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Chapter 10

Chapter 10 Economics.docx

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Economics 10a
Gregory Mankiw

Chapter 10 Economics: Externalities • Externality: the uncompensated impact of one person’s actions on the well-being of a bystander o Negative externality: if the side effect is adverse  Exhaust from automobiles b/c it creates smog; drivers pollute too much, so the government taxes gasoline to reduce the amount that people drive o Positive externality: if the side effect is beneficial  Restored historic buildings b/c people who walk by them get to enjoy the beauty and history of the building; many governments regulate the destruction of old buildings (which benefits the owners) by providing tax breaks to owners who restore them o Because buyers and sellers neglect the negative external effects of their actions when deciding how much to demand or supply, the market equilibrium is not efficient when it comes to externalitiesthe equilibrium fails to maximize the total benefit to society • The height of the demand curve shows the willingness to pay of the marginal buyer (the value to the consumer of the last unit bought) • The height of the supply curve shows the cost to the marginal seller (the cost of producing the last unit sold) • Because of the negative externality, the cost to society of producing the good is larger than the cost to the producers o The social cost includes the private cost of producers o The social cost curve is above the supply curve because it takes into account the external costs imposed on society by the production of the good (with the negative externality)  The difference of these curves is the cost of the externality o The optimal level of the good with the negative externality is the place at which the demand curve crosses the social-cost curve  Below this, the value of the good to the consumers exceeds the social cost of producing the good  Above this, the social cost of the producing the good exceeds the value to consumers o Q Market Q Optimumthis inefficiency occurs because market equilibrium reflects only the private costs of production o Aplanner could achieve the optimal outcome by taxing the producers by an amount that accurately reflected the external cost of the externality  This is called internalizing the externality: alerting incentives so that people take account of the external effects of their actions • Positive Externality: educationnot only does education yield a more productive worker who earns higher wages, but it also leads to more informed voters, a lower crime rate, and better dissemination of technological advances o Beause the social value is greater than the private value, the social-value curve lies above the demand curve o The optimal quantity is found where the social-value curve and supply curve (the cost to society) intersect  The socially optimal quantity is greater than the quantity determined by the private market o The government can correct the market failure (meaning the distance between Q Market and Q Optimum by internalizing the externality through a subsidy  Case in point: education is heavily subsidized • Summary of Positive and Negative Externalities: o Positive externalities lead markets to produce a smaller quantity than what is socially desirable o Negative externalities lead markets to produce a larger quantity that is socially desirable o To fix these market failures, the government can internalize the externality by taxing goods that have negative externalities and subsidizing goods that have positive externalities • Technology spillover: a type of positive externality in which the impact of one firm’s research and production efforts on other firms’access to technological advance o The government subsidizes industries or provides tax breaks for research and development in order to promote technology spillover o Patent protection also internalizes the externality by giving the firm a property right over its inventions, effectively incentivizing research and other activities that advance technology • All public policies regarding externalities share the goal of moving the allocation of resources toward the social optimum, thereby increasing efficiency • Command-and-control policies: regulate behavior directly by making certain behaviors required or forbidden o Society has to way the costs and benefits to decided the types and quantity of pollution that it will allow • Market-based pol
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