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Published byChad Collins Modified over 9 years ago
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L23 Externalities
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Road map 1) Consumers choice 2) Equilibrium, Producers (Pareto efficiency) 3) Market Failures - fixed cost: monopoly and oligopoly - externalities and public goods - asymmetric information
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Externalities u So far: utilities on own actions only u Reality: we are not islands u An externality is a cost or a benefit imposed upon someone by actions taken by others. - benefit - positive externality. - cost - negative externality.
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Examples of Negative Externalities u Air or water pollution. u Loud parties next door. u Traffic congestion. u Second-hand cigarette smoke. u Increased insurance premiums due to alcohol or tobacco consumption. u Bad smell!
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Examples of Positive Externalities u A well-maintained property. u High “human” capital u A pleasant cologne or scent worn by the person seated next to you. u A scientific advance.
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Today’s questions: u Efficiency of interactions with externalities u Too much or too little activity with externality? u How can we reestablish Pareto efficiency? – taxes – creating markets – social norms
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Example: Negative externality u Two producers: steel mill and fishery u A steel mill produces steel u It can also choose the level of pollution u The pollution adversely affects a nearby fishery
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Steel mill problem
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Fishery problem
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Pareto efficient production
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u When negative externality – too much activity in decentralized markets u You will show in PS that when externality if positive – too little activity. Conclusion 1
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u Problem: information! Implementation: Pigouvian Tax
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Creation of missing markets
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Property rights (Coase Theorem)
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u Social norm: “do not pollute” u Moral cost u Many norms can be explained using efficiency argument Social norms: moral cost
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