Richard Damra Wednesday, February 6, 2013
Econ 1B03 – Chapter 10
Now, consider the discovery of penicillin as treatment for STDs.
The drug not only helps those with an STD but also benefits all society by limiting their exposure
The discovery and production of penicillin has a positive externality.
The social value: includes not only the private value to those who take the drug but it also
includes the value to the rest of society
Market for Penicillin:
We should be buying a selling Q optimum not Q market.
The socially desirable level of out is greater than the market equilibrium level of output
In other words, we are not producing enough of the good.
If we produced more, there would be greater benefits for society.
The government can internalize the externality by subsidizing the production of the good – get
firms to supply more.
Government action is not always necessary.
The private sector can sometimes solve the problems of externalities.
o Moral codes and social sanctions. Most people don’t litter, due to morality (knows it’s
wrong). Boycott polluting producers.
o Charities encourage positive externalities. Greenpeace to protect the environment.
Alumni gifts to schools because education has a positive externality
o Contracts between parties. Two firms can make a deal Richard Damra Wednesday, February 6, 2013
The Coase Theorem
This is a proposition that if private parties can bargain without cost over the allocation of
resources, they can solve the externalities problem on their own.
However, property rights have to be well defined for bargaining