Module
Econ: 74
Introduction to Externalities
•KRUGMAN'S
•MICROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• What externalities are and why they can
lead to inefficiency in a market economy.
• Why externalities often require government
intervention.
• The difference between negative and
positive externalities.
• The importance of the Coase theorem,
which explains how private individuals can
sometimes
I. The Economics of Pollution
A. Marginal social cost
(MSC): the additional
costs imposed on
society as a result of
one more unit of
pollution.
B. Marginal social
benefit (MSB): the
additional benefits
received by society as a
result of one more unit
of pollution.
II. The External Cost of Pollution
A. External Cost – an uncompensated cost
that an individual or firm imposes on
others
B. Also called a negative externality
The Inefficiency of Excess Pollution
At Qmkt, suppose we
could reduce pollution
by one ton.
What would we lose?
Since MSB is zero, one
less ton of pollution
would come at almost
$0 of sacrifice to
society.
What would we gain?
Since MSC is $1000, if
we reduced pollution
by one ton we would
avoid nearly $1000 of
harmful costs.
MSC and MSB
of pollution
$1000
MSC
MSC=MSB
MSB
Qmkt
Qopt
Qty of Pollution Emitted (tons)
III. Private Solutions to Externalities
A. The Coase Theorem - so long as property rights are
clearly defined, and transaction costs are minimal, a
private solution can be found to a situation such as
this.
B. These private solutions internalize the externality.
The party that is imposing the hardships on the
other is required to compensate the victim.
C. Many times transaction costs are too high to make
a private solution easy to negotiate. (legal costs)
Module
Econ: 75
Externalities and Public Policy
•KRUGMAN'S
•MICROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• How external benefits and costs cause
inefficiency in markets.
• Why some government policies to deal with
externalities, such as emissions taxes,
tradable emissions permits, and Pigouvian
subsidies, are efficient, although others,
including environmental standards, are not.
I. Policies Toward Pollution
A. Environmental
Standards
B. Emissions Taxes
C. Tradable Emissions
Permits
Production, Consumption, and Externalities
• Private versus social benefits
• Private versus social costs
II. Negative Externalities
A.
When the
production and
consumption of a
good creates costs to
third parties, that
good is said to create
negative externalities
to society.
B. Pigouvian Tax
Price, MSC
MSC
MPC
Popt
Pmkt
Tax
Pfirm
D
Qopt Qmkt
Qty electricity
III. Positive Externalities
A.
When the
production and
consumption of a
good provides
benefits to third
parties, that good
is said to provide
positive
externalities to
society.
B. Pigouvian Subsidy
Price, MSB
S
Popt
Pmkt
Subsidy
Pcons
MPB
Qmkt Qopt
MSB
Qty home
improvements
IV. Network Externalities
A. A network externality exists when the
value to an individual of a good or
service depends on how many other
people use the same good or service.
B. Example: When more people use
Facebook or Twitter, it becomes
more valuable to you
Module
Econ: 76
Public Goods
•KRUGMAN'S
•MICROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• How public goods are characterized and why markets
fail to supply efficient quantities of public goods.
• What common resources are and why they are
overused.
• What artificially scarce goods are and why they are
under-consumed.
• How government intervention in the production and
consumption of these types of goods can make society
better off.
• Why finding the right level of government intervention
is often difficult.
I. Private Goods
A. Private goods are what we have studied thus far
B. Private goods have two characteristics. They are;
1. Excludable- You can prevent people who don’t
pay from consuming it
2. Rival- the unit of the good cannot be consumed
by more than one person at the same time
II. Public Goods
A. Public goods are;
1. Non-excludable- Can’t exclude anyone on basis of
payment
2. Non-rival- more than one person can consume it
at the same time without the benefit going down
III. Common Resources
A. Common resources are;
1. Non-excludable
2. Rival
IV. Artificially Scarce Goods
A. Artificially scarce goods are;
1. Excludable
2. Non-rival
V. Markets Only Provide Private
Goods Efficiently
A. Markets will not
provide the
efficient level of
public goods
B. The efficient level
of public goods is
the quantity
where MSC = MSB
VI. Providing Common Resources
A. The problem of overuse
and the “Tragedy of the
Commons”
B. Maintaining a common
resource
C. Examples of common
resources?
iphoto
VII. The Efficient Level of
Artificially Scarce Goods
A. MC of providing the
good is zero
B. Firms can’t set price
equal to zero
C. Example of artificially
scarce good?
