19
Externalities
Spillover Costs
Spillover Benefits
The market tends to overproduce.
The market tends to underproduce.
The Economics of Pollution
 Company A produces 40,000 units and emits 600
tons of pollution. Clean-up is costly.
Clean-up cost (000$)
90
30,000
60
100
30
30,000
200 300
400 600
Pollution (tons)
Pollution
(tons)
Clean-up
cost
0
$90,000
200
$40,000
400
$10,000
600
$0
MC
per ton
Marginal “Benefit” of Pollution
Marginal benefit ($)
 The marginal “benefit” of pollution is the cost of
cleaning-up an extra ton.
600
MB: Company B
400
 Company B has higher
clean-up costs.
200
MB: Company A
200 400 600
Pollution (tons)
Costs and Benefits of Pollution
MC and MB ($)
 Costs and benefits of pollution for the economy as
a whole.
600
MC
400
MB
200
20,000 40,000 60,000
Pollution (tons)
 30,000 tons of pollution
is optimal.
 the benefit from an
extra ton of pollution is
offset by the cost
 without regulation,
companies will emit
60,000 tons
Environmental Standards
Marginal benefit ($)
 A standard might require all companies to cut
emissions to 300 tons.
600
MB: Company B
400
200
 The marginal and total
cost for Company B is
higher.
Company
Clean-up
cost
MC
per ton
A
$22,500
$150
B
$45,000
$300
MB: Company A
200 400 600
Pollution (tons)
Emission Taxes
Marginal benefit ($)
 Alternatively, the government could impose a tax of
$200 per ton.
600
 Each firm chooses an
optimal level of pollution
400
 Total pollution is the
same but at lower cost.
200
200 400 600
Pollution (tons)
Company
Clean-up
cost
MC
per ton
A
$40,000
$200
B
$20,000
$200
Firms Choose How Clean to Be
Firm A
600
tons
Clean-up cost
$0
Emissions tax
$120,000
Total
Firm B
200
tons
0
tons
$10,000
$40,000
$90,000
400
tons
200
tons
0
tons
$20,000
$80,000
$180,000
$120,000
600
tons
Clean-up cost
$0
Emissions tax
$120,000
Total
400
tons
$120,000
Marketable Pollution Permits
 The government allocates permits to firms.
 Firms are allowed to buy and sell permits.
 Permits encourage the lowest cost clean-up to be
done first.
 Environmental groups can buy permits to reduce
pollution.
Marginal Benefit of Transactions
Marginal benefit of
2nd unit is $16.
Price
$20
Marginal benefit of 5th
unit is $9.
16
$8
12
$4
8
$5
$8
4
2
4
6
8
10
12 Quantity
External Costs (Before a Tax)
Large consumer and
producer surplus if
government pays for the
clean-up.
Price
Consume
r Surplus
40
35
30
25
$2,250
20 $2,250
Producer
15
Surplus
10
5
External
Cost
Net benefit =
$1,875
$2,625
100
200
300
400
500
Quantity
Marginal Benefits and Costs
Marginal benefit of
100th unit is $20.
Price
Consume
r Surplus
40
35
30
25
Producer
20
Surplus
15
10
Marginal cost of
100th unit is $7.50.
5
External
Cost
100
200
300
400
500
Quantity
Marginal Benefits and Costs
Price
Consume
r Surplus
40
Marginal benefit of
200th unit is $10.
35
30
25
Marginal cost of
200th unit is $10.
Producer
20
Surplus
15
10
5
External
Cost
100
200
300
200 = optimal quantity
= optimal tax
400 $10500
Quantity
Marginal Benefits and Costs
MC & MB
40
35
30
25
20
Margina
l benefit
Margina
l cost
15
10
5
100
200
300
400
500
Quantity
Price
Tax on External Costs
40
35
30
25
20
15
10
5
$10
With the tax,
consumers and producers
cover the external costs.
100
200
300
400
500
Quantity