Chapter 5 EXTERNALITIES. When actions spillover to affect 3 rd parties. 5. CHAPTER. Chapter Outline and Learning Objectives. Externality. A benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service. EXTERNALITIES.
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When actions spillover to affect
Chapter Outline and Learning Objectives
So far, we have only looked at situations where our decisions have had no influence on others
What happens if our actions do affect others, yet we don’t take this into account?
Externalities - could be positive (external benefit)
or negative (external cost)
1) Negative externality (pollution, noise)
2) Positive externality (education, health care)
If transactions costs are low, private bargaining will result in an efficient solution to the problem of externalities.
2) Also, we could INTERNALIZE THE EXTERNALITY
This is done by adjusting the marginal cost/benefit of a
good/service so efficient allocation is achieved.
2 ways to do this:
1) Corrective Tax (Pigovian Tax)
2) Corrective Subsidy (Pigovian Subsidy)
How does corrective tax help reduce negative externality?Will do example in class. How does subsidy help increase positive externality? Will do example in class.
Tragedy of the commons
Pigovian taxes and subsidies