1. Page 440 #1 Wastewater runoff from poultry farm affects neighbors: a. Pollution in runoff negatively affects them – negative externality (uncompensated cost) b. Absence of govt involvement or private deal = too much pollution than what is socially optimal c. Socially optimal outcome = less pollution (must match marginal benefit to marginal SOCIAL cost) #2 Yasmin suggests huge fine to quell late book returns. Allowing some lateness can be socially optimal: you get some marginal benefit from keeping book late even though there is a marginal social cost too Huge fine would lead people to return book before work is complete – marginal social benefit of keeping book one more day may be more than the marginal social cost of this

2. b. Market equilibrium (MC = MB): 4 tons of steel c. Socially optimal quantity (MSC = MB): 2 tons of steel d. Optimal Pigouvian tax to remedy negative externality: $60 per ton (the exact external cost to society)

3. a.Positive externality. MSB > MB. Too few flowers planted than socially optimal without intervention. b.Negative externality. MSC > MC. Too many fires started w/o intervention. c.Positive externality. MSB > MB. Too few bees kept w/o intervention. d.Negative externality. MSC > MC. Too much gasoline consumed w/o intervention.

4. Remember – plot the points at the MIDPOINTS

5. a.MSC = MSB at 95 dB b.Sorority bears none of cost (MC = 0). Will play music where volume = 96.5 dB. c.Tax of $3 per dB  MC to sorority is $3. Will play music at volume of 96 dB. Not an optimal tax.

6. Add this problem to the back of the final review packet (if it isn’t already there): 20. John buys bread and cheese. Bread is $2 per loaf, and cheese is $4 per pound. The marginal utility of the last loaf of bread purchased was 20 utils. The marginal utility of the last pound of cheese purchased was also 20 utils. a. Is the current level of consumption correct? b. If not, what should John do?

7. For each of the following situations, come up with examples of the costs and benefits (non-monetary AND not immediately expected) associated with each. Window side groups: A new highway is constructed through a town. Middle groups: The airport nearby now offers international flights, not just domestic. Side boards groups: A new stadium for the A’s is built in downtown Oakland.

8.  An external cost is an uncompensated cost that an individual or firm imposes on others.  An external benefit is a benefit that an individual or firm confers on others without receiving compensation. These are otherwise referred to as externalities. The classic case of negative externality?

9. The Socially Optimal Quantity of Pollution Marginal social cost, marginal social benefit Quantity of pollution emissions (tons) Q OPT 0 $200 Marginal social cost, MSC, of pollution O Socially optimal quantity of pollution Socially optimal point Marginal social benefit, MSB, of pollution

10. A Market Economy Produces Too Much Pollution Q MKT Q H Q OPT 0 $400 300 200 100 O Marginal social benefit at QMKT Market-determined quantity of pollution MSC of pollution The market outcome is inefficient: marginal social cost of pollution exceeds marginal social benefit Marginal social cost, marginal social benefit Quantity of pollution emissions (tons) Socially optimal quantity of pollution Marginal social cost at QMKT MSB of pollution MSB falls directly on the producer/polluter

11. Marginal social cost of pollution: add’l cost on society Ex: pollution kills fish, forests, etc MSC = private MC + MC of externalities Marginal social benefit of pollution: add’l benefit to society from pollution MSB = private MB + MB of externalities If a company is polluting, how does a producer get benefit from this?

12. Private vs Social Costs Example: livestock 1. Who experiences costs: 2. Who gets the benefit: 3. Positive or negative externalities? 4. Is the amount of livestock adequate (socially optimal)?

13. Negative Externalities and Production MSC of livestock S = MC D = MB Q OPT P P MSC MKT P Q E O (a) Negative Externality Price, marginal social cost of livestock Quantity of livestock Marginal external cost Optimal Pigouvian tax MKT MC = marginal cost of livestock incurred by suppliers (supply of livestock) D = demand for livestock (marginal benefit incurred by consumers) MSC = marginal SOCIAL cost (MC + external cost) ex: livestock market + the rest of us = society

14. Add a MSC column. Also: graph the MR, MC and MSC curves at the midpoints

15. Private vs. Social Benefits Example: flu shots 1. Who experiences cost? 2. Who gets benefit? 3. Positive or negative externalities? 4. Is the amount of vaccinations adequate then?

16. Positive Externalities and Consumption S = MC D = MB MSB of flu shots O (a) Positive Externality Price of flu shot Q OPT P P MSB P MKT Q S D O Quantity of flu shots Q OPT Q MKT (b) Optimal Pigouvian Subsidy E MKT E Price, marginal social benefit of flu shot Price to producers after subsidy Optimal Pigouvian subsidy Price to consumers after subsidy Marginal external benefit Quantity of flu shots

17. Hint: Plot demand curve (demand = marginal benefit)  Supply curve!  Be sure to READ the problem first!

19. Private solutions to externalities I. The Coase theorem A.An efficient solution can always be reached provided the costs of making a deal are sufficiently low (transaction costs) B. Example: My upstairs neighbor likes to play Wii at 11 PM, which annoys me to no end while I’m trying to sleep. An argument ensues. Who wins?

20. Individuals have an incentive to make mutually beneficial deals – internalizing the externality When might this not happen? 1. Costs of communication might be high if many people are involved. 2. Cost of legal services might be too high. 3. Costly delays involved in bargaining might lead to increased effort/wasted time.

21. Government Policies Toward Pollution I. Environmental standards A.Rules that specify actions by producers and consumers 1.Ex: emissions standards for cars II. Emissions taxes A.Depends on amount of pollution produced B.Pigouvian tax: tax designed to reduce external costs C.The problem:

22. Environmental Standards Versus Emissions Taxes (b) Emissions Taxes(a) Environmental Standard 0600400200 $600 200 0600300 $600 150 300 MB B B A A T A S A S B T B Emissions tax Environmental standards forces both plants to cut emission by half Without government action, each plant emits 600 tons. Marginal benefit to individual polluter Quantity of pollution emissions (tons) Plant A has a lower marginal benefit of pollution and reduces emissions by 400 tons Plant B has a higher marginal benefit of pollution and reduces emissions by only 200 tons

23. The major point: Emissions taxes are usually more efficient than environmental standards – emissions taxes ensure that the marginal benefit of pollution is equal for all sources Another way to see this: calculate total surplus for both situations – surplus is maximized with the tax option

24. III. Tradable Emissions Permits A. Licenses to emit limited quantities of pollutants that can be bought and sold B. Firms w/different costs of reducing pollution can engage in mutually beneficial transactions C. Efficient? Definitely! D. Incentives to change methods, not just limit production

27. Warm-up: January 4, 2012 Answer the following question in your notebook.

28. Network Externality: A good’s value to an individual is greater when many people own or use same good Examples: Communications (fax machine) Computer operating systems (Windows) Types of cars (Ford/Chevy in rural areas) Voltage in the US