Microeconomics Externalities Chapter 10
Externality: the uncompensated impact of one person’s actions on the well-being of a bystander
Externalities and Market Inefficiency
Negative Externalities
Ex: aluminum factories emit pollution: for each unit of aluminum produced, certain amount of smoke enters atmosphere
Cost to society of producing aluminum larger than cost to aluminum producers
Social cost includes private costs of aluminum producers plus costs to those bystanders affected adversely by the pollution
How can social planner achieve optimal outcome? Tax aluminum producers for each ton of aluminum sold
Internalizing the externality: altering incentives so that people take account of external effects of their actions
Positive Externalities
Ex: education
Education mainly private: consumer of education becomes more productive worker, reaps benefit in form of higher wages
Positive externalities from education include:
More informed voters better government for everyone
Lower crime rates
Development and dissemination of technological advances higher productivity and wages
Summarize
Negative externalities lead markets to produce larger quantity than is socially desirable
Positive externalities lead markets to produce smaller quantity than is socially desirable
Remedy the problem: gov’t can internalize the externality by taxing goods with negative externalities and subsidizing goods with positive externalities
Public Policies Toward Externalities
Command-and-Control Policies: Regulation
Can regulate by making behaviors required or forbidden
Ex: crime to dump poisonous chemicals into the water supply
Ex: can dictate max level of pollution that factory may emit
Market-Based Policy 1: Corrective Taxes and Subsidies
Can use market-based policies to align private incentives with social efficiency
Gov’t can internalize externality by taxing activities that have negative externalities & subsidizing activities that have positive externalities
Corrective taxes (aka Pigovian taxes):
Externalities and Market Inefficiency
Negative Externalities
Ex: aluminum factories emit pollution: for each unit of aluminum produced, certain amount of smoke enters atmosphere
Cost to society of producing aluminum larger than cost to aluminum producers
Social cost includes private costs of aluminum producers plus costs to those bystanders affected adversely by the pollution
How can social planner achieve optimal outcome? Tax aluminum producers for each ton of aluminum sold
Internalizing the externality: altering incentives so that people take account of external effects of their actions
Positive Externalities
Ex: education
Education mainly private: consumer of education becomes more productive worker, reaps benefit in form of higher wages
Positive externalities from education include:
More informed voters better government for everyone
Lower crime rates
Development and dissemination of technological advances higher productivity and wages
Summarize
Negative externalities lead markets to produce larger quantity than is socially desirable
Positive externalities lead markets to produce smaller quantity than is socially desirable
Remedy the problem: gov’t can internalize the externality by taxing goods with negative externalities and subsidizing goods with positive externalities
Public Policies Toward Externalities
Command-and-Control Policies: Regulation
Can regulate by making behaviors required or forbidden
Ex: crime to dump poisonous chemicals into the water supply
Ex: can dictate max level of pollution that factory may emit
Market-Based Policy 1: Corrective Taxes and Subsidies
Can use market-based policies to align private incentives with social efficiency
Gov’t can internalize externality by taxing activities that have negative externalities & subsidizing activities that have positive externalities
Corrective taxes (aka Pigovian taxes):