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

2. 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
Qtyx /T Qe

3. 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

4. Negative Externality in ConsumptionSx
$ Price x
$Pe
$Pe’ Dx
Dx’
Qe’ Qe
Qty x /T

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

6. 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)

7. Positive Externality in ConsumptionSx
$ Price x
$Pe’
$Pe
Dx’ Dx Qe
Qe’
Qty x /T

8. 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)

9. 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.

10. Market Failures Private markets and social efficiency Nonexcludability
Free riding
Nonrivalry