2016-2017 EOC101 Economics
Weekly Lecture: Week 03
Chaps 7, 8 & 9 –Government Actions in Markets, Global
Markets in Action & Externalities: Pollution, Education,
and Health Care
Chaps 7 Government Actions in Markets
CHAPTER ROADMAP
 What
’
sNe
wi
nt
hi
sEdi
t
i
on?
Chapter 7 is updated from the fifth edition, with updated data for the Eye
applications.
 Where We Are
We use the demand and supply graph to study how the government can influence
markets. Taxes, price ceilings, price floors, and price supports can prevent markets
from efficiently allocating resources. Examples show how these actions impact
consumers and firms, how equilibrium prices and quantities change, and how they
create deadweight losses.

Whe
r
eWe
’
veBe
e
n
We
’
vede
ve
l
ope
dt
hede
ma
nda
nds
uppl
ymode
l
,at
oolt
ous
ei
nexamining how
markets determine their equilibrium prices and quantities. The elasticities of supply
and demand reflect how responsive quantities are to a change in price. These ideas
play an important role in showing how market interventions create inefficiency and
unfairness.

Whe
r
eWe
’
r
eGoi
ng
The next chapter examines how global markets work and looks at the effects of
government policies such as tariffs and quotas.
CHAPTER LECTURE
 7.1
Taxes on Buyers and Sellers
Tax Incidence
Tax incidence is the division of the burden of a tax between the buyer and the seller.
The buye
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1
2016-2017 EOC101 Economics
i
mpos
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imposed. The tax incidence does not depend on whether the tax law imposes the tax
on buyers or on sellers.
 A tax on sellers:
 Imposing a tax on sellers
decreases the supply because the
tax is like a cost that sellers must
pay. The supply curve shifts
leftward and the vertical distance
between the initial supply curve
and the new supply curve is
equal to the amount of the tax.
The price paid by buyers rises,
the price received by sellers falls,
and the quantity decreases.
 The figure shows the effect of a tax imposed on sellers. The initial price is
$12 and the initial quantity is 10,000. When the tax is imposed, the supply
curve shifts from S to S + tax. The length of the double headed equals the
amount of the tax, $2. With the tax imposed, buyers pay $13, sellers
receive $11, and the quantity decreases to 9,000.
 A tax on buyers:
 Imposing a tax on buyers
decreases the demand because
the tax lowers the amount they
are willing to pay to the sellers.
The demand curve shifts leftward
and the vertical distance between
the initial demand curve and the
new demand curve is equal to the
amount of the tax. The price paid
by buyers rises, the price received
by sellers falls, and the quantity
decreases.
 The figure shows the effect of a tax imposed on buyers. The initial price is
$12 per DVD and the initial quantity is 10,000 DVDs per month. When
the tax is imposed, the demand curve shifts from D to D tax. The length
of the double headed equals the amount of the tax, $2. With the tax
imposed, buyers pay $13 per DVD, sellers receive $11 per DVD, and the
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2016-2017 EOC101 Economics
quantity of DVDs decreases to 9,000 per month.
 The figures above confirm the general conclusion: Regardless of whether the
tax is imposed on buyers or sellers, the tax leads to the same outcome in which
the new equilibrium price and quantity are identical. The tax burden is split the
same way regardless of who is responsible for paying the tax to the
government.
Taxes and Efficiency
 Taxes place a wedge between the price buyers pay and sellers receive. It
therefore puts a wedge between marginal benefit and marginal cost and creates
inefficiency. The quantity produced is less than the efficient quantity.
 Taxes create an excess burden, which is the amount by which the burden of a
tax exceeds the tax revenue received by the government—the deadweight loss
from a tax.
Incidence, Inefficiency, and the Elasticity of Demand
 Perfectly Inelastic Demand: Buyer Pays and Efficient: The buyer pays the
entire tax if demand is perfectly inelastic (so the demand curve is vertical). In
general, the less elastic the demand, the larger the tax burden paid by the
buyers. When demand is perfectly elastic, the outcome is efficient because
marginal cost equals marginal benefit.
 Perfectly Elastic Demand: Seller Pays and Inefficient: The seller pays the
entire tax if demand is perfectly elastic (so the demand curve is horizontal) In
general, the more elastic the demand, the larger the tax burden paid by the
sellers. Because marginal benefit exceeds marginal cost, the outcome is
inefficient.