Module
Econ: 77
Public Policy
to Promote Competition
•KRUGMAN'S
•MICROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• The three major antitrust laws and how they
are used to promote competition.
• How government regulation is used to
prevent inefficiency in the case of natural
monopoly.
• The pros and cons of using marginal cost
pricing and average cost pricing to regulate
prices in natural monopolies.
I. Promoting Competition and
Efficiency
A. Antitrust laws
1. Protect competition
2. Ensure lower prices
3. Promote development of
better products
B. Price regulation
1. When economies of scale
make it efficient to have
one firm in a market, that
natural monopoly can be
taken over by the
government or regulated
II. Antitrust Laws
A. Sherman Act
B. Clayton Act
C. FTC Act
III. Price Regulation
A. Marginal-cost pricing- the firm must operate at the
point where P=MC. Government would subsidize any
losses at taxpayer expense.
B. Average-cost pricing- the firm must operate at the
point where P=ATC. This insures that the firm will
earn normal economic profit, but some dead weight
loss will occur.
Module
Econ: 78
Income Distribution
and Income Inequality
•KRUGMAN'S
•MICROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• What defines poverty, what causes poverty,
and the consequences of poverty.
• How income inequality in America has
changed over time.
• How programs like Social Security affect
poverty and income inequality.
I. Poverty
•
•
•
•
Trends in poverty
Who is poor?
Causes of poverty
Consequences of
poverty
II. Lorenz Curve
Lorenz curve: A Lorenz curve shows the
degree of inequality that exists in
the distributions of two variables,
and is often used to illustrate the
extent that income or wealth are
distributed unequally in a particular
society.
Gini coefficient: A Gini coefficient is a
summary numerical measure of how
unequally one variable is related to
another. The Gini coefficient is a
number between 0 and 1, where
perfect equality has a Gini coefficint
of zero, and absolute inequality
yields a Gini coefficint of 1
III. Income Inequality
Income
group
Average 2008
income
% of total income 2008 % of total
if distributed
income
equally
Bottom
$11,656
quintile
Second
$29,517
quintile
Third quintile $50,132
20%
3.4%
20%
8.6%
20%
14.7%
Fourth
quintile
Top quintile
$79,760
20%
23.3%
$171,057
20%
50%
• Using quintiles to analyze income distribution
• The Gini coefficient
IV. Economic Insecurity
A.
In addition to the problem of poverty, we are
concerned with the possibility that people or
families can fall into poverty due to unanticipated
events.
B. Because these uncertain events can cause any
family to have economic insecurity, we have a
welfare state to provide temporary assistance.
V. U.S. Antipoverty Programs
A. Means-tested
1. Criteria is established to qualify
2. An example would be level of income and
size of family
B. Social Security and unemployment insurance
– Social Security funded by tax on wages
– Unemployment funded by tax on employers
C. The effects of programs on poverty
– Research says yes, but…
VI. The Debate Over Income
Redistribution
• Problems with income
redistribution
• The politics of income
redistribution
• Barstool Economics
The Laffer Curve
The curve suggests that, as taxes
increase from low levels, tax
revenue collected by the
government also increases. It
also shows that tax rates
increasing after a certain point
(T*) would cause people not to
work as hard or not at all,
thereby reducing tax revenue.
Eventually, if tax rates reached
100% (the far right of the
curve), then all people would
choose not to work because
everything they earned would
go to the government.