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Chapter 7 Notes: Externalities

by: Devon Black

Chapter 7 Notes: Externalities Econ 10A

Marketplace > Harvard University > Economics > Econ 10A > Chapter 7 Notes Externalities
Devon Black
Harvard University

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About this Document

First chapter of unit 4; start of second midterm material
Principles of Economics
N. Gregory Mankiw
Class Notes
Economics, Microeconomics, externalities, externality, Taxes
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This 2 page Class Notes was uploaded by Devon Black on Saturday October 1, 2016. The Class Notes belongs to Econ 10A at Harvard University taught by N. Gregory Mankiw in Fall 2016. Since its upload, it has received 4 views. For similar materials see Principles of Economics in Economics at Harvard University.

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Date Created: 10/01/16
Principles of Economics, 7 th ed. Chapter 10: Externalities I) Externalities and Market Inefficiency A) Welfare Economics: A Recap B) Negative Externalities 1) Create a second supply curve known as the social cost curve that is to the left of the original supply curve (a) While Q* is the original equilibrium, the optimal Q is less than Q* because of the social cost (b) Q* is actually an inefficient quantity 2) Generally, taxes are used to move the quantity from the market quantity to the optimum quantity 3) Cause overproduction of the good C) Positive Externalities 1) Creates a second demand curve known as the social value curve that is to the right of the original supply curve 2) Subsidies move the quantity to the market quantity 3) Cause under-production of the good II) Public Policies toward Externalities A) Command and Control Policies: Regulation B) Market-Based Policy 1: Corrective Taxes and Subsidies 1) Tax on undesirable behavior is just as effective as regulation (a) Also raises money if they don’t stop polluting 2) Totally elastic C) Market-Based Policy 2: Tradable Pollution Permits 1) Voluntary transfer of the right to pollute from one firm to another 2) Totally inelastic 3) Makes it more costly for firms to pollute, just like corrective taxes 4) Allows the government to cut the externality to a specific point D) Objections to the Economic Analysis of Pollution 1) Just Mankiw defending why economists don’t defend the environment more III) Private Solutions to Externalities A) The Types of Private Solutions 1) Rely on the self-interest of relevant parties (a) Merge the parties (b) Create a contract between the parties B) The Coase Theorem 1) Pay money to get rid of the problem: cost has to be higher than the benefit C) Why Private Solutions Do Not Always Work 1) Sometimes because of transaction costs (a) Different languages spoken  need to hire a translator 2) Straight up don’t get along 3) Constantly try to hold out for a better deal 4) Probability of reaching agreement decreases as number of relevant parties increases (a) Government can act as a player IV) Conclusion Vocabulary Externality: the uncompensated impact of one person’s actions on the well-being of a bystander Negative if the impact is adverse Positive if the impact is beneficial Internalizing the Externality: altering incentives so that people take account of the external effects of their actions Social Cost: private cost and external cost Social Value: private value and external benefit Corrective Tax: a tax designed to induce private decision makers to take account of the social costs that arise from a negative externality Command and Control Policies: regulate behavior directly Market-Based Policies: AKA Pigovian taxes, provide incentives so that the private decision makers will solve the problem on their own Coase Theorem: the proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own Transaction Costs: the costs that parties incur in the process of agreeing to and following through on a bargain


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