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Econ 224 Week 7 Chapter 10 Notes

by: Jaynie Buford

Econ 224 Week 7 Chapter 10 Notes Econ 224

Marketplace > University of South Carolina > Economics > Econ 224 > Econ 224 Week 7 Chapter 10 Notes
Jaynie Buford

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About this Document

These notes are very helpful for the upcoming Exam 2
Introduction to Economics
Class Notes
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This 7 page Class Notes was uploaded by Jaynie Buford on Thursday September 29, 2016. The Class Notes belongs to Econ 224 at University of South Carolina taught by Nigam in Fall 2016. Since its upload, it has received 4 views. For similar materials see Introduction to Economics in Economics at University of South Carolina.


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Date Created: 09/29/16
Externalities Chapter 10 ­Externality ▯ The uncompensated impact of one person’s actions on the well­being of a bystander ▯ Market failure ­Negative externality ▯ Impact on the bystander is adverse ­Positive externality ▯ Impact on the bystander is beneficial ­Market equilibrium ▯ Inefficient allocation of resources ▯ Buyers and sellers neglect the external effects of their actions when deciding how  much to demand or supply ▯ Fails to maximize the total benefit to society as a whole ­Government ▯ Protects the intersects of bystanders ­Welfare exonomics: recap ▯ Demand curve ­ value to consumers ­Prices they are willing to pay ▯ Supply curve ­ cost to suppliers ▯ Equilibrium quantity and price ­Efficient ­Maximizes sum of producer and consumer surplus ­Negative externalities ▯ Cost to society (of producing a good) ­Larger than the cost to the good producers ▯ Social cost ­Private costs of the producers (supply) ­Plus the costs to those bystanders affected adversely by the negative externality ▯ Social cost curve ­ above the supply curve ­Negative externalities ▯ Optimum quantity produced ­Maximize total welfare ­Smaller than market equilibrium quantity ­Government ­ correct market failure ▯ Internalizing the externality ­Altering incentives so that people take account of the external effects of their  actions ­Positive externalities ▯ Education (e.g. flu shot) ­Benefit of education ­ private ­Externalities: better government, lower crime rate, higher productivity and wages ▯ Social value ­ demand ­Higher than private value ▯ Social value curve ­Above demand curve ▯ Socially optimal quantity ­Greater than market equilibrium quantity ▯ Government ­ correct market failure ­Internalize the externality ­Subsidy ­Negative externalities ▯ Markets ­ produce a larger quantity than is socially desirable ▯ Government: tax ­Positive externalities ▯ Markets ­ produce a smaller quantity than is socially desirable ▯ Government: subsidy ­Example ­Technology spillover = positive externality ▯ Impact of one firm’s research and production efforts on other firms’ access to  technological advance ▯ Government: internalize the externality ­Subsidy = value of the technology spillover ­Industrial policy ▯ Government intervention in the economy that aims to promote technology ­  enhancing industries ­Patent law ▯ Protect the rights of inventors by giving them exclusive use of their inventions for a  period of time Public policies toward externalities 1. Command­and­control policies 1. regulate behavior directly 2. regulation 2. Market­based policies 1. provide incentives so that private decision makers will choose to solve the  problem on their own 1. corrective taxes and subsidies 2. tradable pollution permits Command­and­control policies ­Regulation ▯ Regulate behavior directly ­Making certain behaviors either required or forbidden ▯ Cannot eradicate pollution ▯ Environmental Protection Agency (EPA) ­Develop and enforce regulations ­Dictates maximum level of pollution ­Requires that firms adopt a particular technology to reduce emissions Market­based policies ­Corrective taxes and subsidies ▯ Corrective tax ­Induce private decision makers to take account of the social costs that arise from a  negative externality ­Places a price on the right to pollute ­Reduce pollution at a lower cost to society ­Raise revenue for the government ­Enhance economic efficiency Example ­Why is gasoline taxed so heavily? ­The gas tax = corrective tax ▯ Three negative externalities associated with driving ­Congestion ­Accidents ­Pollution ▯ Makes the economy work better ­Less traffic congestion, safer roads, and cleaner environment ­How high should the tax on gasoline be? ▯ Most European countries ­Higher gas tax than in the US ▯ 2007, journal of economic literature ­Optimal corrective tax on gasoline = $2.10 ­Actual tax in the US = $0.40 ­Tax revenue from the gasoline tax ▯ Used to lower taxes that distort incentives and cause deadweight losses ­Some government regulations ▯ Production of fuel­efficient cars ­ unnecessary Market­based policies ­Tradable pollution permits ▯ Voluntary transfer of the right to pollute from one firm to another ▯ New scarce resource: pollution permits ▯ Market to trade permits ▯ Firm’s willingness to pay ­Depend on its cost of reducing pollution ▯ Advantage of free market for pollution permits ­Initial allocation of pollution permits doesn't matter ­If firms can reduce pollution at a low cost ▯ Sell whatever permits they get ­If firms can reduce pollution only at a high cost ▯ Buy whatever permits they need ­Efficient final allocation ­Reducing pollution using pollution permits or corrective taxes ▯ Firms pay for their pollution ­Corrective taxes ­ pay to the government ­Pollution permits ­ pay to buy permits ▯ Internalize the externality of pollution (external cost into account) ­Objections to the economic analysis of pollution ▯ “We cannot give anyone the option of polluting for a fee” ­ by late senator edmund  muskie ­People face trade­offs ▯ Eliminating all pollution is impossible ▯ Clean water and clean air ­ opportunity cost ­Lower standard of living ­Clean environment ­ is a normal good ▯ Positive income elasticity ­Rich countries can afford a cleaner environment  ­More rigorous environmental protection ▯ Clean air and clean water ­ law of demand ­The lower the price of environmental protection ­The more the public will want it ­The types of private solutions ▯ Moral codes and social sanctions ▯ Charities / NGOs ▯ Self­interest of the relevant parties ­Integrating different types of businesses ▯ Interested parties can enter into a contract ­The Coase theorem ▯ If private parties can bargain without cost over the allocation of resources ­They can solve the problem of externalities on their own ▯ Whatever the initial distribution of rights ­Why private solutions do not always work ▯ High transaction costs ­Costs that parties incur in the process of agreeing to and following through on a  bargain ▯ Bargaining simply breaks down ▯ Large number of interested parties Coordinating everyone is costly


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