7.2 Spillover Effects and Market Failure External effects of economic activity which have an impact on outsiders who are not producing or consuming a product Aka “Externalities” Can take the form of costs or benefits

Spillover Costs & Benefits Some things we have for free: air Spillover Costs are negative external effects of producing or consuming a product that fall on outsiders, not market participants e.g. Environmental Pollution Producers making products only focus on private costs as they make supply decisions Thus prices of products made are insufficient to pay for both private and spillover costs

Spillover Costs of Gasoline $1.50 per liter for a quantity of 6 million liters of gasoline Due to environmental damage created by both production/consumption of gasoline, there are spillover costs S1: supply curve for only private costs of producing gasoline S2: supply curve for public and private costs of gasoline Without gov’t intervention, equilibrium: where D1 meets S1 To account for spillover costs, the gov’t may impose an excise tax of $1/L Thus, supply curve shifts from S1 to S2, moving equilibrium to where D1 meets S2 Spillover Costs, Excise Tax

Other Spillover Effects Taxes are a way of dealing with spillover costs Federal & provincial excise taxes are also on alcohol and cigarettes Taxes on these items can reduce spillover costs, such as: The public damage caused by an impaired driver Health-related effects of second hand smoke

Carbon Emissions Policy makers take into account the future costs of higher global temperatures, and based on that, issue a carbon tax. Carbon Tax: Excise tax levied on a wide range of products to counteract spillover costs associated with carbon emissions. Applied to anything whose production and consumption requires significant transportation of materials

Spillover Benefits Spillover Benefits: Positive external effects of producing or consuming a product e.g. Education, since society as a whole gains from this service Without gov’t intervention in market for engineering education, equilibrium occurs where D0 meets S If spillover benefits are determined to be $2000 per student, government can create a subsidy for students pursuing a career in engineering Thus, demand curve shifts from D0 to D1, new equilibrium point is where D1 meets S Spillover Benefits, Student Subsidy

Public Goods Extreme Case: there are some products for which private benefits and spillover benefits cannot be separated Public Good: A product whose benefits cannot be restricted to certain individuals While some consumers pay for a product, others get a “free ride” e.g. Lighthouse – all boats benefit, regardless if they help pay for it

Is Internet a Public Good? No one owns the internet, and the price of accessing the internet is not a lot, especially if you access it from school/work There are many sites and organizations that provide resources that can help you, which gives it many of the features of a public good