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Chapter 10

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Boston University
CAS EC 101

Chapter 10: Externalities - Externality: arises when a person engages in an activity that influences the well- being of a bystander and yet neither pays or receives any compensation for that effect o Negative externality o Positive externality o b/c buyers and sellers neglect the effects of their actions when deciding how much to demand or supply, the market equilibrium is not efficient when there are externalities o - Externalities and market efficiency o Welfare economics: a recap  In absence of government intervention, prices adjust to balance supply and demand • Is efficient b/c it maximizes the sum of producer and consumer surplus o Negative externalities  External cost higher than producer cost  Planner would choose the level of production at which the demand curve passes the social-cost curve  determines the optimal amount from the view of society as a whole  Below this level of production, the value to consumers exceeds social cost planner does not producer more than this level b/c the social cost of producing more exceeds the value to customers  Internalizing the externality: altering incentives so that people take into account of the external effects of their actions o Positive externalities  b/c social value is greater than private value, the social cost curve lies above the demand curve  optimal quantity is found where the social-value curve and the supply curve intersect - Public Policies toward externalities o Command and control polices: regulations  EPA o Market based policy 1: corrective taxes and subsidies  Corrective taxes: taxes enacted to deal with negative externalities • Idea
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