Microeconomics ch 10 externalities
Microeconomics ch 10 externalities ECON 211
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This 4 page Class Notes was uploaded by Addie Pearson on Sunday April 10, 2016. The Class Notes belongs to ECON 211 at Clemson University taught by prof fiore in Winter 2016. Since its upload, it has received 10 views. For similar materials see Micro Economics in Economcs at Clemson University.
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Date Created: 04/10/16
CHAPTER 10 ((extra practice problems online)) Recap: the efficiency of the equilibrium P and Q - The equilibrium price and quantity: o Goods are allocated to the buyers who value them the most o Goods are produced by sellers w lowest costs o Total surplus (gains from trade) is maximized - From the perspective of efficiency (i.e. gains from trade), as long as all benefits and costs are reflected in demand and supply, the equilibrium CANNOT BE IMPROVED UPON - Any different price, higher or lower, will result in LOWER total surplus (gains from trade) o Of course, specific groups or individuals may be made better off But what if all benefits and costs are not being taken into account? - What if some are external to the decision maker? o Then we have what is known as an EXTERNALITY o Externalities are an example of “market failure” In the presence of external cost or benefits, the market fails to maximize total gains from trade - the river ( a story) o meat packing plant located on a river; a rater enjoys rafting down the river while packing eat the plant drops wastes into the river this garbage lowers the enjoyment for the rafter o because some of the costs aren’t being counted, too much of the good is produced Qmarket > Qefficient Summing up external benefits and costs - we assume t at rational individiuals take into account the benefits and costs of their cations, and so act efficiently o i.e. act when MB > MC - but if some of the benefits or costs are instead borne by their priorities , the rational individual may not take them filly into account! o Still acts rationally based off of their own MB and MC - However, the fact that the rational individual does not take them into account DOES NOT MAKE THOSE BENEFITA AND COSTS GO AWAY! - They are simply eternal to the individuals decision - We say that such situations CREATE EXTERNALITIES - NEGATIVE EXTERNALITY: the “doer” does not bear the full cost of the action o There is a COST that is external to the doer’s decision making, so that the doer doesn’t take it into account o because some of the costs aren’t being counted, TOO MUCH of the good is produced Qmarket > Qefficient - POSITIVE EXTERNALITY: the “doer” does ot receive the full benefit of the action o There is a BENEFIT that is external to the doers decision making, so that the doer doesn’t take it into account o Bc soe of the benefits aren’t being counted, TOO LITTLE of the good is produced Qmarket < Qefficient - When there are externalities, the market outcome will be inefficient (there will be deadweight loss) Dealing with externalities: standard approach - Two most common policy responses 1. Quality reg 2. Taxation/subsidies 3. Either has to potential to induce the efficient level of output - Policy responses to negative externalites: o Q regulation: ban on texting while driving o Taxation: tax on alcohol Regulation and taxation Both reg and tax are intended to force the doer to internalize Taxation is generally preferred to a reg for this reason But just because there is an externality does not mean the situation can be improved upon Is there a better approach to externalities? - Why do externalities occur? o Bc there are costs and benefits not being taken into account - Why are there costs or benefits nto being taken into account? o Because there is something “unowned” - The ownership of a resource ensures its efficient use (the owner loses out otherwise) - If a resource is being used inefficiently (MB < MC) it must be that the user is not the “full” owner o And outside party is stuck absorbing some of the costs without being compensated, or gets to reap some of the benefits without having to compensate the doer Ownership and externalities - When property rights are well defined, trade is possible - Recall the river story: o If the rafter owns the river, can the meatpacker dump cow heads in Only if the rafter is COMPENSATED o If the meatpacker owns the river, can the rater pay it to not dump cow heads in? The rafter can! - The possibility of trade ensures the “doer” INTERNALIZES all costs and benefits - So, by clearly defining property rights and allowing trade, we can internalize externalities - Ex: the market for honey o While producing honey, bees pollinate nearby fruits and veggies o Benefit to nearby farms o In less than the efficient amount of honey produced because of these external benefits? No! farmers pay bee keeper for pollination o Property rights are well defined: Bee keepers own the bees Farmers own the fruit and veggies - Ex: tradeable pollution permits o Distribute a certain amount of pollution rights to each firm o Allow firms to trade pollution rights Firms who can reduce emissions at lower cost do more Firms for whom reducing emissions is very expensive do less o Given level of emission reduction achieved but at a lower total cost than requiring each firm to reduce pollution by the same amount Public goods and common resources - Extenalities are a particular problem with goods that you can’t stop others from using o Non- excludable goods - PUBLIC GOOD: a non-excludable good for which one person’s use does not reduce the amount left for another o Ex: plowing snow off the neighborhood roads Values of the public: $5000 per person Cost to do: $2000 per person o Is it efficient to plow the roads? Yes! (MB>MC) o But how do we fund it? What about people who refuse to pay? FREE RIDER: a person who receives the benefit of a good without paying for it When the cost of excluding free-riders is very high, less than the efficient quantity will be produced (POSITIVE EXTERNALITY) - COMMON RESOURCE: a non-excludable good for which one person’s use leaves that much less for everyone else o Examples: Great plain bison Deep sea fishing Global warming o Since no one takes into account the effect of their use on what’s left for others, more than the efficient amount will be done (NEGATIVE EXTERNALITY) o When goods are non-excludable, they will probably NOT be used efficiently o Tragedy of the commons o Failure to define property rights Great plain bison vs cows Sea fishing vs. fish farms END MATERIAL FOR EXAM 3
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