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Lecture 11

ECO105Y1 Lecture Notes - Lecture 11: Passive Smoking, Social Cost, Marginal Cost

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Avi Cohen

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Lecture 11 ECO105
Externalities are integral for traffic congestions, environmental issue discussions
Whe eteralities eist, pries do’t reflet all soial osts ad eefits; arkets fail to
coordinate private smart choices with social smart choices
DDT harmful carcinogenic so there have been efforts to ban it. However, it is the most
important in killing mosquitos in Africa Every choice has an opportunity cost, and
there is a tradeoff which can be affected by externalities
Negative Externalities external costs/costs to society from your private choice that
affect others, but you do not pay. You have a transaction, but there are consequences
external to you, affecting others e.g. second-hand smoke, noisy parties, mid-90s Ottawa
trip updated to business class and disturbed by party
Positive Externalities benefits that your private choices give without cost to others
e.g. vaccinations protect YOU and as more people get it the slower the disease spreads,
taking the TTC gets you to places while also helping the environment and other drivers
What’s oo to oth eteralities is the asee of propert rights i.e. o oe has
property rights over the atmosphere, air. This is:
o Tragedy of the commons the overuse and depletion of a resource that no one
can be excluded from because of missing property rights. Named after a
Medieval England grazing practice in a publicly owned field, and because no one
owned it, everyone used it without thinking about the cost of grazing too much.
This is also what happened in the East Coast fishery where nobody has property
o Free riders people who use a resource without paying. This happens in group
work when one person free rides off another
Whe eteralities eist, pries do’t reflet all soial osts and benefits, and markets
fail to produce efficient outcomes. Instead markets produce if osts do’t reflet all of
the osts, ad if eefits do’t reflet all the eefits, ou a’t ake a sart hoie.
Too many products and services with negative externalities (second-hand smoke,
pollution, traffic jams)
Too few products and services with positive externalities (vaccinations, education)
For an efficient market outcome:
Choose the quantity of output where MARGINAL SOCIAL COST equals
Efficient pollution balances the additional environmental benefits of lower pollution
with additional opportunity costs of reduced living standards. There is a cost to reducing
pollution, so how do you find a treadeoff?
Marginal social cost (MSC) = marginal private cost plus marginal external cost along
with the cost of the decision to YOU, you had the cost it will have on society
o Marginal external cost = the price of preventing or cleaning up damage to others
external to the original activity negate the damage of the decision
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Marginal social benefit (MSB) = marginal private benefit (MB) plus marginal external
o Marginal external benefit =
Pulp Market
A negative externality because of acid rain
Demand Column Marginal Benefit curve view which gives the price for each quantity.
Shows the principal of diminishing returns/diamond-water paradox. It follows basic law
of demand. In this section, the marginal social benefit is the same as marginal private
benefit because the latter is zero i.e. you are not benefitting society
Supply Column - Increasing marginal cost as a business increases its output and needs to
receive a higher price to cover all opportunity costs. It follows basic law of supply.
Marginal social cost is always greater than the private cost so this shows that marginal
external cost is $30 i.e. every extra pulp would require $30 to prevent the
environmental damage it could cause
Demand Curve = Marginal Benefit = Marginal Social Benefit
Supply Curve = Marginal Cost Curve
At $80, intersection of demand and supply, will be the equilibrium
Now, if you consider a marginal social cost (the red graph), the space between this and
the supply curve would be your marginal social cost. Now, the socially optimal outcome
would be where the demand curve/marginal social benefit is interested with the
marginal social cost curve i.e. at $100.
Market outcome is inefficient if you take ALL COSTS into account
If polluters are forced by government to pay the marginal external costs of their
pollution, this internalizes the externalities/costs into private choices, creating smart
social choices. Take those costs/benefits and make them into something individuals
have to pay for.
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