McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
CHAPTER 5
ExternalitiesExternalities
5-2
Externalities
Externality – An activity on one entity that affects the welfare of another entity in a way that is outside the market mechanism
5-3
The Nature of Externalities
Externalities can be produced by consumers as well as firms
Externalities are reciprocal in nature Externalities can be positive Public goods can be viewed as a special kind
of externality
5-4
The Nature of Externalities-Graphical Analysis
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Actual outputSocially efficient output
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5-5
What Pollutants Do Harm?
Empirical Evidence: What is the Effect of Pollution on Health?
What Activities Produce Pollutants? What is the Value of the Damage Done? Empirical Evidence: The Effect of Air
Pollution on Housing Values
5-6
The Coase Theorem
Coase Theorem – Provided that transaction casts are negligible, an efficient solution to an externality problem is achieved as long as someone is assigned property rights, independent of who is assigned those rights
Assumptions necessary for Coase Theorem to work The costs to the parties of bargaining are low The owners of resources can identify the source of
damages to their property and legally prevent damages
5-8
Public Responses to Externalities - Taxes
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Pigouviantax revenues
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5-9
Public Responses to Externalities - Subsidies
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Pigouviansubsidy
5-10
Cap-and-Trade v Emissions Fee
0Pollution reduction
MSB
MC*
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ef e’
Too much pollution reductionToo little pollution reduction
5-11
Cap-and-Trade v Emissions Fee
0Pollution reduction
MC*
e*
f*
$
MC’
ef e’
MSB
Too much pollution reductionToo little pollution reduction
5-12
Emissions Fee v Cap-and-Trade
Responsiveness to Inflation Responsiveness to Cost Changes Responsiveness to Uncertainty
5-13
Command-and-Control Regulation
Incentive-based regulations Command-and-control regulations
technology standard performance standard
Is command-and-control ever better? hot spots
5-15
Progress with Incentive-based Approaches
Policy Perspective: Cap-and-Trade for Sulfur Dioxide
Policy Perspective: Cap-and-Trade to Protect Fisheries and Wildlife individual transferable quotas