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Chapter 10 Note.docx

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University of Ottawa

Chapter 10 Externalities Negative externality any negative spillover cost stemming from a production activity that is imposed on a party other than the decision maker Decision maker does not face the external cost Example a crack house operating next to a day care centre or a pulp and paper mill upstream from a fishery Positivity externality any positive spillover benefit stemming from a production activity that is imposed on a party other than the decision marker The decision marker does not reap the external benefit Example OC transpo and stores near the transit wayBoth positive and negative externalities cause market failure in the form of an inefficient level of output Efficiency means that total surplus is maximized at the level of production Equivalently the marginal benefit which is the consumers willingness to pay for the last unit equals the supplies valuation of the last unit which is the cost of production The implication is that in the presence of an externality that efficient level of output is not attained PolutionWhat is the optimal level of output for a polluting firm Typical the polluting firm produces something that is valued by consumers so some output and therefore some pollution as a byproduct should be produced The polluting firm doesnt care the costs that t is imposing on others as these costs are external to its decision process It makes its choices based on its own marginal benefit and the costs that is faces The costs that is imposes on others are
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