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Textbook Notes - Oct 31.docx

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Economics 1021A/B
Michael Parkin

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Nicole Wallenburg Economics Mr. Parkin Oct 30, 2011 Economics – Textbook Notes Externalities in Our Lives An Externality is a cost of a 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. An externality that imposes a cost is a negative externality and an externality that provides a benefit is a positive externality.  Negative Production Externalities  Negative Consumption Externalities  Positive Production Externalities  Positive Consumption Externalities Negative Production Externalities The most costly and widespread negative production externalities are:  Congestion o Drivers on the 401  Time costs and fuel costs  Pollution and Carbon Emission o Running air conditioning o Using hot water o Taking a trip by car, train, or plane  Contributes to pollution and increases your carbon footprint o Types of Pollution  Air Pollution  Cars  Water Pollution  Dumping waste in water  Land Pollution  Dumping toxic waste on the land Negative Consumption Externalities Negative consumption externalities are a source of irritation for most of us  Smoking tobacco in a confined space o To deal with this, most places ban smoking o This causes a negative consumption externality on smokers  Noisy parties and outdoor concerts o To deal with this they could ban loud music o This causes a negative consumption externality on party-goers  The majority imposes a cost on the minority Positive Production Externalities  If a honey farmer places beehives beside an orange grower’s orchard, two positive production externalities arise o The honey farmer gets a positive production externality from the orange grower because the bees collect pollen and nectar from orange blossoms Nicole Wallenburg Economics Mr. Parkin Oct 30, 2011 o The orange grower gets a positive production externality because the bees pollinate the blossoms Positive Consumption Externalities  When you get the flu vaccination, you lower your risk of getting infected this winter o But if you avoid the flu, your neighbour who didn’t get vaccinated has a better chance of avoiding it too  When the owner of an old building restores it, everyone who see the building gets pleasure from it Negative Externalities: Pollution To study the economics of the negative externalities that arise form pollution, we distinguish between the private cost and the social cost of production. Private Costs and Social Costs A private cost of production is a cost that is borne by the producer of a good or service. Marginal cost is the cost of producing an additional unit of a good or service. Marginal private cost (MC) is the cost of producing one more unit of a good or service that is borne by the producer of that good or service An external cost is a cost of producing a good or service that is not borne by the producer but borne by other people. A marginal external cost is the cost of producing an additional unit of a good or 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. MSC = MC + Marginal External Cost  Valuing an External Cost o Economics use market prices to put dollar value on the cost of pollution  External Cost and Output o The marginal cost curve, MC, describes the marginal private cost borne by the firms that produce the chemical 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.  The 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.  With an external cost, the allocation is efficient when marginal social benefit equals marginal social cost o The unregulated market overproduces, and a deadweight loss is created Nicole Wallenburg Economics Mr. Parkin Oct 30, 2011 Property Rights Property rights are legally established titles to the ownership, use, and disposal of factors of production and goods and services that are enforceable in the courts.  Suppose that the chemical factor owns the river and the 500 homes alongside it  The chemical factories are now confronted with the cost of their pollution – forgone rent from the people who live by the river o The MSC curve now becomes the marginal private cost curve MC. All the costs fall on the factories, so the market supply curve is based on all the marginal costs and the curve is now labelled S=MC=MSC The Coase Theorem The coase theorem is the proposition that if property rights exist, if only a small number of parties are involved, and if transaction costs are low, then private transactions are efficient. There are no externalities because the transacting parties take all the costs and benefits into account.  The quantity of chemical produced and the amount of waste dumper are the same whoever owns the home, river/land/air o If the factories own them, the bear the cost of pollution because they receive a lower income from home rents o If the residence own the homes and the river the factories bear the
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