Externalities and Public Policy
Lesson20
Sections 74, 75
Market Failure
• What is market failure?
– Failure to set the correct price
– Unintended consequences
– Allocation of goods not efficient
Externalities
• Externalities
– External Cost: Negative Externality
– External Benefit: Positive Externality
Private Solutions to Externalities
• Internalize the Externalities
– Coarse theorem
• Private parties can reach a solution?
– BBQ and loud music vs neighbor that can’t stand the music
» Payment?
– Transaction cost
The Economics of Pollution
• Cost and Benefit
of Pollution
– Marginal Social
Cost of Pollution
– Marginal Social
Benefit of
Pollution
– Socially Optimal
Quantity of
Pollution ?
Policies Toward Pollution
• Environmental Standards
• Emissions Tax
• Tradable Permits
Production, Consumption, and
Externalities
• Private vs Social Benefits
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Marginal Social Benefit
Marginal Personal Benefit
Marginal External Benefit
MSB=MPB+MEB
• Private vs Social Costs
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Marginal Social Cost
Marginal Personal Cost
Marginal External Cost
MSC=MPC+MEC
Pigouvian Subsidy
Pigouvian Tax
Technology Spillover
Network Externality
– Who else is using it?