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1 (6.2) - Externalities

The document discusses externalities, which are external costs or benefits affecting third parties not involved in a transaction. It explains positive externalities, where social benefits exceed private benefits, and negative externalities, where social costs exceed private costs, leading to market failures. Solutions for addressing these externalities include private negotiations, government interventions like direct controls, taxes, and tradable permits.

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18 views14 pages

1 (6.2) - Externalities

The document discusses externalities, which are external costs or benefits affecting third parties not involved in a transaction. It explains positive externalities, where social benefits exceed private benefits, and negative externalities, where social costs exceed private costs, leading to market failures. Solutions for addressing these externalities include private negotiations, government interventions like direct controls, taxes, and tradable permits.

Uploaded by

krishbhakta2007
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Unit 6: Market Failures and the Role

of the Government
6.2 Externalities
6.1 and 6.2 on AP Classroom
Externalities

Positive Externality: Negative Externality:

- External benefits - External costs


- EX: I fix up the front yard of my house. I paid - EX: I live downriver from a factory. The factory
for it. You are selling your house next door, has been dumping pollution into river. I have
and you can sell for a higher price because nothing to do with the factory, and sludge has
been drifting through my property, and it has
my house looks so nice.
been affecting my health.
- You get a positive externality from my
- I suffer a negative externality form the
landscaping, and you didn’t pay anything pollution – I suffer a cost without getting any
compensation for it
http://economicsoftheoffice.com/all/?q=externality
https://modernfamilyecon.com/2018/07/09/extern
alities-in-a-small-room/
Positive
- Marginal Private Benefit (MPB): what do you
think it means?

Externalities: - Marginal External Benefit (MEB): ???

Private Vs. Social


Benefits
Positive Externality
DWL
- Externalities are a form of Market Failure
- When a positive externality exists, the socially
optimal quantity is higher than the market
equilibrium quantity, and the deadweight loss
triangle points to the right
Solving Positive
1. Try to solve it privately: Coase Theorem
a. An efficient solution can always be reached

Externalities
provided the costs of making a deal are
sufficiently low
2. Government Interventions:
a. Direct control: make a law that requires it
b. Pigouvian Subsidy: a payment designed to
correct for the effects of external benefits
Negative
- Marginal PRIVATE cost (MPC): ???
- Marginal EXTERNAL cost (MEC): ???

Externalities:
Private Vs. Social
Costs
Negative Externality
DWL
- When a negative externality exists, the socially
optimal quantity is lower than the market
equilibrium quantity, and the deadweight loss
triangle points to the left.
Solve a Negative
Government Interventions

1. Direct control: Laws that prevent it


Externality 2. Taxes
3. Quotas
4. Market based tradable permits (Cap and Trade)
Government
- Pass legislation limiting an activity
- Force the offending firms to incur the actual

Intervention- -
costs of the activity
Direct Controls raise the marginal cost of

Direct Controls production


Government
- Emissions taxes or charges specifically on the
good generating externality

intervention- -
-
The problem: the process if very trial and error
Firms can either pay the tax or spend the funds

Specific Taxes to purchase or develop substitute products


Market Based
- Aka Vouchers: Licenses to emit limited
quantities of a negative externality (pollution)

Approach– -
that can be bought and sold by the producers
This is also sometimes referred to as “cap and

Tradable Permits -
trade”
Difficult to know how many permits to issue
Terms for
Terms and Vocab:

- Positive Externality
Worksheet/Activity - Negative Externality

#4
- Solving Positive Externalities
- Solving Negative Externalities

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