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ECON 200
Peter Coughlin

Discussion Notes 12. Tax revenue= T*Q T inc (10%) P inc (5%)  Q dec (4%) Measuring Elasticity ­ Initial point method ­ E= (% change in Q)/ (% change in P) ­ = [(Q2­Q1)/ Q1]/ [(P2­P1)/(P1)] ­ Midpoint method (Q1,P1)  (Q2, P2) • = (Q2-Q1)/ [(Q2+Q1)/2] •   (P2­P1)/(P2+P1)/2] Ex. Initial point method (E is price elasticity of demand?) lEl= 2 P1= $1, P2= $1.03 Q demanded will rise or fall? And by how much? 2= %Q/ .03 Q=.06 (fall by .06) b/c P was increasing so Q decreases ­ Using midpoint method lEl= 2. What’s going to happen to Q if P inc by .1% 2=Q/.1 Q=.2% dec Perfectly inelastic- vertical Lecture- 10/29/13 Chapter 10- Externalities Decisions of self-interested buyers/ sellers in perf competitive market where no gov intervention, end up maximizing total surplus that can be obtained from market. Markets are inefficient in some cases ­ When markets fail to produce efficient outcome, called market failure (fails to max total surplus) ­ Whenever there is a market failure, there is a potential role for government as its intervention may achieve efficiency ­ In some markets, decision of one agent (individual or firm) will affect well-being of another agent Ex. Steel firm produces steel AND pollution Sometimes, firms/ individuals don’t bear all of consequences or reap all of rewards of their actions ­ If costs of an agent’s decision aren’t entirely paid by benefits are not entirely reaped, we say an externality exists When does externality occur ­ When person/ firm engages in activity that influences well- being of a bystander butt bystander neither pays nor receives compensation for the side-effect Negative externalities-impose costs on others (steel firm belch poisonous fumes and create neg externality, but doesn’t have to pay for cost imposed on others) Positive externalities- an externality providing benefits to others ­ Firm using pollution- abatement equipment creates pos externality When there is no government intervention in a market, a neg/ pos externality can cause market to be inefficient The benefit from an additional unit of g/s that consumer of that g/s receives will be called “private value” ­ Another term for willingness to pay of a marginal buyer ­ Demand curve shows private value- price buyers wiling to pay The cost of producing additional unit of g/s borne by producer of g/s wil be called “private cost” ­ Cost borne by marginal seller ­ Supply curve shows private cost (costs directly incurred by sellers) Market equilibrium would maximize sum of consumer and producer surplus The cost to bystanders affected adversely by neg externality, called “external cost” (those producing polluted air and end up w/ lung ailments) Ex. Market for gasoline- Good w/ negative externality (*graph on paper) ­ External cost= cost of neg impact on bystanders= $1 per gallon (monetary value of harm from congestion, accidents, pollution) ­ Social Cost (the total cost of sellers and all others) = private+ external cost • Pick a random Q (=25), social cost is one unit higher than what have on supply curve Evaluating market equilibrium: Our measure of society’s well-being= consumer surplus + producer surplus – total external cost ­ The quantity above that maximizes our measure of society’s well- being will be called a “socially optimal quantity” (or a social optimum) ­ The socially optimal quantity is determined by the intersection of demand curve and the social- cost curve ­ In example, socially optimal quantity is less than the market equilibrium quantity • A good w/ neg externality is overproduced by market b/c when let market operate and sellers concerned w/ maximizing profits and consumers search for best deal, then some of social costs of producing good are not taken into account by firm actually producing the good • Cost of society> private cost to firm, and it is the private cost figures into how much the market produces  sellers only worry about their own costs ­ The gov could potentially improve market outcome by altering the sellers’ incentives in a way that gets them to take external effects of their actions into account ­ Altering incentives so that decision makers take account of the external effects of their actions is called internalizing the externality ­ Impose tax on sellers shifts supply curve ($1 gallon tax on seller would shift S curve up $1) as inc cost to sellers, and makes seller’s costs EQUAL to the social costs (S’ curve=social cost curve) When market participants must pay the social costs Market equilibrium Q= socially optimal Q Sales tax= social costs, same effect on market participants (so imposing tax on buyers would also get the market eq Q to be equal to optimal Q) Ex. Federal gas tax is 18.4 cents per gallon, and MD gas tax is 23.5 cents per gallon Example of a positive externality Ex. Being vaccinated against contagious disease protects not only you, but people who visit the salad bar or produce section after you ­ Supply curve (private cost- cost on sellers) and demand curve (private value- price willing to pay by marginal buyer) ­ Impact on bystanders who are affected beneficially by positive externality called external benefit ­ Market equilibrium max consumer + producer surplus Social value= private value + $10 external benefit  so add $10 to demand curve Socially optimal quantity is determined by intersection of supply curve and social value curve ­ Socially optimal Q= 25, w/o intervention is 20, sooo socially optimal Q is greater than market equilibrium Q ­ Good w/ pos externality genetrates greater social benefit at margin than is reflected in marketplace, os is underproduced by market • Gov could improve market outcome by internalizing the externality • One solution is having $10/ shot subsidy for buyers, shift D curve up $10, so D curve in same position as social value and market equilibrium Q= 25 Lecture Notes 10/31/13[ Chapter 10 Externalities continued… Approaches used by Gov. 1. Market based policies – take advantage of natural forces in markets provide incentives so private decision makers end up solving the problem on their own (ex. corrective taxes and subsidies) a. subsidize- make something less expensive for consumers (useful b/c can make more of good) 2. Command and Control policies- regulate behavior directly (something is wrong dictate policy to correct) a. Limits on quan
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