Externalities Ch 10,11 Week 12 April 19-21, 2010 ECON 160 Externalities Ch 10,11 Week 12 April 19-21, 2010

Market is Efficient since at Qe the Marginal Value = Marginal cost $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Demand Supply Pe Dx Total Revenue = Price x Quantity $6 x 5 = $30 Marginal Value Marginal Cost 1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T Qe

Externalities Some Transactions affect other people than the Buyers and Sellers The market outcome may not be efficient There may be an appropriate role of government to intervene to increase social welfare

Negative Externality in Consumption Sx $ Price x $Pe $Pe’ Dx Dx’ Qe’ Qe Qty x /T

Negative Externality in Production Sx’ True MC $ Price x Sx $Pe’ $Pe Dx Qe’ Qe Qty x /T

Solutions to Negative Externalities Problem: Market overproduces relative to optimum Solution: Reduce output to optimum Tax buyers (reduced demand  reduces Qty.) Tax Sellers (reduces supply  reduces quantity)

Positive Externality in Consumption Sx $ Price x $Pe’ $Pe Dx’ Dx Qe Qe’ Qty x /T

Solutions to Positive Externalities Problem: Market underproduces relative to optimum Solution: Increase output to optimum Subsidize buyers (Increase demand  increase Qty.) Subsidize Sellers (Increase supply  increase quantity)

Public Goods Good where one person’s consumption increases consumption available for others Nonexcludable: Once produced, cannot exclude consumption by others Nonrivalrous: Once produced, consumption by one does not exclude consumption by others.

Market Failures Private markets and social efficiency Nonexcludability Free riding Nonrivalry