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Externalities AKA Spillovers

Externalities AKA Spillovers. When Markets Work. (a) Producers are responsible for all costs & those costs are reflected in the price of the good or service. P. S =Marginal Social Cost (MSC) =Marginal Private Cost (MPC).

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Externalities AKA Spillovers

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  1. Externalities AKA Spillovers

  2. When Markets Work (a) Producers are responsible for all costs & those costs are reflected in the price of the good or service. P S =Marginal Social Cost (MSC) =Marginal Private Cost (MPC) The private costs and social costs are both reflected in the supply curve P D =Marginal Social Benefit (MSB) =Marginal Private Benefit (MPB) Q Q

  3. When Markets Work (a) Producers are responsible for all costs & those costs are reflected in the price of the good or service. (b) Paying customers are the only beneficiaries of the good or service. P S=Marginal Social Cost (MSC) =Marginal Private Cost (MPC) The private benefits and social benefits are both reflected in the demand curve P D =Marginal Social Benefit (MSB) =Marginal Private Benefit (MPB) Q Q

  4. When Markets Don’t Work Market Failure Externalities When someone other than the buyer and seller receives a cost or benefit for which they didn’t ask/pay

  5. When Markets Don’t Work Market Failure Externalities AKA Spillover or Third Party Costs/Benefits

  6. Negative Externality (or spillover) Example: Factory pollution contaminating water supply The firm is passing on – externalizing- the cost to villagers

  7. Negative Externality Marginal Social Cost (MSC) MSC > MPC Psocial There is an OVERALLOCATION (making too much) of the good at too low a price Qso Example: Factory Pollution P Marginal Private Cost (MPC) Pmarket D =Marginal Social Benefit (MSB) =Marginal Private Benefit (MPB) Qm Q

  8. Negative Externality Why is this bad? Deadweight loss MSC P MPC TO FIND THE AREA OF THE DEADWEIGHT LOSS FOLLOW THE MARKET Q UP TO THE MSC CURVE. IT’S THE AREA BETWEEN MSC, MSB AND QMARKET Pso Pm MSB Qso Qm Q

  9. Negative Externality Why does this happen? Why is this bad? Deadweight loss MSC P MPC TO FIND THE AREA OF THE DEADWEIGHT LOSS FOLLOW THE MARKET Q UP TO THE MSC CURVE. IT’S THE AREA BETWEEN MSC, MSB AND QMARKET Pso Pm MSB Qso Qm Q

  10. Tragedy of the Commons Where there is no clear ownership of rights to a natural resource, the users of the resource are likely to overexploit it.

  11. Tragedy of the Commons Drilling for Oil

  12. http://www.petroleum.co.uk/geograph/page4.htm

  13. Tragedy of the Commons Pump as much oil as fast as you can to get the oil before someone else does--

  14. Private property Private Bathroom in Doctor’s office

  15. Access is restricted

  16. Clean, decorated, well stocked

  17. Public High School Bathroom

  18. Tragedy of the Commons

  19. Negative Externality Possible Solutions: Property Rights:establishing ownership can provide motivation to include external costs into the price

  20. Tragedy of the Commons The herds get smaller. http://ens.lycos.com/ens/oct2000/2000L-10-16-15.html The hunters shoot the buffalo. http://www.fayettevilleobserver.com/news/archives/1998/tx98aug/n19buff.htm You better quick and hunt them before someone beats you to the punch.

  21. Did barb wire help or hurt the buffalo population? Barb wire saved the buffalo by establishing property rights at a relatively low cost. Prior to barb wire, it was too expensive to establish property rights.

  22. Negative Externality Possible Solutions: Property Rights:establishing ownership can provide motivation to include external costs into the price Coase Theorem: as long as transaction costs are low, it doesn’t matter which party has property rights, they will negotiate a solution to the externality without the need for gov’t intervention. Ronald H. Coase But, this often isn’t a plausible option

  23. Property rights of smoking have changed over the years. It used to be, “Would you like a smoke”? Then it became, “Do you mind if I smoke”?

