Principles 17F Lecture6

10/22/2017
N. GREGORY MANKIW
Look for the answers to these questions:
PRINCIPLES OF
• What is an externality?
ECONOMICS • Why do externalities make market
Eight Edition
outcomes inefficient?
• What public policies aim to solve
CHAPTER the problem of externalities?
Externalities • How can people sometimes solve the
10 problem of externalities on their own?
Why do such private solutions not
Premium PowerPoint Slides by: always work?
V. Andreea CHIRITESCU
Modified by Joseph Tao-yi Wang Eastern Illinois University
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
1
management system for classroom use.
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 2
Externalities Externalities
• ‘Markets are usually a good way • Negative externality
to organize economy – Impact on the bystander is adverse
activity’ • Positive externality
– In absence of market failures, the – Impact on the bystander is beneficial
competitive market outcome is
efficient, maximizes total
• Self-interested buyers and sellers
surplus – Neglect the external costs or
• Externality: one type of market failure benefits of their actions
– So the market outcome is not efficient
– The uncompensated impact of one
person’s actions on the well-
being of a bystander as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
4
Externalities ASK THE EXPERTS

Vaccines
• ‘Government action can
“Declining to be vaccinated against contagious
sometimes improve upon diseases such as measles imposes costs on
market outcomes’ other people, which is a negative externality.”
– Why markets sometimes fail to
allocate resources
efficiently
– How government policies can
potentially improve the
market’s allocation
– What kinds of policies are likely to
work best © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
6
1
10/22/2017
Recap of Welfare Economics

Negative Externalities
P The market for gasoline The market equilibrium
• Examples of negative externalities $50 maximizes consumer
• Air pollution from a factory + producer surplus.
• The neighbor’s barking dog 40
Supply curve shows
• Late-night stereo blasting from the
private cost, the costs
dorm room next to yours 30
$25 directly incurred by
• Noise pollution from construction
sellers.
projects 20 Demand curve shows
• Health risk to others from 10 private value, the value
second-hand smoke to buyers (the prices they
are willing to pay).
• Talking on cell phone while driving 0
0 10 20 25 30 Q
makes the roads less safe for others (liters)
Analysis of a Negative Externality Analysis of a Negative Externality
P The market for gasoline P The market for gasoline

The socially
$50 $50
Social cost Social optimal quantity
= private + external cost cost is 20 liters.
40 external 40
cost Supply (private cost) S At any Q < 20,
30 value of additional gas
30 External cost
exceeds social cost.
= value of the
20 negative impact 20 At any Q > 20,
on bystanders D social cost of the
10 = $10 per liter 10 last liter is
(value of harm greater than its value
0 from smog, 0 to society.
0 10 20 30 Q 0 10 20 25 30 Q
greenhouse gases)
(liters) (liters)
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 9 as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 10
management system for classroom use. management system for classroom use.
Analysis of a Negative Externality

Externalities
P The market for gasoline Market equilibrium
$50 (Q = 25) • Internalizing the externality:
Social
cost
is greater than – Altering incentives so that people take
40 social optimum
S
into account the external effects
(Q = 20).
30
of their actions
– In our example, the $10/liter tax on
20 One solution: sellers makes sellers’ costs = social
D tax sellers $10/liter, costs.
10 would shift S curve
up $10. • If market participants pay social costs
0 – Market equilibrium = social optimum
0 10 20 25 30 Q
(liters)
2
10/22/2017
Positive Externalities Positive Externalities

• Examples of positive externalities • With a positive externality
• Being vaccinated against – The social value of a good includes
contagious diseases protects not • Private value – the direct value to
only you, but people who visit buyers
the salad bar or produce section
• External benefit – the value of the
after you
positive impact on bystanders
• Research and development
creates knowledge others • The socially optimal Q maximizes welfare:
can use • At any lower Q, the social
• People going to college raise the value of additional units
population’s education level, which exceeds their cost.
reduces crime and improves • At any higher Q, the cost of the
government last unit exceeds its social
value.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
Active Learning 1 Analysis of a positive externality

