ExternalitiesSpillover Costs & Spillover Benefits
Chapter 10 (pages 203-208)
Switzerland & Garbage
35 Liter Swiss Trash Bag
EXTERNALITIES
• An externality is the uncompensated impact of one person or firm’s actions on another person/society – Both positive externalities & negative externalities exist
• All externalities are considered market failures (inefficient)
– That is, markets with externalities do not maximize total surplus (welfare)
– Governments can correct externalities with taxes or subsidies
Factory A Factory B
Negative Externalities
– Automobile exhaust
– Cigarette smoking
– Barking dogs
– Loud stereos in an apartment building
– Noisy Students
– Neighbor’s poorly maintained property
Positive Externalities – Immunizations– Restored historic buildings– Research into new technologies– Neighbor’s well maintained property– Volunteering
Spillover Costs & Spillover Benefits
• Spillover Costs- external costs not included in supply curve (MC)
– External costs exist with ALL negative externalities
– MC is understated => which leads to overproduction
• Spillover Benefits-external benefits not included in demand curve (MB)
– External benefits exist with ALL positive externalities
– MB is understated => which leads to underproduction
MB
MC
Graphing Externalities
• When graphing negative externalities use MC & MB curves– Then add any spillover cost or benefit to existing curve
• Marginal Social Cost (MSC) = MC + spillover cost (external cost)
• Marginal Social Benefit (MSB) = MB + spillover benefit (external benefit)
MB
MC
Negative Externality
MB
MC
MSB
Positive ExternalityMSC
Internalizing Externalities
• Internalizing an externality involves altering incentives to improve market outcomes (i.e. to increase total welfare)
• Government Solutions– Taxes or Subsidies– Laws (immunization laws, pollution laws)
– Patents
• Free market Solution: – Trading pollution credits => i.e. cap & trade
Internalizing Negative Externalities
Impose Tax = spillover cost Shifts Supply Curve left
Reach social optimal output
Total Cost = Total Benefit
Total Cost = MSC (MCP + MCS)
Total Welfare is Maximized!
Assume this Factory PollutesAluminum Cans
Quantity0
Price
MBPMBP
MCPMCP
Q1Q1
P1E1
MSC
-----------------------------------
Q2
P2 E2
MC
MB
Large SUV Production Electric Cars
Quantity0
Price
MBPMBP
MCPMCP
Q1Q1
P1E1
Quantity0
Price
MBPMBP
MCPMCP
Q1Q1
P1E1
WORKSHEET
Subsidizing Positive Externalities
Impose Subsidy = spillover benefit Shifts demand curve right
Reach social optimal output
Total Cost = Total Benefit
Quantity0
Price
MBMB
MCMC
QMARKETQMARKET
External social benefit
External social benefit
EquilibriumEquilibriumOptimumOptimum
QOPTIMUMQOPTIMUM
Spillover BenefitSpillover Benefit
MSB
Electric CarsAssume these cars have external benefits
Bottled WaterWhat is the real cost?
Start 20 minutes in…
Documentary
1) Demand Section 12 min.2) Recycle Section
Only 11 states have recycle deposits lawsOnly 20% of U.S. water bottles are recycled
Internalizing Negative Externalities
Impose Tax = spillover cost This puts a price on “external costs”
Reach socialy optimal output @ Q2
MSC = MCp + MCs (internal & external)
Bottled Water
Quantity0
Price
MBPMBP
MCPMCP
Q1Q1
P1E1
MSC
-----------------------------------
Q2
P2 E2
MC
MB
Top Related