Chapter 10 Externalities
Externalities
● Externalities are one type of Market failure.
● Education is a positive externality.
● Pollution is a negative externality.
● Negative externalities lead markets to produce a larger quantity than is socially desirable.
Positive externalities lead markets to produce a smaller quantity than is socially desirable. To
remedy the problem, the government can internalize the externality by taxing goods with
negative externalities and subsidizing goods with positive externalities.
● If a negative externality is the result of a producing good, then the social cost curve will be
above the supply curve. As a result, the social optimal quantity will be less than the
equilibrium quantity.
● Show cost refers to the cost of producing a commodity that is not only bared by the
producer but also by the entire society. The social cost is the sum of the private cost and
external cost. B
● A corrective tax raises the price by the amount of the marginal externality or internality.
● The command and control regulation can be better than a tax because it stops production
immediately.
● According to the Coase Theorem, private actors can reach an agreement to solve the
problem of externalities without the government.
● The Coase Theorem does not apply if transaction costs make negotiation difficult.
● Transaction costs are costs that parties incur during the process of agreeing to and following
through on a bargain.
● The market equilibrium quantity occurs at the intersection of the private cost curve and the
private value curve.
● The socially optimal quantity occurs at the intersection of the social cost curve and the
social value curve.
● Social cost of production = private cost of production + the external cost
● A tax equal to the external cost ($245) would cause the socially optimal quantity of steel to be
produced. This is called a Pigovian tax, and it causes the plant to internalize the negative
externality so that the private cost now exactly equals the social cost.
● A command-and-control policy, or regulation, remedies an externality by legally limiting a
specific behavior by a specific entity. Some examples of command-and-control policies are
directly limiting the emissions of carbon dioxide by each factory or mandating that firms adopt
emissions-reducing technology.-The government orders every factory to adopt a new
technology, which reduces carbon-dioxide emissions into the atmosphere.
● A tradable permit system remedies an externality by regulating general behavior—in this case,
total emissions of carbon dioxide—but also by allowing market forces to determine individual
outcomes—in this case, the amount that each individual factory pollutes.-The government limits
total carbon-dioxide emissions by all factories to 150,000 tons per month. Each individual factory
, is given the right to emit 180 tons of carbon dioxide, and factories may buy and sell these rights
in a marketplace.
● A corrective subsidy encourages behavior that has positive external effects. Since planting trees
generates a social value beyond the private value to the tree planter, a corrective subsidy to
induce citizens to plant trees can help achieve the efficient quantity.-Trees take carbon dioxide
out of the air and convert it to oxygen, so the government funds a tree-planting initiative by
offering $400 to any citizen who plants a tree.
● A corrective tax, also known as a Pigovian tax, discourages behavior that has negative external
effects. For example, since carbon-dioxide pollution generates a social cost beyond the private
costs to the factory owner, a corrective tax can help achieve the socially optimal quantity of
pollution.-The government charges factories $400 for every ton of carbon dioxide they emit.
● When there are many people either impacted by or contributing to an externality, it can be too
difficult and costly to coordinate them and get them to come to an agreement. The government
may be able to help in this situation by making this coordination easier to achieve or by leading
the charge to correct for the externality.
Externalities
● Externalities are one type of Market failure.
● Education is a positive externality.
● Pollution is a negative externality.
● Negative externalities lead markets to produce a larger quantity than is socially desirable.
Positive externalities lead markets to produce a smaller quantity than is socially desirable. To
remedy the problem, the government can internalize the externality by taxing goods with
negative externalities and subsidizing goods with positive externalities.
● If a negative externality is the result of a producing good, then the social cost curve will be
above the supply curve. As a result, the social optimal quantity will be less than the
equilibrium quantity.
● Show cost refers to the cost of producing a commodity that is not only bared by the
producer but also by the entire society. The social cost is the sum of the private cost and
external cost. B
● A corrective tax raises the price by the amount of the marginal externality or internality.
● The command and control regulation can be better than a tax because it stops production
immediately.
● According to the Coase Theorem, private actors can reach an agreement to solve the
problem of externalities without the government.
● The Coase Theorem does not apply if transaction costs make negotiation difficult.
● Transaction costs are costs that parties incur during the process of agreeing to and following
through on a bargain.
● The market equilibrium quantity occurs at the intersection of the private cost curve and the
private value curve.
● The socially optimal quantity occurs at the intersection of the social cost curve and the
social value curve.
● Social cost of production = private cost of production + the external cost
● A tax equal to the external cost ($245) would cause the socially optimal quantity of steel to be
produced. This is called a Pigovian tax, and it causes the plant to internalize the negative
externality so that the private cost now exactly equals the social cost.
● A command-and-control policy, or regulation, remedies an externality by legally limiting a
specific behavior by a specific entity. Some examples of command-and-control policies are
directly limiting the emissions of carbon dioxide by each factory or mandating that firms adopt
emissions-reducing technology.-The government orders every factory to adopt a new
technology, which reduces carbon-dioxide emissions into the atmosphere.
● A tradable permit system remedies an externality by regulating general behavior—in this case,
total emissions of carbon dioxide—but also by allowing market forces to determine individual
outcomes—in this case, the amount that each individual factory pollutes.-The government limits
total carbon-dioxide emissions by all factories to 150,000 tons per month. Each individual factory
, is given the right to emit 180 tons of carbon dioxide, and factories may buy and sell these rights
in a marketplace.
● A corrective subsidy encourages behavior that has positive external effects. Since planting trees
generates a social value beyond the private value to the tree planter, a corrective subsidy to
induce citizens to plant trees can help achieve the efficient quantity.-Trees take carbon dioxide
out of the air and convert it to oxygen, so the government funds a tree-planting initiative by
offering $400 to any citizen who plants a tree.
● A corrective tax, also known as a Pigovian tax, discourages behavior that has negative external
effects. For example, since carbon-dioxide pollution generates a social cost beyond the private
costs to the factory owner, a corrective tax can help achieve the socially optimal quantity of
pollution.-The government charges factories $400 for every ton of carbon dioxide they emit.
● When there are many people either impacted by or contributing to an externality, it can be too
difficult and costly to coordinate them and get them to come to an agreement. The government
may be able to help in this situation by making this coordination easier to achieve or by leading
the charge to correct for the externality.