Active Learning 1 Answers
P The market for flu shots P The market for flu shots
$500 • External benefit Socially optimal Q
$500 = 25 shots.
= $100/shot external
400 – Draw the benefit To internalize the
400
social externality, use
S
300 value S subsidy = $100/shot.
300
curve.
200 Social value
– Find the 200 = private value
socially + $100 external benefit
100 optimal Q.
D 100
– What policy D
0
0 10 20 30
would
internalize 0 Q
0 10 20 25 30
this 15
16
externality?
ASK THE EXPERTS

Effects of Externalities: Summary
Vaccines
• If negative externality “Considering the costs of restricting free choice, and
– Market quantity larger than socially the share of people in the US who choose not to
desirable vaccinate their children for measles, the social
benefit of mandating measles vaccines for all
• If positive externality Americans (except those with compelling medical
– Market quantity smaller than reasons) would exceed the social cost.”
socially desirable
• To remedy the problem, “internalize
the externality”
– Tax goods with negative externalities
– Subsidize goods with positive © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
18
externalities
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
3
10/22/2017
Public Policies Toward Externalities Public Policies Toward Externalities

• Command-and-control policies • Corrective taxes and subsidies
– Regulate behavior directly – Corrective taxes (Pigovian taxes)
• Limits on quantity of pollution emitted – Induce private decision makers to take
• Requirements that firms adopt a account of the social costs that arise
particular technology to reduce from a negative externality
emissions
– Places a price on the right to pollute
• Market-based policies
– Reduce pollution at a lower cost to society
– Incentives so that private decision
makers will choose to solve the
– Raise revenue for the government
problem on their own – Enhance economic efficiency
• Corrective taxes and subsidies © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
• Tradable pollution permits
Corrective Taxes vs. Regulations Corrective Taxes vs. Regulations

• Different firms • A pollution tax is efficient:
– Have different costs of – Firms with low abatement costs
pollution abatement will reduce pollution to
• Efficient outcome reduce their tax burden.
– Firms with the lowest abatement – Firms with high abatement costs
costs reduce pollution the most have greater willingness to pay
tax.
• Regulation requiring all firms to reduce
pollution by a specific amount
– Is not efficient
Example of a Corrective Tax: The Gas Tax

Corrective Taxes vs. Regulations
The gas tax targets three negative
• Corrective taxes are better for externalities:
the environment: – Congestion
– The corrective tax gives firms The more you drive, the more you contribute to
incentive to continue reducing congestion.
pollution as long as the cost – Accidents
of doing so is less than the tax Larger vehicles cause more damage in an
• If a cleaner technology becomes accident.
available, the tax gives firms an – Pollution
incentive to adopt it Burning fossil fuels produces greenhouse gases.
– In contrast, firms have no
incentive for further reduction © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 24
beyond the level specified management system for classroom use.
in a regulation
4
10/22/2017
ASK THE EXPERTS ASK THE EXPERTS

Carbon Taxes Carbon Taxes
“The Brookings Institution recently described a U.S. carbon tax of “A tax on the carbon content of fuels would be a
$20 per ton, increasing at 4 percent per year, which would raise less expensive way to reduce carbon-dioxide
an estimated $150 billion per year in federal revenues over the
emissions than would a collection of policies such
next decade. Given the negative externalities created by carbon
dioxide emissions, a federal carbon tax at this rate would involve as ‘corporate average fuel economy’ requirements
fewer harmful net distortions to the U.S. economy than a tax for automobiles.”
increase that generated the same revenue by raising marginal tax
rates on labor income across the board.”
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 25 permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 26
Active Learning 2 Reducing pollution Active Learning 2 A. Regulation

