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ECON 101 NOTES: Externalities and types of goods

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Alexander Gainer

PUBLIC SECTOR EXTERNALITIES - Externality – a market failure Ex. A free market outcome is inefficient and total surplus is not maximized Gives government the opportunity to improve outcome - The solution is to internalize externalities NEGATIVE EXTERNALITY - Someone performs an action and does not bear all of the costs - Total social cost curve = private cost (supply curve) + external cost - The total social curve is above the supply curve - In a free market the quantity is above the socially optimal level Ex. Too much pollution or too much noise - New equilibrium is where the demand curve intersects the total social cost curve POSITIVE EXTERNALITY - Someone performs an action and does not receive all the benefits - Total social value curve = private value (Demand curve) + External value - The total social value curve is above the demand curve - In a free market (capitalism) there is not enough supplied Ex. Not enough compensation for research because other people will use your research - Below socially optimal - New equilibrium is where supply curve intersects the total social value curve GOVERNMENT POLICY 1. Corrective Taxes – designed to induce private decisions - The suppliers will take into account the social costs that negative externalities causes - Another name is Pigovian Tax - Ideal corrective tax is equal to the external cost - Give incentives - For taxes on pollutions, companies that have low abatement costs will reduce pollution to reduce burden, but companies that have a lot of pollution would rather pay the tax if it costs more to reduce pollution than the tax. 2. Subsidies – for positive externalities - Give incentives 3. Regulation - Inefficient compared to taxes - Requires a firm to do something, so people won’t have the incentive to do something Ex. If a firm is required to reduce x amount of pollution, they won’t reduce more than that amount because they aren’t benefiting. However, if a firm would get taxed for pollution, they will reduce as much as possible to pay as little as possible. 4. Tradable Pollution Permits
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