Class Notes (839,091)
Canada (511,184)
Economics (1,511)
EC120 (577)

Chapter 10 Externalities

2 Pages

Course Code

This preview shows 80% of the first page. Sign up to view the full 2 pages of the document.
KEITHD IAZ Chapter 10 – Externalities  Externality: the uncompensated impact of one’s actions on the well-being of a bystander.  Internalizing externality: altering incentives so people take account of external effects of actions  It is difficult to be efficient if there are a lot of interested parties  transaction costs = difficult  Optimal value = social value  not always equilibrium Community Surplus  When a market is in equilibrium, with no external influences/effects, it’s in a state of Pareto optimality: it’s impossible to make someone better off without making someone worse off. This does not mean everyone is equal. The market is socially efficient: community surplus is maximised.  At any lower Q, social value > costs, and any higher Q, the cost of the last unit > social value.  S is private cost, and D is private value  Supply = marginal social cost (MSC)  marginal cost to whole community (including externalities)  Demand = marginal social benefit (MSB) marginal benefit to whole community (including externalities) Existence of externalities  Externality occurs when the production/consumption of a good/service affects a third party  MPC (marginal private cost): private supply curve that is based on the firm’s costs of production. MSC = MPC +/- any external cost/benefit of production.  MPB (marginal private benefit): private demand curve that is based on the utility/benefits to consumers. MSB = MPB +/- any external cost/benefit of consumption.  Thus, if no externalities exist in a market, MSC = MSB and there’s social efficiency and maximum community surplus. If externalities exist, MSC does not equal MSB, so there is market failure. 1) Negative externalities of production: when the production of a good/service creates external costs. MSC > MPC. The firm is only concerned with its private costs, and will produce at market equilibrium, not optimal (where MSC = MSB), so there is market failure. Too much is produced for too low a price. There is a welfare loss = yellow triangle. Total cost to society is between MSC and Qmkt, so F + G + B + C + H. Q mkt Qopt Change Consumer surplus F + G + B + C + H D - (A + B + C) Producer surplus E – (B + C + H) A + E A + B + C + H = (E + F + G) – TC Total surplus D + A + E – H D + A + E H 2) Positive externalities of production: production creates external benefits. The firm produces below socially efficient level. There is a potential welfare gain shown by the triangle, where MSB > MSC. A. Subsidize the cost. MPC shifts right by subsidy, to MSC 3) Negative externalities of consumption: when products are consumed, they negatively affect third parties. Hence, MSB < MPB. But consumers consume at Q1 (MSC = MPB), ignoring negative externality (triangle). Hence, they over-con
More Less
Unlock Document

Only 80% of the first page are available for preview. Some parts have been intentionally blurred.

Unlock Document
You're Reading a Preview

Unlock to view full version

Unlock Document

Log In


Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.