Acme and US Electric run coal-burning power • Policy option 1: Regulation
plants. Each emits 40 tons of sulfur dioxide Every firm must cut its emissions 25% (10
per month, total emissions = 80 tons/month. tons).
• Goal: Reduce SO2 emissions 25%, to • Your task: Compute the cost to each firm
60 tons/month and total cost of achieving goal using
• Cost of reducing emissions: this policy.
– $1,000/ton for Acme
– $2,000/ton for US Electric
Active Learning 2 A. Answers Active Learning 2 B. Tradeable pollution permits
Each firm must reduce emissions by 10 tons. • Policy option 2: Tradable pollution permits
– Issue 60 permits, each allows one
Cost of reducing emissions: $1,000/ton for
ton SO2 emissions.
Acme, $2,000/ton for US Electric.
– Give 30 permits to each firm.
• Compute cost of achieving goal with this
– Establish market for trading permits.
policy:
– Each firm may use all its permits to emit 30
– Cost to Acme: (10 tons) x ($1,000/ton) = $10,000 tons, may emit < 30 tons and sell leftover
– Cost to USE: (10 tons) x ($200/ton) = $20,000 permits,
– Total cost of achieving goal = $30,000 or may purchase extra permits to emit > 30 tons.
• Your task: Compute cost of achieving goal
if Acme uses 20 permits and sells
10 to USE for $1,500 each.
5
10/22/2017
Active Learning 2 B. Answers Active Learning 2 B. Answers

Goal: reduce emissions from 80 to 60 tons • Compute cost of achieving goal for USE:
Cost of reducing emissions: $1,000/ton for – Buys 10 permits from Acme, spends $15,000
Acme, $2,000/ton for USE. – Uses these 10 plus original 30 permits,
• Compute cost of achieving goal for Acme: emits 40 tons
– Spends nothing on abatement
– Sells 10 permits to USE for $1,500 each, gets
$15,000 – Net cost to USE = $15,000
– Uses 20 permits, emits 20 tons SO2 Total cost of achieving goal
– Spends $20,000 to reduce emissions by 20 =$5,000+$15,000=$20,000
tons • Using tradable permits, goal is achieved
– Net cost to Acme: $20,000 − $15,000 = at lower total cost and lower cost
$5,000 to each firm than using regulation.

• Tradable pollution permits system • Reducing pollution using pollution
– Reduces pollution at lower cost permits or corrective taxes
than regulation – Firms pay for their pollution
• Firms with low cost of reducing • Corrective taxes: pay to the government
pollution do so and sell their • Pollution permits: pay to buy permits
unused permits
– Internalize the externality of pollution
• Firms with high cost of reducing
pollution buy permits
– Result: Pollution reduction is
concentrated among those firms
with lowest costs © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use

• Objections to the economic analysis • Clean environment is a normal good
of pollution – Positive income elasticity
– “We cannot give anyone the • Rich countries can afford a
option of polluting for a cleaner environment
fee.” - by late Senator Edmund • More rigorous environmental protection
Muskie – Clean air and clean water - law of
• People face trade-offs demand
• The lower the price of
– Eliminating all pollution is impossible
environmental protection
– Clean water and clean air – • The more the public will want it
opportunity cost: lower
standard of living © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
6
10/22/2017
Private Solutions to Externalities Private Solutions to Externalities

• The types of private solutions • The Coase theorem
– Moral codes and social sanctions – If private parties can bargain without
– Charities cost over the allocation of
– Self-interest of the relevant parties resources
• They can solve the problem of
• Integrating different types of businesses
externalities on their own
– Interested parties can enter into a
• Whatever the initial distribution of rights
contract
– Interested parties can reach a bargain:
• Everyone is better off
• Outcome is efficient
Private Solutions to Externalities Private Solutions to Externalities

1.Dick has the legal right to keep a 2.Dick has the legal right to keep a
barking dog (Spot). barking dog (Spot).
– Dick gets a $5,000 benefit from the dog – Dick gets a $10,000 benefit from the dog
– Jane bears an $8,000 cost from the – Jane bears an $8,000 cost from the
barking barking
– Efficient outcome: – Efficient outcome:
• Jane can offer Dick $6,000 to get rid of • Dick turns down any offer below $10,000
the dog • Jane will not offer any amount above
• Dick will gladly accept $8,000
• Bye-bye Spot! • Dick keeps the dog
• Both are better off
39 as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
40
Private Solutions to Externalities Active Learning 3 Applying Coase
3.Jane can legally compel Dick to get Collectively, the 1000 residents of Chou Tribe
rid of the dog (Spot) value swimming in Sunny Moon Lake at
$1,000,000.
– Dick gets a $8,000 benefit from the dog
A nearby factory pollutes the lake water, and
– Jane bears an $5,000 cost from the
would have to pay $500,000 for non-polluting
barking
equipment.
– Efficient outcome
A. Describe a Coase-like private solution.
• Dick keeps Spot
• Private outcome: Dick pays Jane
B. Can you think of any reasons why this
$6,000 to put up with Spot’s barking solution might not work in the real
world?
The private market achieves the efficient outcome
regardless of the initial distribution of rights as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
42
7
10/22/2017
Private Solutions to Externalities Summary

