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ECON 1B03 (303)
Chapter 10

Chapter 10

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Usman Hannan

CHAPTER 10: EXTERNALITIES - externality: the uncompensated (does not pay or receive) impact of one person’s actions on the well- being of a bystander - positive externality if it is beneficial, negative externality if it is not - government tries to implement laws or taxes to help benefit the bystanders Externalities and Market Inefficiency Negative Externalities - the cost to society of producing is higher than the cost to the producers - for each unit of a product produced the social cost includes the private costs of the producers plus the costs to those bystanders affected - the difference between the social cost curve and the supply curve reflects the cost of the externality - optimal equilibrium from the standpoint of society as a whole is where the social cost curve crosses the demand curve > reducing production and consumption below market equilibrium raises total economic well-being - measure the value of increase in economic well-being by using the deadweight loss concept > the triangle formed by Qmarket (supply to social cost) to new equilibrium Qoptimum - consumers lose surplus, producers gain surplus - internalizing the externality: alter incentives so that people take account of the external effects of their actions (i.e. placing a tax to shift the supply curve enough so it is at the social cost curve) - market quantity larger than socially desireable Positive Externalities - social value curve lies above demand curve - includes private value (the direct value to buyers) and external benefit (value of the positive impact on buystanders) - leads markets to produce a smaller quantity than is socially desirable - government subsidizes goods (pays for part of cost to aid buyer) Public Policies Towards Externalities - government responds to externalities in 2 ways > 1) command and control (regulates behavior directly) 2) market-based policies (provide incentives so that they will choose to solve the problem on their own) Command and Control Prices: Regulation - makes certain behaviours required or forbidden - government regulators must know details about specific industries and alternati
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