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Micro: Chapter 16

Midterm 3

externalities a cost/benefit that is only felt by others and doesn't affect the individual who engages in the activity;
positive externalities makes someone else better off, but they don't have to compensate you for it; ex= education, flu shots/vaccinations, research & development
negative externalities makes someone else worse off, but you don't have to compensate them for it
Why are externalities problematic? when indiv make choices that have externalities and dont take them into account, then the end result wont maximize total benefit of socity; only take into account effect on self, not effect on others; maximize private outcomes, not overall social outcomes
marginal private cost (MC) cost to the individual making the choice
marginal external cost (MEC) cost to society (everyone else except the decision maker)
marginal social cost (MSC) MC + MEC; the additional cost imposed on society as a whole from an additional unit of whatever good (individual plus external)
marginal private benefit (MB) benefit to the individual
marginal external benefit (MEB) benefit to everyone else except the decision maker
marginal social benefit (MSB) MB+MSB; the additional gain to society as a whole from an additional unit of whatever good
2 options for modeling externalities... give the externality its own market; fit the externality in the market we've already seen
(1) give the externality its own market modeling the MB and MC of one more unit of externality (like MB and MC of other choices)
marginal benefit of pollution? (or any negative externality in general..) the benefit of not having to not make the externality; more specifically, not deviating from what you would prefer to do; ex= benefit of pollution is that companies don't have to use more expensive measures to cut down on pollution
(2) fit the externality in the market we've already seen stick w/market of the good, not the market for the externality; model MSC and MSB instead of MC and MB; same models used before, addition of social costs/benefits is straightforward
negative externality market MSC = MC + externality cost; bc individuals don't see the externality cost, individuals will always choose the level where MC=0; by definition of a negative externality, there is no benefit felt beyond the decision maker (MSB=MB, MEB=0)
marginal curves in a negative externality market MSC=0+MEC (always increasing, MC=0); MSB=MB+0; the individual will choose to be where the MSB intercepts the x-axis. why? because that is where the firms MB=MC which means that it is the perfect amount of production FOR THE INDIVIDUAL
What is equilibrium? the socially optimal level; the point where the cost of producing one more unit of ____ = benefit of producing one more unit of _____
Why does MSB intersect the x-axis where it does? firm picks some level of production it wants to do and ignores the externalities (MSC); that level of production generates some externality level; how much externality would we get if the firm did exactly what they wanted to do?
Why does MC = 0 on this graph? Because we're graphing the EXTERNALITY! In a negative externality, there is no marginal cost to the individual of producing more externalities
Is the right level of a negative externality always not zero? No - not if the MSC of the first unit is already greater than the MSB. Then, zero externality is socially optimal; ex = DDT, mercury in baby food, lead paint; cost is so great that there's never a point where any of it is acceptable
Model 2.... graphing the good, not the externality; talking about thing that creates the externality; curves are MC (marginal cost of production ($ to make the good) and MB (marginal benefit of production ($ from selling it); cost vs benefit of producing 1 more good
Where does the market end up in terms of total production and price? MC=MB; in this graph, MSC=MC+MEC and MSB=MB (no MEB bc positive externality); socially optimal point is where MSC=MB; true cost is above marginal cost, but additional expense not felt by producer; private market will overproduce
negative externality summary (model w/market for the externality) market will arrive where MSB of externality = 0 and ignore the MSC; we want the market to be at the socially optimal level where MSB=MSC
negative externality summary (model w/market for the good) market will arrive where MB=MC and ignore the MSC; we want the market to be at the socially optimal level where MSB = MSC of good
negative externality summary (end result) any good with an externality means that the choice a private firm will make is not the socially optimal choice; private markets will overproduce - too much good and too much externality
positive externalities ex= education; more productive and employable workforce, higher mobility, etc; producing goods creates an external benefit not felt by the individual
positive external market (model 1 when x=externalities) MB=0 bc graphing externalities, and there's no marginal benefit to the individual for an additional unit of externality; MSB = 0+MEB; MSC=MC (MEC=0 bc positive); indiv doesn't think about MEB, so you choose to be at MSC=MC=0
positive externality market (model 2 when x=good) in this graph, you have an MB, MC, and MSB curve; socially optimal quantity is when MSB=MSC (and MSC=MC); we're going to stop too soon
positive externality summary (market externality) market will arrive where MSC of externality (which is also the MC [because MEC doesn't exist])=0; MSB will be ignored; social surplus is maximized when MSB =MSC (so MC=MSB) (and MSB = MEB, because MB=0)
positive externality summary (market for good) market will arrive where MB good = MC of good; socially optimal level is when MSB good = MSC good (where MSC=MC, because no MEC)
positive externality summary (end result) for positive externalities, private markets will underproduce
externality basics: summary externality present means the market will yield socially suboptimal result (market gets it wrong); negative= good will be over produced/consumed; positive= good will be under produced/consumed
dealing with externalities - how do you solve them? direct regulation, pigouvian taxation, creation of new markets (tradable permits, property rights)
direct regulation legally regulate the externality or behavior that produces it; ex EPA has regulations on lead content in gasoline, sulfur content in coal; usually act of last resort -> there are more efficient results w/lower cost to socity
pigouvian taxes/subsidies negative ex= tax that makes producer feel the cost; positive ex= subsidy that makes producer feel the benefit; get individual to make same choice as society; internalizing the externality
adding the pigouvian tax you can either charge the tax for every unit of the externality you produce (so MC is no longer 0, but is the cost of the PT); or you can tax the good that makes the externality, which will shift up the MC line; firm will choose socially optimal point
benefit of pigouvian tax tax revenue!; we go back to being efficient, so now DWL and we get tax revenue in addition to lowering other taxes (double dividend)
why do economists prefer pt over regulation? double dividend; incentives: w/regulation, less incentive to develop more efficient methods (no need for increasing production efficiency if stopped @ quota); efficiency: if there are multiple producers, taxes = less expensive burden to remove externality
how much should the pigouvian tax be want the price to be as high as necessary so that the quantity is the socially optimal amount; difference between socially efficient price and MC; market will end at efficient level bc for every unit of good/externality, you now feel higher price/cost
efficiency and pigouvian taxes 2 firms: we care about pollution reduction in cheapest possible manner; more efficient factories= reduce more (easier/cheaper for them to do so) and less efficient factories= reduce less (harder/more expensive for them to cut back); lower cost to society
permits create a market for externalities; buying the "right" to pollute; good solution if we know level you want, but not the perfect tax (common); ex: only want 1000 tons of pollution, so let firms buy/sell permits from each other, 1 permit = 1 ton of pollution
Why are permits better than regulation? invisibile hand... different costs for 2 factories? 1 will keep selling and 1 will keep buying until their costs for producing are the same; doesn't matter who starts with the permits (except for profits)
benefits of permits politically friendly (between businesses not government); incentivizes technological advances and efficiency gains (each ton you don't pollute is one more you can sell)
property rights assign property rights -> tell factory they have right to pollute and let fisherman pay to make them not and vice versa; end result is the same either way
issues with property rights whoever starts with rights ends up being paid (is it fair?); what if there are lots of parties involved; how much you would pay to avoid something as opposed to how much you would accept to be exposed to it
network externalities value of a good increases as more people use it; can mean adopting new technologies is tougher (ex: electric cars); certain products win even if inferior (VHS vs Betamax); influence firm behavior (take a profit hit for bigger market like Kindle)
Created by: nicook



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