Ecological Economics Week 5 Tiago Domingos Assistant Professor Environment and Energy Section Department of Mechanical Engineering Doctoral Program and Advanced Degree in Sustainable Energy Systems Doctoral Program in Mechanical Engineering

Assignments Choice

Market Demand Cost Curves Equilibrium Assignments

Externalities External cost versus external benefit –An external cost or benefit exist when the following two conditions prevail: An activity by one agent causes a loss or gain (respectively) of welfare to another agent; The loss or gain of welfare is uncompensated. –Both conditions are necessary. For example, if the loss of welfare is accompanied by compensation by the agent causing the externality, the effect is said to be internalised Private versus social –MSC – Marginal Social Cost –MSB – Marginal Social Benefit –MPC – Marginal Private Cost –MPB – Marginal Private Benefit –MEC – Marginal External Cost –MEB – Marginal External Benefit

Social Optimum (1/3) Coase Theorem: –Left unregulated, the polluter will try to operate at Qπ. –Consider a situation in which the sufferer has the property rights. The sufferer has the right not to be polluted and the polluter does not have the right to pollute.

Social Optimum (2/3) Achieved when:

Social Optimum (3/3) A B E G D J I H C F –Producer and consumer supply: ABCD –External cost: AEHD –External Benefit: AEFG –Social balance: ABFG – DCH, which is equal to DIJ.

Market Equilibrium to Social Optimum A B E G D J I H C F –We want to create a system that obliges to move from the market equilibrium to social optimum L M

Market Equilibrium to Social Optimum Pigou taxes –We have a negative externality which we want to internalise. A tax shifts the marginal private cost curve up by the amount of the tax. Faced with this cost increase, the producers have an incentive to reduce output to the socially optimum level by reducing the marginal externality to the marginal tax.

Market Equilibrium to Social Optimum In a more generic way...

Market Equilibrium to Social Optimum Negative Pigou taxes – Pigou subsidy –We have a positive externality which we want to internalise.