Incidence, Inefficiency, and the Elasticity of Supply
 Perfectly Inelastic Supply: Seller Pays and Efficient: The seller pays the entire
tax if supply is perfectly inelastic (so the supply curve is vertical). In general,
the more inelastic the supply, the larger the tax burden paid by the sellers.
When supply is perfectly elastic, marginal benefit equals marginal cost, so the
outcome is efficient.
 Perfectly Elastic Supply: Buyer Pays and Inefficient: The buyer pays the entire
tax if supply is perfectly elastic (so the supply curve is horizontal). In general,
the more elastic the supply, the larger the tax burden paid by the buyers.
Marginal benefit exceeds marginal cost, so the outcome is inefficient.
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2016-2017 EOC101 Economics
If either the demand or the supply is perfectly inelastic, there is no deadweight loss
from the tax because the equilibrium quantity does not change. In all other cases,
there is a deadweight loss.
 7.2
Price Ceilings
 A price ceiling is a government regulation that places an upper limit on the
price at which a particular good, service, or factor of production may be
traded.
A Rent Ceiling
 A rent ceiling is a price ceiling
applied to a housing market. A rent
ceiling is a regulation that makes it
illegal to charge more than a
specified rent for housing.
 A rent ceiling set below the
equilibrium rent creates a shortage.
 In the figure, the equilibrium rent is
$800 per month and the equilibrium
quantity is 3,000 units rented. If a
$600 per month rent ceiling is
imposed, the quantity of units
demanded increases (to 4,000 units in the figure) the quantity of units supplied
decreases (to 2,000 units in the figure) and a shortage emerges (of 2,000 units
in the figure).
 Rent ceilings lead to the development of black markets and increased search
activity.
 A black market is an illegal market that operates alongside a
government-regulated market. The price in a black market exceeds the
legally imposed price ceiling. In a black market illegal arrangements are
made between renters and landlords—often at effective rental rates that are
higher than would be the case in an unregulated market.
 Search activity is the time spent looking for someone with whom to do
business.
Are Rent Ceilings Efficient?
Rent ceilings lead to inefficiency. In a competitive market, the equilibrium quantity is
the same as the efficient quantity. In a housing market with a rent ceiling, the quantity
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2016-2017 EOC101 Economics
of units is less than the equilibrium quantity and so is less than the efficient quantity.
There is a deadweight loss.
Are Rent Ceilings Fair?
 Us
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and disadvantaged. Some other allocative mechanism, such as a lottery,
queuing, some form of discrimination is often used to allocate housing. These
alternative allocation methods of distribution do not favor the poor and
disadvantaged.
If Rent Ceilings Are So Bad, Why Do We Have Them?
 Current renters gain from the presence of rent ceilings and so they lobby
politicians to maintain the ceilings.
 7.3
Price Floors
 A price floor is a government regulation that places a lower limit on the price
at which a particular good, service, or factor of production may be traded.
The Minimum Wage
 When a price floor is applied to labor markets, it is called a minimum wage. A
minimum wage law is a government regulation that makes hiring labor for
less than a specified wage illegal.
 If a minimum wage is set below the equilibrium wage, it has no impact.
 If a minimum wage is set above the equilibrium wage rate, the quantity of
labor demanded is less than the quantity of labor demanded. The minimum
wage creates unemployment because some workers who are willing to work at
the minimum wage will not find a job.
 A minimum wage set above the equilibrium wage leads to increased
job-search activity and illegal hiring of workers paid less than the
minimum wage.
Is the Minimum Wage Efficient?
 The equilibrium quantity of workers is the efficient quantity because that is
quantity at which the marginal benefit to firms equals the marginal cost to
workers. A minimum wage decreases the quantity of workers employed, so
there is a deadweight loss with less than the efficient quantity of workers are
employed.
Is the Minimum Wage Fair?
 A minimum wage gives unfair results because only the people who find jobs
benefit. It has unfair rules because it blocks voluntary exchange.
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2016-2017 EOC101 Economics
If the Minimum Wage Is So Bad, Why Do We Have It?
 Some supporters believe that not much unemployment results. Labor unions
lobby for the minimum wage because a higher minimum wage puts upward
pressure on all wages.
 7.4
Price Supports in Agriculture
How Governments Intervene in Markets for Farm Products
 To support farmers government generally rely upon three elements:
 The government isolates the domestic market from foreign competition by
restricting imports.
