ECON 1B03 Chapter Notes - Chapter 10: Social Cost, Demand Curve, Externality

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29 Jul 2016
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10. Externalities
externalities: the uncompensated impact of one
person’s actions on the wellbeing of a bystander
a. negative externality: externalities that has an adverse
impact on the bystander
b. positive externality: externalities that have a
beneficial impact on the bystander
Externalities and Market Inefficiency
Negative Externalities
When there are negative externalities, it involves the private
costs along with the societal costs (the sum is known as the
social cost, a form of deadweight) which are represented as
the social cost curve
The social cost curve (social cost) is above that of the supply
curve (private cost)
The social optimum equilibrium is the point at which the
social cost curve meets the demand curve  lower Qoptimum
than Qmarket
internalizing the externality: altering incentives so
that people take account of the external effects of
their actions
a. negative externality  government should tax goods
b. positive externality  government should subsidize
goods
Positive Externalities
Education can create educated citizens that not only
contribute purely to their workplace but also to their
social groups and political contributions
When there are positive externalities, it involves the private
values along with the societal benefits (the sum is known as
the social value) which are represented as the social value
curve
The social value curve (social value) is above that of the
demand curve (private value)
The social optimum equilibrium is the point at which the
social value curve meets the supply curve  higher Qoptimum
than Qmarket
Public Policies Toward Externalities
Command-and-Control Policies: Regulation
The policymakers that impose pollution control have to
weigh out the costs and benefits of and to the society and
polluter to decide how much pollutants is acceptable
The difficulties of government regulation and management of
policymaking and information collection:
1. The details about the industry have to be known
2. The technological advancements requested to reduce
negative externalities have to be clearly understood
as well
Market-Based Policy I: Corrective Taxes and Subsidies
corrective taxes = Pigovian taxes: taxes enacted to
correct the effects of negative externalities
Ideal corrective taxes should be = to the difference between
the social cost curve and the private supply curve
Ideal corrective subsidies = external benefit
The reason why taxing is more effective than regulation to
control negative externalities:
1. it government can still regulate the amount of
negative externalities produced by taxing at the
appropriate level
2. different industries have a different capability to
reduce their negative externalities; one can reduce
substantially more than another and will choose to
do so
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