  24. Then it became, “Thank you for not smoking.” Finally, an outright ban on smoking.

  25. Negative Externality 1. Tax – could pay for fixing extra cost – or at least decrease Q Possible Solutions: Government intervention: 2. Q Restriction – establish a law to force correction 3. Price Control – establish an effective price floor 4. Permits – i.e.. pollution permits that can be bought and sold among polluters

  26. Pass out Negative Externalities Homework Pass Out & do example together & do example together

  27. ABC Plastics is polluting the ground water surrounding it’s factory. The Gov’t decides to tax their product and use the $ to treat the area. Graph the externality including the tax. • Start with a base S/D graph, except • label supply MPC and demand MSB • Label P&Q - Pm & Qm P MPC Pm MSB Qm Q

  28. ABC Plastics is polluting the ground water surrounding it’s factory. The Gov’t decides to tax their product and use the $ to treat the area. Graph the externality including the tax. MSC • Add the externality P MPC • Add in the social cost (MSC) line Pso • Draw social equilibrium lines and labels Pso & Qso Pm MSB • Add arrow to show direction of change in cost lines, P’s and Q’s Qso Qm Q

  29. ABC Plastics is polluting the ground water surrounding it’s factory. The Gov’t decides to tax their product and use the $ to treat the area. Graph the externality including the tax. MSC You have drawn the Externality, now add the tax P MPC TAX Pso 4. Shade in the area of the tax and label it You can either write it inside the shaded area or outside with an arrow Pm MSB Qso Qm Q

  30. When Markets Don’t Work Market Failure Positive Externality (or spillover) Example: Getting a vaccine for a contagious disease The rest of the population benefits from the protect, but doesn’t pay for it.

  31. Positive Externality There is an UNDERALLOCATION (making too little) of the good at too high a price Psocial MSB > MPB Marginal Social Benefit (MSB) Qso Example: Vaccinations P Marginal Social Cost (MSC) Pmarket Marginal Private Benefit (MPB) Qm Q

  32. Positive Externality Why is this bad? Deadweight loss P TO FIND THE AREA OF THE DEADWEIGHT LOSS FOLLOW THE MARKET Q UP TO THE MSC CURVE. IT’S THE AREA BETWEEN MSC, MSB AND QMARKET MSC Pso Pm MSB MPB Qm Qso Q

  33. Positive Externality Why does this happen? Why is this bad? Deadweight loss P TO FIND THE AREA OF THE DEADWEIGHT LOSS FOLLOW THE MARKET Q UP TO THE MSC CURVE. IT’S THE AREA BETWEEN MSC, MSB AND QMARKET MSC Pso Pm MSB MPB Qm Qso Q

  34. "Free" Rider Problem When the accessible and desirable nature of public goods inclines people to use these goods, sometimes without paying for the privilege

  35. "Free" Rider Problem Public vs. Private Goods Private goods 1. Exclusionary – owner can exclude those who don’t pay for it 2. Rival – consuming it prevents others from doing the same Example: Can of soda

  36. "Free" Rider Problem Public vs. Private Goods Public goods 1. Non-exclusionary – owner cannot exclude those who don’t pay for it 2. Nonrival – consuming it doesn’t prevent others from doing the same

  37. "Free" Rider Problem Public vs. Private Goods Public goods Examples: Lighthouses All the captains use it to keep from crashing, but they don’t pay for it and there isn’t a good way to make them

  38. "Free" Rider Problem Public vs. Private Goods Public goods Examples: Street Light Systems Anyone walking by benefits from the light, but does not have to pay for the benefit

  39. "Free" Rider Problem Public vs. Private Goods Public goods The market will not provide optimum amounts of these good, or provide them at all because there is no way to make a profit from them. The production of public goods results in positive externalities which are not paid for, so there is less incentive to produce it.

  40. In a family of four, there are two cops and two robbers. Who are the “free” riders and why?

  41. What’s Wrong with this picture? It wouldn’t work because Sunsets are a non-excludable good, in that non-payers can't be prevented from enjoying them. 

  42. Positive Externality Possible Solutions: 1. Government Production: have the gov’t produce the good using tax dollars Interstate Highway System Examples: National Defense

  43. Why do governments pay for mosquito spraying of neighborhoods? Why isn’t this privatized?

  44. Free Rider Problem

  45. Positive Externality Possible Solutions: 1. Government Production: have the gov’t produce the good using tax dollars 2. Subsidy: to either producer or consumer of the product 3. Legal Mandate: legally require consumption or production of the good

  46. Positive Externality Possible Solutions: Example: Education – all 3 are used The more education a person has, the less likely they are commit crimes & the more likely they are to solve problems, help people….contribute to society

  47. Positive Externality Possible Solutions: Example: Education – all 3 are used Education produces a positive externality It is under produced or underallocated at too high a price

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