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Externalities AKA Spillovers

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Externalities AKA Spillovers. When Markets Work. (a) Producers are responsible for all costs & those costs are reflected in the price of the good or service. P. S =Marginal Social Cost (MSC) =Marginal Private Cost (MPC). - PowerPoint PPT Presentation

Text of Externalities AKA Spillovers

  • PQS =Marginal Social Cost (MSC) =Marginal Private Cost (MPC)

    D =Marginal Social Benefit (MSB) =Marginal Private Benefit (MPB)PQWhen Markets Work(a) Producers are responsible for all costs & those costs are reflected in the price of the good or service.The private costs and social costs are both reflected in the supply curve

  • PQS=Marginal Social Cost (MSC) =Marginal Private Cost (MPC)

    D =Marginal Social Benefit (MSB) =Marginal Private Benefit (MPB)PQWhen Markets Work(a) Producers are responsible for all costs & those costs are reflected in the price of the good or service.(b) Paying customers are the only beneficiaries of the good or service.The private benefits and social benefits are both reflected in the demand curve

  • When Markets Dont WorkMarket FailureExternalities When someone other than the buyer and seller receives a cost or benefit for which they didnt ask/pay

  • When Markets Dont WorkMarket FailureExternalities AKA or Third Party SpilloverCosts/Benefits

  • Negative Externality (or spillover)Example:Factory pollution contaminating water supplyThe firm is passing on externalizing- the cost to villagers

  • Negative ExternalityExample: Factory PollutionPQMarginal Private Cost (MPC)D =Marginal Social Benefit (MSB) =Marginal Private Benefit (MPB)PmarketQm

  • Negative ExternalityWhy is this bad?PQMPCMSBPmQmPsoQsoMSC TO FIND THE AREA OF THE DEADWEIGHT LOSS FOLLOW THE MARKET Q UP TO THE MSC CURVE. ITS THE AREA BETWEEN MSC, MSB AND QMARKET

    Deadweight loss

  • Negative ExternalityPQMPCMSBPmQmPsoQsoMSC TO FIND THE AREA OF THE DEADWEIGHT LOSS FOLLOW THE MARKET Q UP TO THE MSC CURVE. ITS THE AREA BETWEEN MSC, MSB AND QMARKET

    Deadweight lossWhy is this bad?Why does this happen?

  • Where there is no clear ownership of rights to a natural resource, the users of the resource are likely to overexploit it.

  • Drilling for Oil

  • http://www.petroleum.co.uk/geograph/page4.htm

  • Pump as much oil as fast as you can to get theoil before someone else does--

  • Private Bathroom in Doctors office

  • Access is restricted

  • Clean, decorated, well stocked

  • Public High School Bathroom

  • Possible Solutions:Negative ExternalityProperty Rights: establishing ownership can provide motivation to include external costs into the price

  • http://ens.lycos.com/ens/oct2000/2000L-10-16-15.htmlhttp://www.fayettevilleobserver.com/news/archives/1998/tx98aug/n19buff.htmYou better quick and hunt them before someonebeats you to the punch.The hunters shootthe buffalo.The herdsget smaller.

  • Barb wire saved the buffalo by establishingproperty rights at a relatively low cost. Prior tobarb wire, it was too expensive to establish propertyrights.Did barb wire helpor hurt the buffalopopulation?

  • Possible Solutions:Negative ExternalityProperty Rights: establishing ownership can provide motivation to include external costs into the priceBut, this often isnt a plausible optionCoase Theorem: as long as transaction costs are low, it doesnt matter which party has property rights, they will negotiate a solution to the externality without the need for govt intervention.Ronald H. Coase

  • It used to be,Would you likea smoke?Then it became, Do you mind if I smoke?Property rights of smoking have changed over the years.

  • Then it became, Thank you for not smoking.Finally, an outright ban on smoking.

  • Negative ExternalityGovernment intervention:2. Q Restriction establish a law to force correction3. Price Control establish an effective price floor4. Permits i.e.. pollution permits that can be bought and sold among pollutersPossible Solutions:

  • Pass out Negative Externalities Homework& do example togetherPass Out& do example together

  • PQMPCMSBPmQmABC Plastics is polluting the ground water surrounding its factory. The Govt decides to tax their product and use the $ to treat the area. Graph the externality including the tax.Start with a base S/D graph, except label supply MPC and demand MSBLabel P&Q - Pm & Qm

  • ABC Plastics is polluting the ground water surrounding its factory. The Govt decides to tax their product and use the $ to treat the area. Graph the externality including the tax.Add the externalityPQMPCMSBPmQmPsoQsoDraw social equilibrium lines and labels Pso & QsoAdd arrow to show direction of change in cost lines, Ps and QsMSC Add in the social cost (MSC) line

  • PQMPCMSBPmQmPsoQsoMSC TAXABC Plastics is polluting the ground water surrounding its factory. The Govt decides to tax their product and use the $ to treat the area. Graph the externality including the tax.You have drawn the Externality, now add the tax4. Shade in the area of the tax and label itYou can either write it inside the shaded area or outside with an arrow

  • When Markets Dont WorkMarket FailurePositive Externality (or spillover)Example:Getting a vaccine for a contagious diseaseThe rest of the population benefits from the protect, but doesnt pay for it.

