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Lecture #13 - Oct 31.docx

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Department
Economics
Course
Economics 1021A/B
Professor
Michael Parkin
Semester
Fall

Description
Nicole Wallenburg Economics Mr. Parkin Oct 31, 2011 Economics – Lecture #13 Externalities in our Lives An externality is a cost or benefit that arises from production and falls on someone other than the producer. Or a cost or benefit that arises from consumption and falls on someone other than the consumer A negative externality imposes a cost and a positive externality creates a benefit  Negative production externality  Positive production externality  Negative consumption externality  Positive consumption externality Negative Production Externalities  Very common  Examples: o Noise from trucks and aircrafts o Polluted rivers and lakes o The destruction of animals habitats o Air pollution in major cities from auto exhaust Positive Production Externalities  Less common than negative production externalities  Example: o Two examples arise in honey and fruit production. o By locating honeybees next to a fruit orchard, fruit production gets an external benefit from the bees, which pollinate the fruit orchards and boost fruit output; and honey production gets an external benefit from the orchards Negative Consumption Externalities  Common part of every day life  Example: o Smoking in a confined space posed health risks to other o Noisy parties or loud music disturb others Positive Consumption Externalities  Common part of every day life  Example: o When you get a flu vaccine, everyone you come in contact with benefits Nicole Wallenburg Economics Mr. Parkin Oct 31, 2011 Negative Externalities: Pollution Private Costs and Social Costs A private cost of production of production is a cost that is borne by the producer, and marginal private cost (MC) is the private cost of producing one more unit of a good or service An external cost of production is a cost that is not borne by the producer, but is borne by others. Marginal external cost is the cost of producing one more unit of a good or service that falls on people other than the producer. Marginal social cost is the marginal cost incurred by the entire society – by the producer and by everyone else who the cost falls – and is the sum of marginal private cost and marginal external cost MSC = MC + Marginal external cost We express cost in dollars but remember that the dollars represent the value of a forgone opportunity. Marginal private cost, marginal social cost, and marginal external cost all increase with output. Figure 16.1 illustrates the MC curve, the MSC curve, and marginal external cost as the vertical distance between the MC and MSC curves. Production and Pollution: How Much? In the market for a good with an externality that is unregulated, the amount of pollution created depends on the equilibrium, quantity of the good produced. Figure 16.2 shows the equilibrium in an unregulated market with an external cost. The quantity produced is where marginal private cost equals marginal social benefit. Nicole Wallenburg Economics Mr. Parkin Oct 31, 2011  At the market equilibrium, MSB is less than MSC, so the market produces an inefficient quantity.  At the efficient quantity, marginal social cost equals marginal social benefit.  With no regulation, the market overproduces and creates a deadweight loss. Property Rights Externalities arise because of the absence of property rights Property rights are legally established titles to the ownership, use, and disposal of factors of production and the goods and services that are enforceable in the courts.  Figure 16.3 illustrates how the establishment of property rights achieves an efficient outcome.  The polluter bears all the costs.  The market is efficient because at the quantity produced MSC equals MSB. The Coase Theorem The Coase Theorem is a proposition that is property rights exists, only a small number of parties are involved, and transactions costs are low, than private transaction costs are efficient. There are no externalities because all parties take into account the externalities involved. The outcome is independent of who has the property rights.  The Coase theorem only works if transaction costs are low  Transaction costs are the cost of conducting a transaction  Example: o The transaction costs of buying a home includes fee of a realtor, a mortgage loan advisor, and legal assistance When a large number of people are involved in an externality and transaction costs are high, the Coase solution of establishing property rights doesn’t work and the government try to deal with the externality. Nicole Wallenburg Economics Mr. Parkin Oct 31, 2011 Government Actions in the Face of External Costs There are 3 main methods that governments use to cope with external costs  Taxes o The government can set a tax equal to marginal external cost o The
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