 The government introduces a price support, which is a price floor in an
agricultural market maintained by a government guarantee to buy any
surplus output at that price.
 The government pays the producers a subsidy. A subsidy is a payment by
the government to a producer to cover part of the cost of production.

Price Supports
 In the figure, the equilibrium price is
$400 per ton and the equilibrium
quantity is 3 million tons produced
and consumed. If the government
sets a support price of $500 per ton,
then the quantity produced is 4
million tons and the quantity
consumed is 2 million tons. There is
a 2 million ton surplus, shown by the
length of the arrow.
 To maintain the price at $500 per ton,
the government must purchase the
surplus. In this case, the government
buys 2 million at $500 per ton and thereby gives the farmers a $1 billion
subsidy.
 Thef
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society is worse off with the price supports.
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2016-2017 EOC101 Economics
Chaps 8 Global Markets in Action
CHAPTER ROADMAP

What
’
sNe
wi
nt
hi
sEdi
t
i
on?
Chapter 8 is updated with new data to reflect changes in international trade since the
sixth edition.

Where We Are
Chapter 8 continues studying markets. We learn some history behind the role
government plays in international trade, the factors that influence trade patterns,
whoga
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nsa
ndwhol
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l
side.

Whe
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surplus, producer surplus, and deadweight loss to understand the impact of trade on
domestic markets.

Whe
r
eWe
’
r
eGoi
ng
Chapter 9 will analyze externalities, both external costs and external benefits,
to further our study of the interaction of government and markets.
CHAPTER LECTURE
 8.1 How Global Markets Work
International Trade Today
 Imports are the goods and services that we buy from people in other countries.
Exports are the goods and services that we sell to people in other countries.
 TheU.
S.i
st
hewor
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a
r
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e
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national trader, comprising 10 percent of
t
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about 14 percent of total U.S. production and total imports were about 17
percent of total U.S. expenditure.
What Drives International Trade?
The fundamental force that generates
international trade is comparative
advantage. A country has a comparative
advantage in producing a good if it can
produce that good at a lower opportunity
cost than any other country.
7
2016-2017 EOC101 Economics

The figure shows the market for airplanes in the United States. The world
price of a plane, $80 million, exceeds the U.S. price, $60 million, which
means that the United States has a comparative advantage in producing
airplanes.
 With no trade, the equilibrium price is $60 million per plane and 300
planes are produced.
 When the United States trades with the world, the supply curve shows that
it will produce 400 planes. Of these 400 planes, the demand curve shows
that 200 will be purchased in the United States. The remaining planes will
be exported to foreigners.
 The number of planes produced in the United States increases but the
number of planes consumed in the United States decreases.

If the world price of a good or service is less than the U.S. price, the United
States does not have a comparative advantage in producing the good or
service and so it will import the good or service from abroad. The amount of
the good or service produced in the United States decreases but the number
consumed in the United States increases.
 
8.2 Winners, Losers, and Net Gains from Trade
Gains and Losses from Imports
The gains and losses from imports are calculated by examining their effect on
consumer surplus, producer surplus, and total surplus.
 Winners see their surplus increase, while losers see their surplus decrease.
 The figure shows the market for
pairs of pants in the United States.
The world price of a pair of pants is
less than the U.S. price, so the
United States imports pants 200
million pairs of pants.
 Consumer surplus increases and
equals the sum of areas C + B +
D. Of this amount, area B is lost
by producers and gained by
consumers. Area D is newly
gained surplus resulting from the
trade.
 Producer surplus decreases and equals area A. Without trade, producer
surplus would be the sum of areas A + B.
8
2016-2017 EOC101 Economics
 Because the total surplus increases by the amount of area D, the United
States is better off with trade.
Gains and Losses from Exports
The gains and losses from exports are likewise calculated by examining their effect on
consumer surplus, producer surplus, and total surplus.
 The figure shows the market for
airplanes in the United States. The
world price of an airplane exceeds
the U.S. price, so the United States
exports pants 200 airplanes.
 Producer surplus increases and
equals the sum of areas C + B +
D. Of this amount, area B is lost
by consumers and gained by
producers. Area D is newly
gained surplus resulting from the
trade.
 Consumer surplus decreases and
equals area A. Without trade, consumer surplus would be the sum of areas
A + B.
 Because the total surplus increases by the amount of area D, the United
States is better off with trade.
