AP Economics
Mr. Bernstein
Module 74:
Introduction to Externalities
January 9, 2015
AP Economics
Mr. Bernstein
The Economics of Pollution
• Environmentalists argue unregulated electricity
producers overpollute because they do not consider
harmful effects
• Producers argue regulation interferes with ability to
produce at lowest cost
• Economists view as topic for cost-benefit analysis
where the socially optimal level is where Marginal
Social Costs (MSC) intersect with Marginal Social
Benefits (MSB)
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AP Economics
Mr. Bernstein
The Economics of Pollution
• MSC curve is
upward sloping
• MSB curve is
downward sloping
(~ cleanup cost savings?)
• Will society
reach OOPT?
• NO!
(Note optimal pollution is not 0)
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AP Economics
Mr. Bernstein
The External Costs of Pollution
• Negative Externality is an uncompensated cost that
a firm or individual imposes on others
• Pollution from an Ohio River electricity plant lands
on Jersey residents who do not benefit from the
electricity
• The unregulated market does not care about the
pollution costs and produces until MSB = 0
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AP Economics
Mr. Bernstein
The External Costs of Pollution
MSC and MSB
of pollution
• Society would
$1000
gain the entire
shaded triangle if
pollution is reduced MSC=MSB
from Qmkt (MSB=0) to
Qopt
MSC
MSB
Qopt
Qmkt Qty of Pollution
Emitted (tons)
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AP Economics
Mr. Bernstein
Private Solutions to Externalities
• Coase Theorem
• Ronald Coase (1960)
• Requires clearly defined property rights plus minimal
transactions costs
• A private solution can be worked out (ie $$ settlement)
• Hurdles include communication problems, high legal
costs, delaying tactics
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