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Chapter 5

ECO2023 Chapter Notes - Chapter 5: Coase Theorem, Deadweight Loss, Economic Equilibrium

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John Slattery

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Microeconomics Chapter 5 Externalities, Environmental Policies and Public Goods
Pollution is one example of an externality
o A benefit or a cost that affects someone who is not directly involved in the production
or consumption of a good or service
Competitive market does well producing economically efficient quantity of a good or service,
but not when there is an externality in the market
When there is a positive externality, the market may produce a quantity that is less than the
efficient among
o Government interventions in the economy can reduce economic efficiency
When externalities are in play, it may increase efficiency and enhance the well-
being of a society.
5.1 Externalities and Economic Efficiency
o The Effect of Externalities
Externalities interfere with the economic efficiency of a market equilibrium
A competitive market achieves economic efficiency by maximizing the sum of
consumer surplus and producer surplus
Externality can cause a difference between the private cost of production and
social cost
Private cost cost borne by the producer of a good or service
Social cost total cost of producing a good or service, equal to private
cost plus any external cost
Externality can cause a difference between the private benefit from
consumption and social benefit
Private benefit benefit received by the consumer of a good
Social benefit total benefit from consuming a good or service, equal to
the private benefit plus any external benefit
o How a Negative Externality in Production Reduces Economic Efficiency
S1 is the market supply curve and represent sonly the private costs that utilities
have to bear in generating electricity
Supply curve represents the marginal cost because firms will supply an
additional unit of good only if they receive a price equal to the
additional cost of producing that unit.
If utilities had to bear the cost of pollution the supply curve will be S2
Market equilibrium is no longer efficient, only the efficient equilibrium
If economic surplus is at max. the net benefit to society from the production of
the good or service is at max.
With equilibrium of quantity of Q efficient, economic surplus is at max., and the
equilibrium is efficient
Equilibrium quantity of Q market, economic surplus is reduced to deadweight
loss, the equilibrium is no efficient
Deadweight loss occurs because the supply curve is above the demand
curve for production of units between Q efficient and Q Market
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