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Chapter 16

Chapter 16- Externalities

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Economics 1021A/B
Michael Parkin

Chapter 16- Externalities in Our Lives • externality- a cost or benefit that arises from production and falls on someone other than the producer, or a cost or benefit that arises from consumption and falls on someone other than the consumer • cost- negative externality • benefit- positive externality Negative Production Externalities congestion, pollution, carbon emission • CONGESTION • costs of congestion are time costs and fuel costs • drivers spend extra hours sitting in stalled traffic, burning additional fuel POLLUTIONAND CARBON EMISSION • economic activity pollutes air, water and land • these individual areas of pollution interact through the ecosystem AIR POLLUTION • 60% of our air pollution comes from road transportation and industrial processes • 20% arises from electric power generation • in many developing countries, air pollution is getting worse • rapid economic development of China has created serious air quality problem for Beijing • air pollution in the world’s richest countries is getting less severe for most substances • air pollution levels have been on a downward trend for more than 30 years • carbon emissions and emissions of other global warming gases are on the increase • carbon dioxide concentration in the Earth’s atmosphere is increasing at an unprecedented pace costs of air pollution and carbon emission are high and widespread • • sulphur dioxide and nitrogen oxide emissions from coal-fired and oil-fired generators of electric utilities cause acid rain • airborne substances such as lead from leaded gasoline are believed to cause cancer • depletion of the ozone layer exposes us to higher doses of cancer-causing ultraviolet rays from the sun • increased carbon concentration is bringing global warming • road vehicles can be made “greener” with new fuels • pollution-free electricity can be generated by harnessing wind power, solar power, tidal power or geo-thermal power • nuclear power is good for air pollution but creates potential long-term problem for land and water pollution WATER POLLUTION • dumping of industrial waste and untreated sewage and the runoff from fertilizers pollute oceans, lakes and rivers • two main alternatives to polluting the waterways and oceans- chemical processing of waste to render it inert or biodegradable, use land sites for storage in secure containers LAND POLLUTION • arises from dumping toxic waste products • ordinary household garbage does not pose a pollution problem unless contaminants from dumped garbage seep into the water • recycling- attractive alternative incineration is a high-cost alternative and produces air pollution • • these alternatives are not free Negative Consumption Externalities • smoking tobacco creates fumes • banning smoking imposes a negative consumption externality on smokers • majority imposes a cost on the minority • noisy parties and outdoor rock concerts are other examples • examples of the fact that a simple ban on an activity is not a solution Positive Production Externalities • a honey farmer places beehives beside an orange grower’s orchard Positive Consumption Externalities • flu vaccination generates positive consumption externalities • education, restoring historic building Negative Externalities: Pollution Private Costs and Social Costs private cost of production is a cost that is borne by the producer of a good or service • • marginal private cost (MC) is the cost of producing an additional unit of a good or service that is borne by the producer of the good/service • external cost is a cost of producing a good or service that is not borne by the producer but by other people • marginal external cost is the cost of producing an additional unit of a good/service that falls on people other than the producer • marginal social cost (MSC) is the marginal cost incurred by the producer and by everyone else on whom the cost falls- by society • sum of marginal private and marginal external costs • MSC= MC + Marginal external cost • express costs in dollar • a cost is an opportunity cost-something real is given up to get something VALUING AN EXTERNAL COST • economists use market prices to put a dollar value on the cost of production EXTERNAL COSTAND OUTPUT • marginal cost curve, MC, describes the marginal private cost borne by the firms that produce the chemical • marginal cost increases as the quantity of chemical produced increases • when the quantity of a chemical produced increases, the amount of pollution increases and the marginal external cost of pollution increases • shows the relationship between the quantity of chemical produced and the cost of the pollution it creates, but it doesn’t tell us how much pollution gets created • quantity depends on how the market for the chemical operates Production and Pollution: How Much? • when an industry is unregulated, the amount of pollution it creates depends on the market equilibrium price and quantity of the good produced • supply curve is the marginal private cost curve because when firms make their production and supply decisions, they consider only the costs that they will bear • must count all the costs- private and external- when we compare marginal social benefit and marginal social cost • with an external cost, the allocation is efficient when marginal social benefit equals marginal social cost • unregulated market overproduces and creates a deadweight loss Property Rights • sometimes it is possible to reduce the inefficiency arising from an externality by establishing a property right • property rights- legally established titles to the ownership, use and disposal of factors of production and goods and services that are enforceable in court • with property rights in place, MC curve no longer measures all the costs that the factories face in producing the chemical • excludes the pollution costs that they must now bear • MSC curve now becomes the marginal private cost curve • all costs fall on the factories, so the market supply curve is based on all the marginal costs and the curve is labelled MC=MSC THE COASE THEOREM • the proposition that if property rights exist, if only a small number of parties are involved, and if transactions costs are low, then private transactions are efficient • no externalities because the transacting parties take all the costs and benefits into account • it doesn’t matter who has the property rights • Coase solution works only when transaction costs are low • transactions costs are the opportunity costs of conducting a transaction • in many situations, transactions costs are so high that it would be inefficient to incur them, Coase solution is not available transactions costs that block a market solution are real costs, so attempts by government to deal • with externalities offer no easy solution Government Actions in the Face of External Costs TAXES • government can use taxes as an incentive for producers to cut back on pollution • taxes used in this way are Pigovian taxes • Arthur Cecil Pigou- economist who first worked out this method of dealing with externalities during the 1
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