  • Positive ExternalityExample: VaccinationsQmPQMarginal Social Cost (MSC) Marginal Private Benefit (MPB)Pmarket

  • Positive ExternalityWhy is this bad?Deadweight lossQmPQMSC MPBMSBQsoPmPsoTO FIND THE AREA OF THE DEADWEIGHT LOSS FOLLOW THE MARKET Q UP TO THE MSC CURVE. ITS THE AREA BETWEEN MSC, MSB AND QMARKET

  • Positive ExternalityWhy is this bad?Deadweight lossQmPQMSC MPBMSBQsoPmPsoTO FIND THE AREA OF THE DEADWEIGHT LOSS FOLLOW THE MARKET Q UP TO THE MSC CURVE. ITS THE AREA BETWEEN MSC, MSB AND QMARKET

    Why does this happen?

  • When the accessible and desirable nature of public goods inclines people to use these goods, sometimes without paying for the privilege

  • Public vs. Private GoodsPrivate goods1. Exclusionary owner can exclude those who dont pay for it2. Rival consuming it prevents others from doing the sameExample: Can of soda

  • 1. Non-exclusionary owner cannot exclude those who dont pay for it2. Nonrival consuming it doesnt prevent others from doing the samePublic vs. Private GoodsPublic goods

  • Public vs. Private GoodsPublic goodsExamples:LighthousesAll the captains use it to keep from crashing, but they dont pay for it and there isnt a good way to make them

  • Public vs. Private GoodsPublic goodsAnyone walking by benefits from the light, but does not have to pay for the benefitStreet Light SystemsExamples:

  • Public vs. Private GoodsPublic goodsThe market will not provide optimum amounts of these good, or provide them at all because there is no way to make a profit from them.The production of public goods results in positive externalities which are not paid for, so there is less incentive to produce it.

  • In a family of four, there are two cops and tworobbers. Who are the free riders and why?

  • Whats Wrong with this picture? It wouldnt work because Sunsets are a non-excludable good, in that non-payers can't be prevented from enjoying them.

  • Possible Solutions:Positive Externality1. Government Production: have the govt produce the good using tax dollarsExamples:National DefenseInterstate Highway System

  • Why do governments pay for mosquito sprayingof neighborhoods? Why isnt this privatized?

  • Possible Solutions:Positive Externality1. Government Production: have the govt produce the good using tax dollars2. Subsidy: to either producer or consumer of the product3. Legal Mandate: legally require consumption or production of the good

  • Possible Solutions:Positive ExternalityExample:The more education a person has, the less likely they are commit crimes & the more likely they are to solve problems, help people.contribute to societyEducation all 3 are used

  • Possible Solutions:Positive ExternalityEducation produces a positive externalityIt is under produced or underallocated at too high a priceExample:Education all 3 are used

  • Possible Solutions:Positive ExternalityExample:The govt produces it (public schools)They subsidize consumers (low cost student loans & scholarships) They subsidize producers (fed grants)Require it 5-18yrs oldsEducation all 3 are used

  • Pass out Negative Externalities Homework& do example togetherPass Out& do example together

  • PQMSCMPBPmQmThe government decides to subsidize consumers for tuberculosis vaccinations by issuing discount coupons to parents of school children. Graph the externality including the subsidy.Start with a base S/D graph, except label supply MSC and demand MPBLabel P&Q - Pm & Qm

  • Add the externalityQmPQMSC PmThe government decides to subsidize consumers for tuberculosis vaccinations by issuing discount coupons to parents of school children. Graph the externality including the subsidy.

  • QmPQMSC MSBPmQsoPsoYou have drawn the Externality, now add the subsidy4. Shade in the area of the subsidy and label itYou can either write it inside the shaded area or outside with an arrowSUBSIDYThe government decides to subsidize consumers for tuberculosis vaccinations by issuing discount coupons to parents of school children. Graph the externality including the subsidy.

    Everything weve learned up until now assumes that the market is working to produce the Market equilibrium which is the most efficient level of Price and Quantity. However, realityIs always messier than our economic models and sometimes markets do not produce theOptima

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