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KTCC. Chapter 2. Day 07. Externalities

The document discusses externalities, defining them as effects from one entity's activity that impact another's welfare without market price transmission. It categorizes externalities into negative, like pollution, and positive, like vaccination, and explores remedies such as market-based solutions and government interventions. The Coase theorem is highlighted for private responses, while public responses include taxes, subsidies, and regulation to address these externalities.

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Thanh Thảo Phan
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14 views18 pages

KTCC. Chapter 2. Day 07. Externalities

The document discusses externalities, defining them as effects from one entity's activity that impact another's welfare without market price transmission. It categorizes externalities into negative, like pollution, and positive, like vaccination, and explores remedies such as market-based solutions and government interventions. The Coase theorem is highlighted for private responses, while public responses include taxes, subsidies, and regulation to address these externalities.

Uploaded by

Thanh Thảo Phan
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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LOGO

PUBLIC ECONOMICS
CHAPTER 2 (cont.)
ECONOMIC EFFICIENCY AND THE GOVERNMENT’S RE-
ALLOCATIVE FUNCTION
Day 07

Externalities

2
Lecture Outline

 The nature of externalities


 Remedies for negative externalities: Market based
solutions
 Remedies for negative externalities: Government
interventions
 Positive externalities

3
What is externality?

Definition:
 An effect occurs when the activity of one entity (a person or
a firm) directly affects the welfare of another in a way that is
not transmitted by market prices.
Notes:
 The effect is on the third party (not participate in the market
transaction)
 The cost or benefit of the effect is not included in market
price
Example:
 Pollution
 Vaccination
4
Classification

 Negative externality: Pollution


 a cost that is suffered by a third party as a result of an
economic transaction
 also called negative spillover effect or external cost
 the cost to society is greater than the cost consumer is
paying for it.
 market production is more than socially efficient level
 Positive externality: Vaccination
 benefit of a decision that is not received by an individual or
firm making that decision
 Also called positive spillover effect or external benefit
 the benefit to society is greater than the benefit enjoyed by
decision maker
 market production is less than socially efficient level

5
Characteristics of externalities

 Externalities can be produced either by producers or consumers


 Externalities have the characteristic that they are reciprocal in
nature
 Externalities can be positive or negative, depending on the
nature of the effect perceived by the third party
 All externalities are socially inefficient
 Public goods can be viewed as a special kind of externality
 Externalities commonly occur in situations where property
rights over assets or resources have not been allocated or are
uncertain.

6
2.1. Negative Externalities: Problem

MB MSC = MPC + MEC


MC Deadweight
loss

C
B MPC

A
MEC

D = MB

0 Q0 Q1 Q
7
Private responses to negative externalities

Internalization
 Establish property right: Coase theorem
 Merger
Social convention: Take advantage of public
pressure

8
Coase Theorem

MB MSC = MPC + Provided that transaction


MC MEC costs are negligible, an
efficient solution to an
externality problem is
C achieved as long as
B MPC someone is assigned
property rights, independent
A of who is assigned those
E
MEC rights
Example 1: What happens if
F the property right is
D = MB assigned to the firm?
NB of firm ≤ rent ≤ MEC for cooperative
0 Q0 Q1 Q Example 2: What happens if
the property right is
assigned to the fishing
cooperative?
NB of firm ≥ rent ≥ MEC for cooperative
9
Assessment of Coase Theorem

Advantage:
 Private negotiation rather than public intervention
Disadvantages:
 Negligible negotiation cost
 Resource owner(s) can identify the source of damages
to their property and legally prevent the damagers
 Different distributional implications regarding who is
assigned property rights.
Then, Coase solution is suitable only with
 Small scaled negative externalities
 Possible to identify source of damages
10
Public responses to negative externalities

Taxes
Subsidies
Creating a market
Regulation

11
Negative externality: Pigouvian tax

MB MSC = MPC + MEC


MC
MPC + t
C
B MPC
N
A
M
E MEC

F D = MB

0 Q0 Q1 Q
12
Negative externality: Subsidy

MB MSC = MPC + MEC


MC

C
B MPC
N’
A
E M’ MEC

D = MB

0 Q0 Q1 Q
13
Negative externality: Creating market for pollution
permits

P (Effluent fee)
SZ

P*
DZ

0 Z*
(associated with output Q0) Right to pollute (permits)

14
2.3. Positive externalities

MB
Deadweight
MC loss S = MC
C
B

A
E
MSB = MPB + MEB
MPB
MEB
0 Q1 Q0 Q
15
Positive externalities: Demand side subsidy

MB
MC
S = MC
C
B
N
A MPB+s
M E
MSB = MPB + MEB
MPB
MEB
0 Q1 Q0 Q
16
Positive externalities: Supply side subsidy

MB
MC
S = MC
C
B
N MC+s

A
M E
MSB = MPB + MEB
MPB
MEB
0 Q1 Q0 Q
17
Positive externalities: Cautionary note

Distributional implication:
 Subsidy comes from taxpayers’ payment
Subsidy is appropriate only if the market does
not allow activity performer to capture the full
marginal return.
Question:
 Why the government has to use large subsidy
(rectangle BEMN) just to capture the smaller
deadweight loss (triangle ABC)?

18

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