Why private solutions do not always work • When a transaction between a buyer and seller
– High transaction costs directly affects a third party, the effect is
called an externality.
• Costs that parties incur in the
process of agreeing to and – If an activity yields negative externalities,
following through on a bargain such as pollution, the socially optimal
quantity in a market is less than the
– Stubbornness: ( 最牛釘子戶 ) equilibrium quantity.
• bargaining simply breaks down – If an activity yields positive externalities, such
– Coordination problems as technology spillovers, the socially
• Large number of interested parties optimal quantity is greater than the
• Coordinating everyone is costly equilibrium quantity.
Summary Summary
• Governments pursue various policies to remedy • According to the Coase theorem, if people can
the inefficiencies caused by externalities. bargain without cost, then they can always
– Regulating behavior reach an agreement in which resources are
– Internalizes an externality using corrective allocated efficiently.
taxes – In many cases, however, reaching a bargain
– Issue permits (similar results to among the many interested parties is difficult, so
imposing corrective taxes on the Coase theorem does not apply.
polluters)
●
Chapter 10: Externalities ●
Chapter 10: Externalities
►Market Failure? Or, Lack of Market Failure! ►Homework:
► Caused by lack of property rights! ► Mankiw, Ch.10, Problem 1, 4, 5, 8, 9
►Challenge Questions (Past Midterms)
►Social Cost/Benefit≠Private Cost/Benefit ► 2007 - Essay Q6b
► 2008 - Essay C5-9 (Multi-Choice Q12, Q13)
►Market-based Public Policy: ► 2009 - Essay C1-4 (Multi-Choice Q13)
► CorrectiveTaxes ► 2010 - Essay A (True/False Q10)
► 2014 - Essay B
► Tradable Pollution Permits
► 2015 - Essay A4-5, B3
►Private Solutions: Coase Theorem ► 2016 - Essay D
●
2017/10/22 ●
Externalities ●
Joseph Tao-yi
Wang ●
2017/10/22 ●
Externalities ●
Joseph Tao-yi
Wang

Principles 17F Lecture6

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Principles 17F Lecture6

Uploaded by

Copyright:

Available Formats

10/22/2017

Externalities ASK THE EXPERTS

Recap of Welfare Economics

Analysis of a Negative Externality Analysis of a Negative Externality

P The market for gasoline P The market for gasoline

Analysis of a Negative Externality

Positive Externalities Positive Externalities

Active Learning 1 Analysis of a positive externality

ASK THE EXPERTS

Public Policies Toward Externalities Public Policies Toward Externalities

Corrective Taxes vs. Regulations Corrective Taxes vs. Regulations

Example of a Corrective Tax: The Gas Tax

beyond the level specified management system for classroom use.

ASK THE EXPERTS ASK THE EXPERTS

Active Learning 2 Reducing pollution Active Learning 2 A. Regulation

Active Learning 2 A. Answers Active Learning 2 B. Tradeable pollution permits

Active Learning 2 B. Answers Active Learning 2 B. Answers

Public Policies Toward Externalities Public Policies Toward Externalities

Public Policies Toward Externalities Public Policies Toward Externalities

Private Solutions to Externalities Private Solutions to Externalities

Private Solutions to Externalities Private Solutions to Externalities

Private Solutions to Externalities Active Learning 3 Applying Coase

Private Solutions to Externalities Summary

You might also like