CHAPTER 16
Externalities
<Review Slides>
PowerPoint® Slides
by Can Erbil
© 2004 Worth Publishers, all rights reserved
What you will learn in this chapter:
Externalities – negative and positive
The Coase theorem
Government policies to deal with externalities, such as
emissions taxes, tradable permits, Pigouvian subsidies, and
environmental standards
Industrial policy
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Costs and Benefits of Pollution
Marginal social cost of pollution
Marginal social benefit of pollution
Socially optimal quantity of pollution
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The Socially Optimal Quantity of Pollution
The socially optimal quantity of pollution is QOPT; at that quantity, the
marginal social benefit of pollution is equal to the marginal social cost,
corresponding to $200.
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Why a Market Economy Produces Too Much
Pollution
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Negative Externalities and Production
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Positive Externalities and Production
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Private versus Social Benefits
The most common examples of external benefits are
technology spillovers. When these occur, the marginal social
benefit of a good or activity exceeds the marginal benefit to
consumers, and too little of the good is produced in the
absence of government intervention.
A Pigouvian subsidy is a payment designed to encourage
activities that yield external benefits.
The socially optimal quantity can be achieved by an optimal
Pigouvan subsidy equal to the marginal external benefit.
An industrial policy is a policy that supports industries
believed to yield positive externalities.
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Policies Toward Pollution
Environmental standards - rules that protect the
environment by specifying actions by producers and
consumers.
Emissions tax - a form of Pigouvian tax, a tax designed to
reduce external costs that depends on the amount of
pollution a firm produces.
Tradable emissions permits - licenses to emit limited
quantities of pollutants that can be bought and sold by
polluters.
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Environmental Standards versus
Emissions Taxes
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The Inefficiency of Excess Pollution
Private Solutions to Externalities:
Coase theorem: even in the presence of externalities an
economy can always reach an efficient solution provided
that the costs of making a deal are sufficiently low.
The costs of making a deal are known as transaction costs.
When individuals do take externalities into account,
economists say that they internalize the externality.
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CHAPTER 17
Public Goods and Common
Resources
<Review Slides>
PowerPoint® Slides
by Can Erbil
© 2004 Worth Publishers, all rights reserved
What you will learn in this chapter:
A way to classify goods that predicts whether a good can
be efficiently provided by free markets
Public goods
Common resources
Artificially scarce goods
Government intervention in the production and
consumption of these types of goods
The right level of government intervention
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Characteristics of Goods
Goods can be classified according to two attributes:
excludable
rival in consumption
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Characteristics of Goods
There are four types of goods:
Private goods
Public goods
Common resources
Artificially scarce goods
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Characteristics of Goods
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Public Goods
A public good is a good that is both nonexcludable and
nonrival in consumption.
Examples:
Disease prevention
National defense
Scientific research
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A Public Good
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A Public Good
No individual has an incentive
to pay for providing the
efficient quantity of a public
good because each
individual’s marginal benefit
is less than the marginal
social benefit.
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Governments Providing Public Goods
Cost-benefit analysis - estimating the social costs and social
benefits of providing a public good
Common resources - nonexcludable and rival in consumption
The problem of overuse - a user depletes the amount of the
common resource available to others but does not take this cost into
account when deciding how much to use the common resource
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A Common Resource
Each fisherman’s
individual marginal
cost does not include
the cost that his or her
actions impose on
others: the depletion
of the common
resource  the
marginal social cost
curve, MSC, lies above
the supply curve; in an
unregulated market,
the quantity of the
common resource
used, QMKT, exceeds
the efficient quantity
of use, QOPT.
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The Efficient Use and Maintenance of a
Common Resource
Find a way of getting individual users of the resource to take
into account the costs they impose on other users:
Use Pigouvian taxes (tax or otherwise regulate the use of
the common resource)
Make it excludable and assign property rights
Create of a system of tradable licenses for the right to use
the common resource
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Artificially Scarce Goods
An artificially scarce good is excludable and nonrival in consumption. It
is made artificially scarce because producers charge a positive price but
the marginal cost of allowing one more person to consume the good is
zero.
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The End of Chapter 17
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