LECTURE #9: MICROECONOMICS
CHAPTER 10
Market Externalities
Solutions to Problems Caused by
Externalities
Market Externalities
Uncompensated impact of one person’s actions
on the well-being of a bystander
Positive Externalities = consumers or producers
benefit
Education
Research activity
Negative Externalities = consumers or
producers do not benefit
Pollution
Loss of Patent Protection
Increases in Cost – Less Quantity at every price
level
Market Externalities
Market Failure
Decision maker - fails to account for externalities
Government intervention: protect the interests of
bystanders
Impact on Welfare Economics
Increase in cost of goods, decrease in revenue to
producers
Taxes imposed to repair effects of externalities
Reduced consumer and producer surpluses
Are reductions in surplus offset by economic value of
increased welfare
Pollution and the Social Optimum
Price of
Aluminum
External
Cost
Social cost (private cost
and external cost)
Supply
(private cost)
Optimum
Equilibrium
Demand
(private value)
0
QOPTIMUM QMARKET
Quantity of
Aluminum
In the presence of a negative externality, such as pollution, the social cost of the good
exceeds the private cost. The optimal quantity, QOPTIMUM, is therefore smaller than the
equilibrium quantity, QMARKET.
4
Education and the Social Optimum
Price of
Aluminum
Optimum
Supply
(private cost)
External
Benefit
Equilibrium
Social value
(private value
and external benefit)
Demand
(private value)
0
QMARKET QOPTIMUM
Quantity of
Aluminum
In the presence of a positive externality, the social value of the good exceeds the private
value. The optimal quantity, QOPTIMUM, is therefore larger than the equilibrium quantity,
QMARKET.
5
Solutions To Problems Caused By
Externalities
Private Market Solutions
Moral codes
Social sanctions
Coase Theorem
private parties bargain on costs
Private solution to externality [problem]
Provide incentives
Corrective taxes and subsidies
Violation carries a price
Conformance obtains a [tax] benefit
Solutions To Problems Caused By
Externalities
Public (Government) Solutions
Regulation
Making certain behaviors either required or forbidden
Cannot eradicate pollution
Taxation and Subsidies
Tradable [Pollution] Permits
Environmental Protection Agency (EPA)
Develop and enforce regulations protecting the environment
Dictates maximum level of pollution
Requires that firms adopt a particular technology to reduce
emissions
Homework
Questions for Review: 3, 4, 6 (4, 5, 6 4th Ed)
Problems and Applications: 1, 6, 12