EXTERNALITIES by shimeiyan

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									     EXTERNALITIES

  Externality: a by-product of a
transaction that affects someone
 not immediately involved in the
           transaction
       EXTERNALITIES

   Positive externality: a party not
immediately involved in the transaction
    benefits from the transaction

 Classic example: orchard owner lives
        next door to a bee keeper
•Fruit trees make bees more product
•Bees pollinate tree blossoms
            EXTERNALITIES

  Negative externality: a party not immediately
  involved in the transaction is harmed by the
                    transaction

  Classic example: Automobile use generates
       sulfur dioxide that pollutes the air
•Asthma sufferers
•Homeowners (paint, metal)
•Tree owners
Negative Externality Application
Hog Production:
• Water quality
• Air quality
• Land Prices
             Negative Externality: Hog Production
       $                                            External cost + private MC

                                                         Supply = private MC


      $105
$5
      $100




                                   50000                        Hogs


     Marginal Social Cost = Private Marginal Cost plus External Cost
        Negative Externality: Hog Production
  $                                            External cost + private MC

                                                    Supply = private MC




 $102
                                             Overproduction and
 $100                                        underpriced relative
                                             to social optimum of
                                             45000 hogs




                                                 Demand



                        45000 50000                        Hogs


Marginal Social Cost = Private Marginal Cost plus External Cost
        Negative Externality: Hog Production
  $                                            External cost + private MC
                                               = social marginal cost

                                                 Supply = private MC
 $105
 $102
                                                    Overproduction:
 $100                                               Value of last hog is
                                                    $100, social cost of
                                                    production is $105.




                                                 Demand = marginal
                                                 value


                        45000 50000                        Hogs


Marginal Social Cost = Private Marginal Cost plus External Cost
        Negative Externality: Hog Production
  $                                            External cost + private MC
                                               = social marginal cost

                                                 Supply = private MC
 $105
 $102
                                                     Overproduction:
 $100                               Deadweight       Value of last hog is
                                    loss from        $100, social cost of
                                    overproduction   production is $105.




                                                 Demand = marginal
                                                 value


                        45000 50000                        Hogs


Marginal Social Cost = Private Marginal Cost plus External Cost
    How can we attain the social
            optimum?
• Tax producers to shift supply curve left
• Tax consumers to shift demand curve to
  the left
• Set quota on output to limit supply to
  45000 hogs
             Negative Externality: Hog Production
       $                                          External cost + private MC
                                                  = private MC + tax

                                                       Supply = private MC

      $105
$5    $102
                                                  Impose $5 tax on
      $100                                        producers, generate
                                                  efficient solution
     $97




                                                      Demand



                             45000 50000                        Hogs


     Marginal Social Cost = Private Marginal Cost plus External Cost
             Negative Externality: Hog Production
       $

                                                         Supply = private MC




                                                  Impose $5 tax on
      $100                                        consumers, generate
                                                  efficient solution
       $97
$5
      $95


                                                      Demand



                             45000 50000                        Hogs


     Marginal Social Cost = Private Marginal Cost plus External Cost
        Negative Externality: Hog Production
  $                                            External cost + private MC

                                                    Supply = private MC




 $102
                                             Impose hog quota of
 $100                                        45000




                                                 Demand



                        45000 50000                        Hogs


Marginal Social Cost = Private Marginal Cost plus External Cost
              Negative Externality: Hog Production
        $                                            External cost + private MC

                                                          Supply = private MC




       $102
                                                   Tradeable pollution
 $5    $100                                        permits = pollution
                                                   consistent with 45000
        $97
                                                   hogs




PERMIT VALUE =                                         Demand
P – Private MC


                              45000 50000                        Hogs


      Marginal Social Cost = Private Marginal Cost plus External Cost
 Positive Externality Application
Live music venue creates foot traffic for
  nearby establishments
• Restaurant sales
• Retail sales
             Positive Externality: Music Venue
       $                                           Supply = private MC


                                                      Private MC – social benefit

      $10
$3
      $7




                                   1000                         Ticket sales


     Marginal Social Cost = Private Marginal Cost minus External Benefit
              Positive Externality: Music Venue
       $                                           Supply = private MC

                                                      Private MC – social benefit
                                                      = social marginal cost

      $10
$3                                                  Underproduction
      $8.50
                                                    and overpriced
      $7                                            relative to social
                                                    optimum of 1000




                                                           Demand =
                                                           marginal value



                              800   1000                        Ticket sales


     Marginal Social Cost = Private Marginal Cost minus External Benefit
               Positive Externality: Music Venue
       $                                           Supply = private MC

                                                      Private MC – social benefit
                                                      = social marginal cost

      $10
                                                           Last unit sold
$3                                                         valued at $8.50 but
      $8.50
                                                           only costs $5.50 to
      $7
                                           Deadweight loss produce
       $5.50                               from under-
                                           production


                                                           Demand =
                                                           marginal value



                              800   1000                        Ticket sales


     Marginal Social Cost = Private Marginal Cost minus External Benefit
    How can we attain the social
            optimum?
• Subsidize music producers to shift supply
  curve rightward
• Subsidize consumers to shift demand
  curve to the right
              Positive Externality: Music Venue
       $                                           Supply = private MC

                                                      Private MC – social benefit
                                                      = Private MC - subsidy

      $10
$3                                                  Provide $3 subsidy
      $8.50
                                                    per ticket to music
      $7                                            producer




                                                           Demand =
                                                           marginal value



                              800   1000                        Ticket sales


     Marginal Social Cost = Private Marginal Cost minus External Benefit
              Positive Externality: Music Venue
       $                                           Supply = private MC




      $10
$3                                                  Provide $3 subsidy
      $8.50
                                                    per ticket to
      $7                                            consumer



                                                          Demand = marginal
                                                          value + subsidy

                                                  Demand


                              800   1000                       Ticket sales


     Marginal Social Cost = Private Marginal Cost minus External Benefit
              Externalities
• Imply that the competitive equilibrium will
  not result in the social optimum
• Imply that the competitive equilibrium will
  result in a dead weight loss
• Create a role for government intervention

								
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