EXTERNALITIES

SSEF5 The student will describe the roles of
government in a market economy.
a. Explain why government provides public
goods and services, redistributes income,
protects property rights, and resolves
market failures.
b. Give examples of government regulation
and deregulation and their effects on
consumers and producers.
Externality
When one person’s
actions imposes a
cost or benefit on the
well-being of a
bystander.
Externalities usually
result in market
failure.
1) Positive Externality:
an external benefit is
imposed on someone.
(examples: gardens,
restored historic buildings,
research)
2) Negative Externality: an
external cost is imposed on
someone. (examples: exhaust
from autos, barking dogs,
noise from airplanes)
Inefficient allocation

 Externalities cause markets to
allocate resources inefficiently
 By:
 CONSUMPTION: consuming a
good results in externality.
 PRODUCTION: producing a
good results in externality.
 an external cost = market
overproduces the good (ie,
paint).
 An external benefit = market
under produces the good (ie,
gardens)
Are there benefits for other
people in the parking lot when
someone puts their car alarm on?
ANSWER:
Yes, because thieves don’t
know which cars have
alarms.
What about the club?
Are there benefits for other people in
the parking lot when someone puts
the club on their car?
ANSWER:
No . . .because the thief
can SEE the club.
Your neighbor puts in a
nice garden. Are you
receiving a benefit?
When you admit you are receiving a
positive benefit, your neighbor asks you
to pay him $100 a month for the benefit.
When you say no, he
puts up a fence.
What if you lived
next door to this?
Do you receive a
benefit?
PROPERTY RIGHTS is the issue?
Who owns the air? The rivers? The
parks?
If we can figure out who pollutes the
stream, we punish the offender because
we are not sure who owns the stream, but
we DO know who pollutes it.
We get into trouble when we use this
criteria regarding the air.
What is the difference between a public good
and a private good?
Exclusion vs. non-exclusion
and
Shared consumption (rival good)
vs.
non-shared consumption (non-rival
good)
What defines property rights?
Property rights are established by formal
and informal rules about the privileges and
limitations on the ownership, use, and
transfer of goods and resources. These
rights are specified in various municipal
ordinances, other legislation, court
decisions (common law), tradition and
custom.
Property rights need to be:
1) clearly defined
2) exclusive
3) enforceable
4) transferable
What is a free-rider?
Someone who uses the good but doesn’t
pay for it.
Free riders occur when there are
nonexclusion and shared consumption.
Spraying for mosquitoes
Police & fire protection
National defense
Street lights
So . . .
Your neighbor plants a garden and it is beautiful.
But 5 years later, the garden has grown and you can no
longer see the lake.
Do you have a right to your view?
If your cat is in your neighbor’s
yard, is it your neighbor’s cat?
What if your cat kills a bird in
your neighbor’s yard?
In review:
Externalities
Positive
Negative
(+benefit)
(+cost)
Consumption
Consumption
(cigarettes)
(education)
Production
(honey)
Production
(pollution)