1. 10
Externalities

2. Figure 1 The Market for Aluminium
Price of
aluminum
Supply
(private cost)
Demand
(private value)
QMARKET
Equilibrium
Quantity of
aluminum
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3. Figure 2 Pollution and the Social Optimum
Price of
Social
cost
aluminum
Cost of
pollution
Demand
(private value)
Supply
(private cost)
Optimum
QOPTIMUM
Equilibrium
QMARKET
Quantity of
aluminum bought and sold
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4. Figure 3 Education and the Social Optimum
Price of
education
Social
value
Supply
(private cost)
Demand
(private value)
QOPTIMUM
QMARKET
Quantity of
Education bought and sold
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5. Figure 4 The Equivalence of Pigovian Taxes and Pollution Permits (1)
(a) Pigovian tax
Price of
pollution
Demand for
pollution rights P
Pigovian
tax Q 1.
A Pigovian
tax sets the
price of
pollution . . .
Quantity of 2.
. . . which, together
with the demand curve,
determines the quantity
of pollution.
pollution
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6. Figure 4 The Equivalence of Pigovian Taxes and Pollution Permits (2)
(b) Pollution permits
Price of Q
Supply of
pollution permits
pollution
Demand for
pollution rights P 2.
. . . which, together
with the demand curve,
determines the price
of pollution.
Quantity of 1.
Pollution
permits set
the quantity
of pollution . . .
pollution
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