 8.3
International Trade Restrictions
Governments restrict international trade to protect domestic industries from foreign
competition.
Tariffs
 A tariff is a tax on a good that is imposed when it is imported.
 A tariff raises the domestic price of
the good. In the figure, the tariff is
equal to $5 per pair of pants, the
length of the grey arrow. As a result,
the domestic price of a pair of pants
rises from $10 to $15.
 The higher price of a pair of
pants decreases the quantity
bought in the nation, from 500
million to 400 million in the
9
2016-2017 EOC101 Economics
figure.
 The higher price of a pair of pants increases the quantity produced in the
nation, from 100 million to 200 million in the figure.
 The quantity of pants imported decreases, from 400 million (= 500 million
demanded 100 million supplied) to 200 million (= 300 million demanded
200 million supplied) in the figure.
 The government collects tariff revenue, $1,000 million (=$5 tariff per
pants 200 million pants imported) in the figure (which is also equal to
area C).
 A tariff benefits producers and the government, harms consumers, and creates
a deadweight loss.
 Consumers lose consumer surplus, equal to area A + area B + area C + area
D.
 Producers gain additional producer surplus, equal to area A in the figure.
 The government collects tariff revenue equal to area C in the figure.
 There is a deadweight loss created from the lost consumer surplus. The
deadweight loss is the sum of areas B and D. The deadweight loss
indicates that the society is made worse off with the tariff.
Import Quotas
 An import quota is a quantitative restriction on the import of a particular
good, which specifies the maximum amount of the good that may be imported
in a given period of time. An import quota decreases the quantity of imports
and thereby decreases the supply of the good. It raises the domestic price so
domestic consumption decreases and domestic production increases. However
the government does not gain any revenue; the person who has the right to
import the good gains the revenue.
 An import quota benefits domestic producers and the importers, harms
consumers, and creates a deadweight loss.
 Consumers lose because the domestic price rises.
 Producers gain producer surplus from selling a greater quantity at a higher
price.
 The importers earn profit from buying at the lower world price and
reselling in the U.S. at the higher domestic price (importer profit would be
the same amount as the government collects in tariff revenue with a
comparable tariff).
 There is a deadweight loss created from the lost consumer surplus. The
deadweight loss indicates that the society is made worse off with the
import quota.
10
2016-2017 EOC101 Economics
 Provided that an import quota is set at the same level of imports that would
result from a tariff, the impact on market outcomes is nearly identical, with
one notable difference—a tariff creates government revenue while an import
quota creates profit for the importer.
Other Import Barriers
 Health, safety, and regulation barriers: Imports of certain goods, such as food,
pharmaceuticals, and toys may be regulated to ensure that they are safe from
contaminants or produced under sanitary conditions.
 Voluntary export restraints resemble import quotas in that imports decrease,
as with an import quota, but with voluntary export restraints the foreign
exporterg
e
t
st
hepr
of
i
tf
r
o
mt
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pbe
t
we
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world price.
Export Subsidies
Subsidies are payments by a government to a producer. An export subsidy is a
subsidy paid to the producer of goods for export. Such subsidies stimulate
production of goods and services and consequently make it difficult for other
producers to compete. Export subsidies lead to global overproduction and
deadweight loss.
 8.4
The Case Against Protection
 Arguments for protection have varying degrees of credibility:
 The national security argument: There is an argument for protection of
some industries, especially those associated with national defense, to make
sure such industries are ready and able to operate in wartime. However, the
argument is usually a veiled argument for more widespread protectionism
because, in a time of war, there is no industry that does not contribute to
national defense. It is more efficient to achieve higher production in target
industries through the use of subsidies rather than trade barriers.
 The infant-industry argument: The so-called infant-industry argument
for protection is that it is necessary to protect a new industry to enable it to
grow into a mature industry that can compete in world markets. The idea
relates to changes in comparative advantages change over because of
learning-by-doing. However, the infant industries argument only applies if
the benefits of learning-by-doing spill over to other industries. Moreover,
historical evidence indicates that protected industries have a difficult time
developing into globally competitive industries.
 The dumping argument: Dumping occurs when a foreign firm sells its
exports at a lower price than its cost of production. Dumping might be
used by a firm that wants to gain a global monopoly. However, it is
difficult to measure the cost of production so whether dumping is taking
11
2016-2017 EOC101 Economics
place is difficult to determine. And charging a different export price than
domestic price is not necessarily evidence of dumping because firms often
sell goods and services for different prices in different markets.
 Saves jobs: The argument that trade protection saves jobs is flawed.
International trade changes the type of jobs in an economy, but it does not
decrease employment in the aggregate because jobs lost in one sector are
offset by jobs created in other sectors.
 Allows us to compete with cheap foreign labor: The argument that trade
protection allows us to compete with cheap foreign labor is flawed.
Differences in real wage rates generally reflect differences in productivity
and to think about competitiveness, we must consider both differences in
wages and differences in productivity.
 Brings diversity and stability: The argument that trade protection brings
diversity and stability is flawed. Big rich countries are already diversified.
And smaller countries can use the proceeds to trade to invest in a variety of
other nations and thereby increase diversity.
 Penalizes lax environmental standards: The argument that trade
l
i
be
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-to-the-bot
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ls
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s
weak. Many poorer countries have comparable environmental standards
and should not be targeted. And environmental standards are positively
related to income (they are a normal good). The best way to encourage
improved environmental standards is to allow trade and the economic
benefits it brings to poorer countries. But using free trade agreements such
as CAFTA to help negotiate policies that avoid irreversible harm to
resources such as rain forests might be useful.
Why Is International Trade Restricted?
Despite arguments against protection, trade is still restricted because key economic
interests benefit from protection.
 Rent Seeking: Rent seeking is lobbying and other political activity that
seek to capture the gains from trade. While the benefits from liberalized
trade are large in the aggregate, they are widespread across all consumers.
Meanwhile, the costs are concentrated on a smaller number of producers.
It is in the interests of those who pay the costs of liberalized trade to
undertake a large quantity of political lobbying to promote protection.
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2016-2017 EOC101 Economics
Chaps 9 Externalities: Pollution, Education, and Health Care
CHAPTER ROADMAP
 What
’
sNe
wi
nt
hi
sEdi
t
i
on?
The emphasis on health care as an example of a product with an external benefit has
been increased. The discussion of the health care market has been expanded, with a
new section discussing asymmetric information in the health-care insurance market
and a health-c
a
r
er
e
f
or
m pr
opos
a
lus
i
ngvouc
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r
s
.Ane
wEy
eon“
Educ
a
t
i
on
Qua
l
i
t
y
:Cha
r
t
e
rSc
hool
sa
ndVouc
he
r
s
”ha
sbe
e
na
dde
d.
 Where We Are
We use the demand and supply curves to show how externalities affect the efficient
use of resources. We see that external costs result in overproduction and that
external benefits result in underproduction. By developing the marginal social cost
curve and marginal social benefit curve, we incorporate these external costs and
external benefits into the basic demand-supply graph. Finally, we investigate how
the government intervenes in the market to promote efficient use of resources.
 Whe
r
eWe
’
veBe
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n
We
’
vee
xpl
or
e
dt
hei
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ndt
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tbr
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boutt
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f
f
i
c
i
e
nt
use of resources by equating marginal benefit to marginal cost. We use the concept
of efficiency in this chapter to discuss the deadweight loss from externalities and
how government action can overcome the inefficiency.
 Whe
r
eWe
’
r
eGoi
ng
After this chapter, the focus turns to exploring the supply curve in greater
de
t
ai
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.Thene
xtc
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o
examine its costs and its cost curves in the short run and in the long run.
CHAPTER LECTURE
 9.1
Negative Externalities: Pollution
Externalities in Our Daily Lives
 An externality is a cost or benefit that arises from production and falls on
someone other than the producer, or a cost or benefit that arises from
consumption and falls on someone other than the consumer. A negative
externality imposes an external cost and a positive externality creates an
external benefit.
 There are four types of externalities:
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2016-2017 EOC101 Economics
 Negative Production Externalities: noise from aircraft and trucks,
polluted rivers and lakes, the destruction of native animal habitat, air
pollution in major cities from auto exhaust.
 Positive Production Externalities: honey and fruit production, in which
fruit production gets an external benefit from locating bee hives next to a
fruit orchard, where the bees pollinate the trees to boost fruit output and
honey production gets an external benefit from the orchard trees that
generate the pollen necessary for honey production.
 Negative Consumption Externalities: smoking in a confined space and
posing a health risk to others, or having noisy parties or loud car stereos
that disturb others.
 Positive Consumption Externalities, flu vaccination because everyone
who comes into contact with the person benefits because they are less
likely to catch the flu.
