Externalities and Environmental Policy

1. Externalities and Environmental Policy Chapter 5

2. Externalities • 1. Hubbard, p.138: “Externality- A cost or benefit that affects someone who is not directly involved in the production, or consumption of a good or service. • Negative externality- the impact is adverse (smoking). • Positive externality- the impact is beneficial (Immunization).

3. Private Versus Public Cost or Benefit) • 2. A private cost is incurred by the individual seller taking part in some economic activity. • A private benefit realized by the individual buyer taking part in some economic activity. • For example, you realize (incur) either a benefit or a cost when you buy a pizza for lunch. • The benefit occurs when your hunger is satisfied and the cost is incurred when you pay for it.

4. Public Benefits Versus Public Costs • 3. Public ( social) benefits or costs are the sum of the benefits realized or costs incurred by all members of society. • Public(social) benefits = private benefit + external benefit (Education) • Public (social) cost = private cost + External cost (Cigarette consumption)

5. Externalities 4. External costs = social costs – private costs • External costs in production • External cost in consumption External benefits= social benefits – private benefits • External benefits in production • External benefits in consumption

6. 5. Negative Externality in the Production of Aluminum Cost of pollution Marginal Social cost =MSC Price of Aluminum Marginal Private cost=MPC D=MPB=MSB Q Q Tons of aluminum opt p

7. 5. Negative Externality in Consumption Price of Alcohol MPC=MSC Qty of alcohol Cost of alcohol MPB MSB Q Q opt p

8. 5. External Benefit in Production Value of technology spillover MPC Price of Robot MSC MPB=MSB Q Q Qty of robots p opt

9. Positive Externality in Consumption Price of Education MPC=MSC Benefits of education MSB MPB Q Q p Qty of Education opt

10. Public policies Toward Externalities • Regulation • The Clean Air Act, 1970 and amended in 1977 and 1990 • The Clean Water Act, 1972 and amended in 1977 • Taxes and subsidies • Tax Polluters • Subsidize pollution abatement • Create tradable pollution permits (emission trading or cap and trade which is a form of carbon pricing right to emit pollutants) Note: (Coase Theorem- The argument that if transactions costs are low, private bargaining will result in an efficient solution to the problem of externalities p. 141).