Externalities Chapter 10. Ratna K. Shrestha. Introduction/Background.
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Ratna K. Shrestha
. . . when a person engages in an activity (production or consumption) that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect.
The government can internalize a negative externality by imposing a Pigovian tax (t = MEC at Qopt) on the producer.
This tax induces the producer to reduce the equilibrium quantity to the socially desirable quantity, and thus eliminate the Dead Weight Loss.
QtaxPigouvian tax: as a solution to negative externality
Market Eqlbm. with tax
Quantity of AL
When an externality benefits bystanders, a positive externality exists.
A technology spillover is a type of positive externality because a firm’s innovation or design not only benefits the firm, but enters society’s pool of technological knowledge and benefits society as a whole.
Subsidy: Government usually uses subsidies (s = MEB at the optimum Q) as the primary method for attempting to internalize positive externalities.
Technology Policy: Government intervention in the economy that aims to promote technology-enhancing industries is called technology policy. Technology policy is also one way to internalize positive production externality
Externalities associated with consumption activities.
(b) Positive Consumption
Government action is not always needed to solve the problem of externalities. Sometimes private polluters themselves take care of it.
Moral codes and social sanctions.
Integrating different types of businesses.
Bargaining between parties
The Coase Theorem states that if private parties can bargain without cost over the allocation of resources, then the private market will always solve the problem of externalities on its own regardless of who (i.e., polluter or victims) owns the property rights.
Transaction costsare the costs that parties incur in the process of agreeing to and following through on a bargain.
Suppose Jim owns a dog from which he gets benefits = $ 500.
The dog’s barking causes harm to Jerry = $ 800.
Since benefit < harm, getting rid of dog is good for Jim and Jerry combined (that is society as a whole).
How can they come to a negotiated solution?
If Jerry has the right to noise-free environment, then Jim cannot offer any amount that is acceptable to Jerry. Jim cannot keep the dog--the efficient solution.
If Jim has the right, then Jerry can offer Jim $501 to $799 to sell off the dog, which he will gladly accept—the efficient solution.
Garbage spilling in NY harbor caused damage to New Jersey shore oftentimes littering its beaches.
New Jersey had right to clean beaches and could have sued NY city.
But by Sept of 1987, they came to a negotiated settlement.
Sometimes the private solution approach fails because transaction costs can be so high that private agreement is not possible.
When externalities are significant and private solutions are not found, government may attempt to solve the problem through . . .
Emission Standard for Cars
If the Environment Canada (EC) decides to reduce the amount of pollution coming from a specific plant, it could…
tell the firm to reduce its pollution by a specific amount (i.e. regulation).
levy a tax of a given amount for each unit of pollution the firm emits (i.e. Pigovian tax).
(b) Pollution Permits
(a) Pigovian Tax
Supply of Permits