Private Costs and Social Costs
 A private cost of production is a cost that is borne by the producer. Marginal
private cost (MC) is the cost of producing an additional unit of a good or
service that is borne by the producer of that good or service.
 An external cost is a cost of producing a good or service that is not borne by
the producer but is born by other people. A marginal external cost is the cost
of producing an additional unit of a good or service that falls on people other
than the producer.
 Marginal social cost (MSC) is the marginal cost incurred by the entire
society—by the producer and by everyone else on whom the cost falls—and is
the sum of marginal private cost and marginal external cost:
MSC = MC + Marginal external cost.
 The figure shows the marginal
private cost curve (MC) and the
marginal social cost curve (MSC)
for a good with an external cost.
The vertical distance between the
two curves is the marginal
external cost.
 Because the marginal social
cost includes the marginal
external cost, the marginal
social cost exceeds the
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marginal private cost (MSC > MC) for all quantities.
 The efficient quantity of output occurs where the marginal social cost
equals marginal benefit, that is, where MSC = MB. In the figure, the
efficient quantity is Q1.
 An unregulated market, however, produces where the MC = MB (which is
equivalent to producing where S = D). In the figure, the unregulated
market is at Q0. At this level of output, MSC exceeds MB so there is, as
illustrated, a deadweight loss.
Production and Pollution: How Much?
 When an industry is unregulated, the amount of pollution it creates depends
upon the market equilibrium price and quantity of the good produced. But it is
an inefficient equilibrium (see the deadweight loss in the figure above).
Therefore, reducing the amount of pollution and eliminating the deadweight
loss brings potential gains. In an example of a factory which dumps waste
chemical into a river, the people who live near the river experience a negative
externality and a deadweight loss. How can the people who live by the
polluted river get the chemical factories to decrease output of the chemical and
thereby cause less pollution? Can a solution be found that benefits everyone?
Solutions can be offered via property rights and the Coase Theorem.
Property Rights
 Property rights are legally established titles to the ownership, use, and
disposal of factors of production and goods and services that are enforceable
in the courts. Assigning property rights can reduce the inefficiency arising
from an externality.
The Coase Theorem
 The Coase theorem is the proposition that if property rights exist, if only a
small number of parties are involved, and if the transactions costs are low,
then private transactions are efficient. Transactions costs are the opportunity
costs of conducting a transaction
 A remarkable feature of the Coase theorem is that it does not matter if the
property right is given to the creators of the externality (the polluters) or to the
victims. In either case, the result will be efficient.
 If the polluters value the benefits from the activity generating the pollution
more highly than the victims value being free from the pollution, (that is,
the cost of reducing the pollution exceeds the benefit from the reduction)
then the efficient outcome is for the pollution to continue. If polluters are
assigned the right to pollute, the victims are not able to pay enough to
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2016-2017 EOC101 Economics
convince the polluters to stop. If the victims are assigned the property right
to be free from pollution, then the polluters are able to pay the victims
sufficient compensation to continue polluting. Either way, the pollution
continues.
 If the victims value the benefits from being free from pollution more
highly than the polluters value the benefits of the pollution, (that is, the
benefit from reducing pollution exceeds the cost of the reduction) then the
efficient outcome is for the pollution to stop. If the polluters are assigned
the right to pollute, then the victims are willing to pay the polluters
sufficient compensation to stop the pollution. If the victims are assigned
the right to be free from pollution, then the polluters are not able to pay the
victims enough to allow them to continue polluting. Either way, the
pollution stops.
Government Actions in the Face of External Costs
 The government can use pollution limits to achieve an efficient outcome. A
quantity limit on a polluting activity will cause the market price to rise,
reducing the quantity demanded to an amount that balances MSC and MB. The
higher price exceeds MC, which creates producer surplus. In reality, pollution
limits are difficult to implement and monitor and the higher price encourages
producers to increase their quantity beyond the limit.
 The government can use pollution charges or taxes that seek an efficient
outcome by making a polluter pay the marginal external cost of pollution. By
charging or taxing an amount equal to the marginal external cost, the MSC
curve becomes the same as the market supply curve. This moves the market to
the efficient quantity and the government collects revenue from the charge or
tax. In the figure above, the appropriate tax equals the length of the double
headed arrow.
 The government can use marketable pollution permits (or cap-and-trade),
wherein pollution rights are assigned or sold to individual producers who are
then free to trade permits with each other. The market in permits determines the
price of a permit and firms will buy or sell permits until their marginal cost of
pollution reduction equals the price of a permit.
