dsoc = MSB = D and Ssoc = MSC = S + MEC. Ssoc = MSC P Negative production externality => Social inefficiency; Qsoc < Qe MEC e.g. cost of pollution Esoc S = MPC Psoc E Pe D = MPB = Dsoc = MSB Q CRC Microeconomics Qsoc Qe

2b. Positive Production Externality Suppose that there is positive production externality, i.e. Dsoc = MSB = D and Ssoc = MSC = S + MEB. P Positive production externality => Social inefficiency; Qsoc > Qe S = MPC MEB E Pe Esoc Ssoc = MSC Psoc D = MPB = Dsoc = MSB Q CRC Microeconomics Qe Qsoc

2c. Production Externalities-Summary Ssoc P P S S MEC Ssoc Esoc MEB Psoc E E Pe Pe Esoc Psoc D D Q Q Qe Qsoc Qsoc Qe Positive Negative CRC Microeconomics

3a. Negative Consumption Externality Suppose that there is negative consumption externality, i.e. Dsoc = MSB = D - MEC and Ssoc = MSC = S. P Negative consumption externality => Social inefficiency; Qsoc < Qe S = MPC = Ssoc = MSC E Pe Psoc MEC Esoc D = MPB Dsoc = MSB Q CRC Microeconomics Qsoc Qe

3b. Positive Consumption Externality Suppose that there is positive consumption externality, i.e. Dsoc = MSB = D + MEB and Ssoc = MSC = S. P Positive consumption externality => Social inefficiency; Qsoc > Qe S = MPC = Ssoc = MSC Esoc Psoc E Dsoc = MSB Pe MEB D = MPB Q CRC Microeconomics Qe Qsoc

3c. Consumption Externalities-Summary P P Dsoc S S Esoc Psoc Dsoc E E Pe Pe Esoc Psoc MEB MEC D D Q Q Qe Qsoc Qsoc Qe Positive Negative CRC Microeconomics

Now you know … • what an externality is. • what the different types of externalities are. • why externalities lead to social inefficiency. • what social efficiency means. CRC Microeconomics

What will you study next? • What is the basic solution to externalities? • How do people deal with externalities? • How do governments deal with externalities? CRC Microeconomics

See You! Take Care! CRC Microeconomics

What did you study last time?