1. Microeconomics 2 John Hey

2. Lecture 32 Externalities – where the actions of one agent directly affects the welfare of another (not indirectly through a market). In consumption… …can be positive (nice smells from someone else)… …or negative. In production… …can be positive (my factory provides heat to yours)… …or negative. In this lecture I will just analyse negative externalities.

3. Bari "Se Parigi avesse il mare, sarebbe una piccola Bari" My first example is inspired by my 7 years in Bari. (pictures courtesy of Wikipedia – except the last which is mine)

5. Externalities in Consumption Bad music… I like silence. So I do not like bad music played at high volume… … but my (mercifully ex-) neighbours in Bari loved terribly bad music at high volume. So when they played very loud music it was a negative externality for me. What happened? What should have happened? (Depends on the law.) Let’s go to Maple...

6. Externalities in Production Two firms… One is a steel producer... …the other is a fishery. They are both located on the banks of a river. With the steel producer upstream of the fishery… …polluting the river… …and creating a negative externality for the fishery. Let’s return to Maple...

7. Summary The existence of an externality can result in an inefficiency. The assignment of property rights, combined with competitive exchange, can eliminate this inefficiency. There are clearly other ways; for example in production: The government can tax the polluter and pay the proceeds to the polluted (implicitly creating a price for pollution – but not one driven by efficiency). The two firms can merge. The government can issue pollution permits that firms can trade.

8. Lecture 31 Goodbye!