 All of these methods have the potential to achieve an efficient outcome if the
marginal external cost is assessed correctly, though that is rarely possible.
Moreover, some producers have a lower marginal cost of avoiding pollution
than others, but pollution limits and pollution charges/taxes confront all
producers with the same incentives to avoid pollution. Cap-and-trade ends up
being a more effective government policy in practice because it provides the
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2016-2017 EOC101 Economics
strongest available incentive to individual producers to find cost effective
technologies that achieve pollution targets.
 9.2
Positive Externalities: Education and Health Care
Private Benefits and Social Benefits
 A private benefit is a benefit that the consumer of a good or service receives.
Marginal private benefit (MB) is the benefit from an additional unit of a
good or service that the consumer of that good or service receives.
 An external benefit from a good or service is a benefit that someone other than
the consumer receives. A marginal external benefit is the benefit from an
additional unit of a good or service that people other than the consumer of that
good or service enjoy.
 Marginal social benefit (MSB) is the marginal benefit enjoyed by the entire
society—by the consumer and by everyone else who enjoys a benefit—and is
the sum of marginal private benefit and marginal external benefit:
MSB = MB + Marginal external benefit.
 The figure shows the marginal private
benefit curve (MB) and the marginal
social benefit curve (MSB) for a good
with an external benefit. The vertical
distance between the two curves
equals the marginal external benefit.
For instance, the length of the arrow
in the figure equals the marginal
external benefit at the quantity Q1.
 Because marginal social benefit
includes marginal external benefit,
the marginal social benefit
exceeds the marginal private
benefit (MSB > MB) for all quantities.
 The efficient quantity of output occurs where the marginal social benefit
equals marginal cost, that is, where MSB = MC. In the figure, the efficient
quantity is Q1.
 An unregulated market produces where the MC = MB (which is equivalent
to producing where S = D). In the figure, the unregulated market
equilibrium is Q0. At this level of output, MSB exceeds MC so there is, as
illustrated in the figure, a deadweight loss.
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2016-2017 EOC101 Economics
Government Actions in the Face of External Benefits
 Public provision, which is when a public authority that receives its
revenue from the government produces the good or service. (Public
schools, colleges, and universities are examples.) In this case, the
government can direct the authority to produce the efficient quantity.
 A subsidy, is a payment that the government makes to a producer to cover
part of the cost of production, can be used. If the government pays the
producer a subsidy equal to the marginal external benefit, then the quantity
produced by the private firm increases to that at which the marginal cost
equals the marginal social benefit and an efficient allocation of resources
occurs. In the figure, the correct subsidy is equal to the length of the
double headed arrow.
 A voucher, which is a token that the government provides to households
to buy specified goods or services, can be used. Households receiving a
voucher effectively have a greater income to be used for the specific good
or service, which increases their demand and increases the quantity
consumed.
 Both public provision and private subsidies may fail to ultimately provide
an efficient outcome due to bureaucratic cost padding and overprovision.
Advocates of vouchers argue that giving financial resources to the
consumer rather than the producer will produce a more efficient outcome
as consumers may monitor performance more effectively than the
government will.
Economic Problems in Health-Care Markets
 Health care can be divided into two markets: the health-insurance care
services market and the health-care insurance market. Problems in each lead to
underprovision.
 Health-care services: Vaccination and public sanitation provide positive
consumption externalities. (For instance, flu vaccination protects the
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catching flu from the person.) With these external benefits, the marginal
social benefit of health care exceeds the marginal private benefit, causing
the unregulated market equilibrium to be inefficiently less than the
efficient quantity.
 Health-care insurance: Asymmetric information is a major problem in the
health care market. People know more about their health than does the
insurance company and doctors know more about the treatment that should
be prescribed and the cost than does the insurance company. Asymmetric
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2016-2017 EOC101 Economics
information means that an unregulated health-care insurance market
equilibrium will have an inefficiently small quantity of health insurance.
 Currently, a mix of public provision and private subsidies are used to increase
the quantity of health care in the U.S., though many people believe the level
still falls short of the efficient quantity. These government actions may reduce
deadweight loss, but are inadequate to eliminate it entirely. Health care reform
aims to increase the quantity of services towards the efficient outcome and
also increase equality of access to those services as well as control the costs of
providing those services.
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