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• Learn the nature of an externality.• See why externalities can make market
outcomes inefficient.• Examine how people can sometimes solve
the problem of externalities on their own.• Consider why private solutions to
externalities sometimes do not work.• Examine the various government policies
aimed at solving the problem of externalities.
• Learn the nature of an externality.• See why externalities can make market
outcomes inefficient.• Examine how people can sometimes solve
the problem of externalities on their own.• Consider why private solutions to
externalities sometimes do not work.• Examine the various government policies
aimed at solving the problem of externalities.
In this Topic you will…In this Topic you will…In this Topic you will…In this Topic you will…
• The Market for Aluminum (cont’d)– What quantity of aluminum should
be produced?• Where the demand curve crosses the
social-cost curve. • Below Qoptimum the value of the
aluminum to consumers exceeds rgw social cost of producing it.
• Above Qoptimum the social cost of producing additional aluminum exceeds the value to consumers.
• The Market for Aluminum (cont’d)– What quantity of aluminum should
be produced?• Where the demand curve crosses the
social-cost curve. • Below Qoptimum the value of the
aluminum to consumers exceeds rgw social cost of producing it.
• Above Qoptimum the social cost of producing additional aluminum exceeds the value to consumers.
Negative Externalities in Negative Externalities in ProductionProduction
Negative Externalities in Negative Externalities in ProductionProduction
Demand (private value)
Supply (private costs)
0
Equilibrium
QmarketQuantity of Aluminium
Price of Aluminium
Social costs
Qoptimum
Cost of pollution
Optimum
Figure 10-2: Pollution and the Social Figure 10-2: Pollution and the Social OptimumOptimumFigure 10-2: Pollution and the Social Figure 10-2: Pollution and the Social OptimumOptimum
• The Market for Aluminum (cont’d)– Reducing aluminum production and
consumption below the market equilibrium level raises total economic well-being.
• The Market for Aluminum (cont’d)– Reducing aluminum production and
consumption below the market equilibrium level raises total economic well-being.
Negative Externalities in Negative Externalities in ProductionProduction
Negative Externalities in Negative Externalities in ProductionProduction
0 Quantity of Aluminium
Price of Aluminium
Social costs
Demand (private value)
Poptimum
Qoptimum
Figure 10-3: Deadweight Loss of a Negative Figure 10-3: Deadweight Loss of a Negative Production Externality Production Externality Figure 10-3: Deadweight Loss of a Negative Figure 10-3: Deadweight Loss of a Negative Production Externality Production Externality
Pmarket
Qmarket
a
b
HD + A + ED + A + E - H
A + B + C + HA + EE - (B + C + H)
- (A + B + C)DA + B + C + D
Total surplus
Producer surplus
Consumer surplus
ChangeAt QOptimumAt QMarket
D
A B C
E
F G
H
• The Market for Aluminum (cont’d)– How the can social optimum of aluminum
production be achieved?• Tax the producers of aluminum thus shifting the
private supply curve up by the amount of the tax so that it coincides with the social-cost curve.
– Internalizing an externality involves altering incentives so that people take account of the external effects of their actions.
– Pigovian taxes are taxes enacted to correct the effects of negative externalities.
– In Figure 10-3, the Pigovian tax is equal to the distance ab.
• The Market for Aluminum (cont’d)– How the can social optimum of aluminum
production be achieved?• Tax the producers of aluminum thus shifting the
private supply curve up by the amount of the tax so that it coincides with the social-cost curve.
– Internalizing an externality involves altering incentives so that people take account of the external effects of their actions.
– Pigovian taxes are taxes enacted to correct the effects of negative externalities.
– In Figure 10-3, the Pigovian tax is equal to the distance ab.
Negative Externalities in Negative Externalities in ProductionProduction
Negative Externalities in Negative Externalities in ProductionProduction
• When an externality benefits the bystanders, a positive externality exists.– The social value of the good exceeds the
private value.• Example:• A technology spillover is a type of positive
externality that exists when a firm’s innovation or design not only benefits the firm, but enters society’s pool of technological knowledge and benefits society as a whole.
• When an externality benefits the bystanders, a positive externality exists.– The social value of the good exceeds the
private value.• Example:• A technology spillover is a type of positive
externality that exists when a firm’s innovation or design not only benefits the firm, but enters society’s pool of technological knowledge and benefits society as a whole.
Positive Externalities in Positive Externalities in ProductionProduction
Positive Externalities in Positive Externalities in ProductionProduction
0
Optimum
Quantity of Robots
Price of Robots
Demand (private value)
Social costs
a
b
Qoptimum
Poptimum
Qmarket
Pmarket Equilibrium
Supply (private costs)Value of technology spillover
Deadweight loss
Figure 10-4: Technology Spillovers and the Figure 10-4: Technology Spillovers and the Social Optimum Social Optimum Figure 10-4: Technology Spillovers and the Figure 10-4: Technology Spillovers and the Social Optimum Social Optimum
• The intersection of the supply curve and the social-value curve determines the optimal output level.– The optimal output level is more than
the equilibrium quantity.– The market produces a smaller quantity
than is socially desirable. – The social value of the good exceeds
the private value of the good.
• The intersection of the supply curve and the social-value curve determines the optimal output level.– The optimal output level is more than
the equilibrium quantity.– The market produces a smaller quantity
than is socially desirable. – The social value of the good exceeds
the private value of the good.
Positive Externalities in Positive Externalities in ProductionProduction
Positive Externalities in Positive Externalities in ProductionProduction
• Internalizing Externalities: Subsidies– Used as the primary method for
attempting to internalize positive externalities.
• Internalizing Externalities: Subsidies– Used as the primary method for
attempting to internalize positive externalities.
Positive Externalities in Positive Externalities in ProductionProduction
Positive Externalities in Positive Externalities in ProductionProduction
– Government intervention in the economy that aims to promote technology-enhancing industries
• Patent laws are a form of technology policy that give the individual (or firm) with patent protection a property right over its invention.
• The patent is then said to internalize the externality.
• The patent system gives firms a greater incentive to engage in research and other activities that advance technology.
– Government intervention in the economy that aims to promote technology-enhancing industries
• Patent laws are a form of technology policy that give the individual (or firm) with patent protection a property right over its invention.
• The patent is then said to internalize the externality.
• The patent system gives firms a greater incentive to engage in research and other activities that advance technology.
CASE STUDY:CASE STUDY: The Debate Over Technology The Debate Over Technology PolicyPolicyCASE STUDY:CASE STUDY: The Debate Over Technology The Debate Over Technology PolicyPolicy
• Some externalities are associated with consumption.
• Figure 10-5 (a) shows a market with a negative consumption externality such as the market for alcoholic beverages.
• Figure 10-5 (b) shows a market with a positive consumption externality such as the market for education.
• Some externalities are associated with consumption.
• Figure 10-5 (a) shows a market with a negative consumption externality such as the market for alcoholic beverages.
• Figure 10-5 (b) shows a market with a positive consumption externality such as the market for education.
Externalities in ConsumptionExternalities in ConsumptionExternalities in ConsumptionExternalities in Consumption
(a) Negative Consumption Externalities (b) Positive Consumption Externalities
Price of Alcohol
Quantity of Alcohol
0 0
Social value
Demand (private value)
Supply (private cost)
Quantity of Education
Price of Education
Social value
Demand (private value)
Supply (private cost)
Qmarket QoptimumQoptimum Qmarket
Figure 10-5: Consumption Externalities Figure 10-5: Consumption Externalities Figure 10-5: Consumption Externalities Figure 10-5: Consumption Externalities