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What did you study last time?. Trade—an exporting country Trade—an importing country Arguments against trade. Do you know …. what an externality is? what different types of externalities are? why externalities lead to social inefficiency? what social efficiency means?.

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What did you study last time

CRC Microeconomics


What did you study last time

What did you study last time?

  • Trade—an exporting country

  • Trade—an importing country

  • Arguments against trade

CRC Microeconomics


Do you know

Do you know …

  • what an externality is?

  • what different types of externalities are?

  • why externalities lead to social inefficiency?

  • what social efficiency means?

CRC Microeconomics


A general concepts

A. General concepts

CRC Microeconomics


1 an externality

1. An externality

  • is the uncompensated (spillover) impact of one person's actions on the well-being of a bystander.

  • occurs when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that impact.

  • e.g. late night party, flu shot, etc.

CRC Microeconomics


2 what are the different types of externalities

2. What are the different types of externalities?

a. Negative externalities

- create adverse (bad) impacts.

- e.g. exhaust from automobiles, barking dogs, etc.

b.Positive externalities

- create beneficial (good) impacts.

- e.g. restored historic building, research into new technologies, etc.

CRC Microeconomics


3 why do externalities lead to social inefficiency

3. Why do externalities lead to social inefficiency?

  • When there are externalities, the market equilibrium fails to maximize the total benefit to society as a whole.

  • The market becomes socially inefficient.

CRC Microeconomics


4 what is social efficiency

4. What is social efficiency?

  • Social efficiency occurs at Qsoc where the total net benefit (TNB) to society is maximized.

  • Define:

    • T = total; N = net; M = marginal

    • S = social; P = private; E = external

    • B = benefit; C = cost

    • e.g. TSB = total social benefit,

    • MEC = marginal external cost, etc.

CRC Microeconomics


4 what is social efficiency1

4. What is social efficiency?

  • Social efficiency occurs at Qsoc where the total net benefit (TNB) to society is maximized.

    a. Total approach

    TSB = TPB + TEB

    TSC = TPC + TEC

    TNB = TSB – TSC

    To maximize TNB, society produces Q*soc.

CRC Microeconomics


4 what is social efficiency2

4. What is social efficiency?

b. Marginal approach

MSB = MPB + MEB

MSC = MPC + MEC

MNB = MSB – MSC

Maximizing TNB requires that MNB = MSB – MSC = 0

i.e. society produces Qsoc where MSB = MSC.

Notes: MSB = Dsoc and MSC = Ssoc

MPB = D and MPC = S

CRC Microeconomics


5 what are the effects of externalities on markets

5. What are the effects of externalities on markets?

Positive externalities

Negative externalities

production

consumption

production

consumption

research

education

pollution

cigarettes,

alcohol, etc.

TSC < TPC

TSB > TPB

TSC > TPC

TSB < TPB

Qe < Qsoc

Qe < Qsoc

Qe > Qsoc

Qe > Qsoc

where Qe = market output; Q*soc = socially optimal output

CRC Microeconomics


B graphs

B. Graphs

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B graphs1

B. Graphs

  • Perfect competition

    a. General case

    b. With no externalities

  • Production externalities

    a. Negative

    b. Positive

    c. Summary

CRC Microeconomics


B graphs2

B. Graphs

3.Consumption externalities

a. Negative

b. Positive

c. Summary

4.Market-based solutions to externalities

a. Pigovian taxes

b. Pollution permits

c. Summary

CRC Microeconomics


1a perfect competition

1a. Perfect Competition

Given a perfectly competitive market, where D = MPB and S = MPC.

P

Perfect competition leads to market efficiency because TS = max.

S

= MPC

E

Pe

D

= MPB

Q

CRC Microeconomics

Qe = Qmarket


1b perfect competition with no externality

1b. Perfect Competition with no Externality

Suppose that there is no externality,

i.e. Dsoc = MSB = D and Ssoc = MSC = S.

P

Perfect Competition + No externality =>

Social Efficiency (Optimum)

S

= MPC

= Ssoc

= MSC

E

= Esoc

Pe

= Psoc

D

= MPB

= Dsoc

= MSB

Q

CRC Microeconomics

Qe = Qmarket

= Qsoc = Qoptimum


2a negative production externality

2a. Negative Production Externality

Suppose that there is negative production externality,

i.e. Dsoc = MSB = D and Ssoc = MSC = S + MEC.

Ssoc

= MSC

P

Negative production externality =>

Social inefficiency; Qsoc < Qe

MEC e.g. cost of pollution

Esoc

S

= MPC

Psoc

E

Pe

D

= MPB

= Dsoc

= MSB

Q

CRC Microeconomics

Qsoc

Qe


2b positive production externality

2b. Positive Production Externality

Suppose that there is positive production externality,

i.e. Dsoc = MSB = D and Ssoc = MSC = S + MEB.

P

Positive production externality =>

Social inefficiency; Qsoc > Qe

S

= MPC

MEB

E

Pe

Esoc

Ssoc

= MSC

Psoc

D

= MPB

= Dsoc

= MSB

Q

CRC Microeconomics

Qe

Qsoc


2c production externalities summary

2c. Production Externalities-Summary

Ssoc

P

P

S

S

MEC

Ssoc

Esoc

MEB

Psoc

E

E

Pe

Pe

Esoc

Psoc

D

D

Q

Q

Qe

Qsoc

Qsoc

Qe

Positive

Negative

CRC Microeconomics


3a negative consumption externality

3a. Negative Consumption Externality

Suppose that there is negative consumption externality,

i.e. Dsoc = MSB = D - MEC and Ssoc = MSC = S.

P

Negative consumption externality =>

Social inefficiency; Qsoc < Qe

S

= MPC

= Ssoc

= MSC

E

Pe

Psoc

MEC

Esoc

D

= MPB

Dsoc

= MSB

Q

CRC Microeconomics

Qsoc

Qe


3b positive consumption externality

3b. Positive Consumption Externality

Suppose that there is positive consumption externality,

i.e. Dsoc = MSB = D + MEB and Ssoc = MSC = S.

P

Positive consumption externality =>

Social inefficiency; Qsoc > Qe

S

= MPC

= Ssoc

= MSC

Esoc

Psoc

E

Dsoc

= MSB

Pe

MEB

D

= MPB

Q

CRC Microeconomics

Qe

Qsoc


3c consumption externalities summary

3c. Consumption Externalities-Summary

P

P

Dsoc

S

S

Esoc

Psoc

Dsoc

E

E

Pe

Pe

Esoc

Psoc

MEB

MEC

D

D

Q

Q

Qe

Qsoc

Qsoc

Qe

Positive

Negative

CRC Microeconomics


Now you know

Now you know …

  • what an externality is.

  • what the different types of externalities are.

  • why externalities lead to social inefficiency.

  • what social efficiency means.

CRC Microeconomics


What will you study next

What will you study next?

  • What is the basic solution to externalities?

  • How do people deal with externalities?

  • How do governments deal with externalities?

CRC Microeconomics


What did you study last time

See You!

Take Care!

CRC Microeconomics


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