1. KHALID AZIZ COMMERCE EXPERT Externalities

2. KHALID AZIZ COMMERCE EXPERT JOIN KHALID AZIZ  ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.  FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.  COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. CONTACT:0322-3385752 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN.

3. KHALID AZIZ COMMERCE EXPERT Market Failures: Externalities u When a market outcome affects parties other than the buyers and sellers in the market, side-effects are created called externalities. u Externalities cause markets to be inefficient, and thus fail to maximize total surplus.

4. KHALID AZIZ COMMERCE EXPERT An externality arises...... when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect.

5. KHALID AZIZ COMMERCE EXPERT Market Failures: Externalities u When the impact on the bystander is adverse, the externality is called a negative externality. u When the impact on the bystander is beneficial, the externality is called a positive externality.

6. KHALID AZIZ COMMERCE EXPERT u Automobile exhaust u Cigarette smoking u Barking dogs (loud pets) u Loud stereos in an apartment building Examples of Negative Externalities

7. KHALID AZIZ COMMERCE EXPERT u Immunizations u Restored historic buildings u Research into new technologies Examples of Positive Externalities

8. KHALID AZIZ COMMERCE EXPERT The Market for Aluminum... Quantity of Aluminum 0 Price of Aluminum Q MARKE T Demand (private value) Supply (private cost) Equilibrium

9. KHALID AZIZ COMMERCE EXPERT Q MARKE T Pollution and the Social Optimum... Quantity of Aluminum 0 Price of Aluminum Demand (private value) Supply (private cost) Social cost Q optimum Cost of pollution Equilibrium Optimum

10. KHALID AZIZ COMMERCE EXPERT Negative Externalities in Production The intersection of the demand curve and the social-cost curve determines the optimal output level. u The socially optimal output level is less than the market equilibrium quantity.

11. KHALID AZIZ COMMERCE EXPERT Positive Externalities in Production When an externality benefits the bystanders, a positive externality exists. u The social costs of production are less than the private cost to producers and consumers.

12. KHALID AZIZ COMMERCE EXPERT Positive Externalities in Production... Quantity of Robots 0 Price of Robot Q OPTIMUM Demand (private value) Supply (private cost) Social cost Q MARKET Value of technology spillover Equilibrium Optimum

13. KHALID AZIZ COMMERCE EXPERT Positive Externalities in Production The intersection of the demand curve and the social-cost curve determines the optimal output level. u The optimal output level is more than the equilibrium quantity. u The market produces a smaller quantity than is socially desirable. u The social costs of production are less than the private cost to producers and consumers.

14. KHALID AZIZ COMMERCE EXPERT Internalizing Production Externalities u Taxes are the primary tools used to internalize negative externalities. u Subsidies are the primary tools used to internalize positive externalities.

15. KHALID AZIZ COMMERCE EXPERT Consumption Externalities... Quantity of Education 0 Price of Education Q MARKET Demand (private value) Social value Q OPTIMUM (b) Positive Consumption Externality Supply (private cost) Quantity of Alcohol 0 Price of Alcohol Q MARKET Demand (private value) Supply (private cost) Social value Q OPTIMUM (a) Negative Consumption Externality

16. KHALID AZIZ COMMERCE EXPERT Externalities and Market Inefficiency u Negative externalities in production or consumption lead markets to produce a larger quantity than is socially desirable. u Positive externalities in production or consumption lead markets to produce a larger quantity than is socially desirable.

17. KHALID AZIZ COMMERCE EXPERT Private Solutions to Externalities Government action is not always needed to solve the problem of externalities.

18. KHALID AZIZ COMMERCE EXPERT The Coase Theorem The Coase Theorem states that if private parties can bargain without cost over the allocation of resources, then the private market will always solve the problem of externalities on its own and allocate resources efficiently.

19. KHALID AZIZ COMMERCE EXPERT Why Private Solutions Do Not Always Work Sometimes the private solution approach fails because transaction costs can be so high that private agreement is not possible.

20. KHALID AZIZ COMMERCE EXPERT Public Policy Toward Externalities When externalities are significant and private solutions are not found, government may attempt to solve the problem through...  command-and-control policies.  market-based policies.

21. KHALID AZIZ COMMERCE EXPERT JOIN KHALID AZIZ  ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.  FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.  COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. CONTACT:0322-3385752 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN.