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Externalities, Environmental Policy, and Public Goods

by: Caitrín Hall

Externalities, Environmental Policy, and Public Goods ARE 1150

Marketplace > University of Connecticut > Agricultural & Resource Econ > ARE 1150 > Externalities Environmental Policy and Public Goods
Caitrín Hall
GPA 3.9

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About this Document

These notes cover chapter 5 material.
Principles of Agriculture & Resource Economics
Emma Bojinova
Class Notes
Economics, Microeconomics, outline
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This 4 page Class Notes was uploaded by Caitrín Hall on Wednesday April 13, 2016. The Class Notes belongs to ARE 1150 at University of Connecticut taught by Emma Bojinova in Spring 2016. Since its upload, it has received 20 views. For similar materials see Principles of Agriculture & Resource Economics in Agricultural & Resource Econ at University of Connecticut.

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Date Created: 04/13/16
Chapter 5 Externalities, Environmental Policy, and Public Goods Externality – a benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service 5.1 Externalities and Economic Efficiency  Private cost – the cost borne by the producer of a good or service  Social cost – the total cost of producing a good or service, including both the private cost and any external (third party) cost  Private benefit – the benefit received by the consumer of a good or service  Social benefit – the total benefit from consuming a good or service including both the private benefit and any external benefit  There are positive and negative externalities  Vertical distance between S a1d S or 2 and 1 = ext2rnality cost  When there is a negative externality in producing a good/service, too much of the good/service will be produced at market EQ o Q >MQ efficient o Economic surplus is reduced by the deadweight loss  When there is a positive externality in consuming a good or service, too little of the good or service will be produced at market EQ o Q <MQ efficient o MB > MC  deadweight loss  Market failure – a situation in which the market fails to produce the efficient level of output What causes externalities?  Property rights – the rights individuals or businesses have to the exclusive use of their property, including the right to buy or sell it  Externalities and market failures result from incomplete property rights or from the difficulty of enforcing property rights in certain situations 5.2 Private Solutions to Externalities: The Coase Theorem The Economically Efficient Level of Pollution Reduction  Completely eliminating a externality usually is not economically efficient  To maximize net benefit to society, pollution should be reduced up to the point where MB = MC The Basis for Private Solutions to Externalities  Coase emphasized that when more than the optimal level of pollution is occurring, the benefits from reducing the pollution to the optimal level are greater than the costs Do Property Rights Matter?  In the absence of utilities being legally liable, victims have incentive to pay the utilities to reduce pollution up to the point where MB = MC  If utilities are legally liable, they have incentive to pay the victims of pollution so they can still pollute up to the same amount  As Coase pointed out, it does not matter who owns the property rights: o Because MB and MC of pollution reduction would not change, the result will be the same efficient level of pollution reduction o Either side will pay to reduce pollution up to the point where MB = MC The Problem of Transaction Costs  Transaction costs – the costs in time and other resources that parties incur in the process of agreeing to and carrying out an exchange of goods/services The Coase Theorem – the argument of economist Ronald Coase that if transactions costs are low, private bargaining will result in an efficient solution to the problem of externalities  In general, private bargaining is most likely to reach an efficient outcome if the number of parties bargaining is small  In practice, private solutions to the problem of externalities will occur only if all parties to the agreement have full information about the costs and benefits associated with the externality, and all the parties must be willing to accept a reasonable agreement 5.3 Government Policies to Deal with Externalities  Providing a disincentive to the firm reduces production to bring Q Market to Q efficient o Ex: the government imposes a tax on an electricity company equal to the cost of acid rain  utilities internalizes the externality by reducing production  – Externality  demand of tax = vertical distance between S & S o1 D 2 1 & D 2  + Externality  amount of subsidy = vertical distance between D & D 1 2 or S1& S 2  Pigovian taxes and subsidies – government taxes and subsidies intended to bring about an efficient level of output in the presence of externalities Command-and-Control vs. Market-Based Approaches  Command-and-control approach – an approach that involves the government imposing quantitative limits on the amount of pollution firms are allowed to emit or requiring firms to install specific pollution control devices  Market-based approach = cap-and-trade system of tradable emissions allowances 5.4 Four Categories of Goods  Rivalry – the situation that occurs when one person’s consuming a unit of a good means no one else can consume it  Excludability – the situation in which anyone who does not pay for a good cannot consume it  Private good – a good that is both rival and excludable  Public good – a good that is both non-rival and non-excludable o Free riding – benefiting from a good without paying for it  Quasi-public goods – goods that are excludable but not rival  Common resource – a good that is rival but not excludable The Demand for a Public Good  To find the demand curve for a public good, add up the price at which each consumer is willing to purchase each quantity of the good  The optimal quantity of a public good is produced where the sum of consumer surplus and producer surplus is maximized Common Resources  Tragedy of the commons – the tendency for a common resource to be overused Is There a Way Out of the Tragedy of the Commons?  The source of the tragedy of the commons is the same as the source of negative externalities: lack of clearly defined and enforced property rights  When enforcing property rights is not feasible  2 types of solutions are possible: 1. If the geographic area involved is limited and # of people involved is small, access to the commons can be restricted through community norms and laws 2. If the geographic area or # of people involve dis large, legal restrictions through taxes, quotas, and tradable permits on access to the commons are required


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