l23 externalities. road map 1) consumers choice 2) equilibrium, producers (pareto efficiency) 3)...
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L23
Externalities
Road map1) Consumers choice
2) Equilibrium, Producers(Pareto efficiency)
3) Market Failures
- fixed cost: monopoly and oligopoly
- externalities and public goods
- asymmetric information
Externalities So far: utilities on own actions only
Reality: we are not islands
An externality is a cost or a benefit imposed upon someone by actions taken by others.
- benefit - positive externality.
- cost - negative externality.
Examples of Negative Externalities Air or water pollution. Loud parties next door. Traffic congestion. Second-hand cigarette smoke. Increased insurance premiums due
to alcohol or tobacco consumption. Bad smell!
Examples of Positive Externalities
A well-maintained property. High “human” capital A pleasant cologne or scent worn by
the person seated next to you. A scientific advance.
Today’s questions:
Efficiency of interactions with externalities Too much or too little activity with
externality? How can we reestablish Pareto efficiency?
– taxes
– creating markets
– social norms
Example: Negative externality
Two producers: steel mill and fishery A steel mill produces steel It can also choose the level of pollution
The pollution adversely affects a nearby fishery
s
2 2( , ) ( 1)sTC s x s x
2( , )fTC f x f xf
x
x
Steel mill problem
( , ) ( , )s s ss x p s TC s x
Steel mill problem 2 2( , ) ( 1)sTC s x s x $2sp
s
s
x
Fishery problem 2( , )TC f x f xf $3fp
f
f
( , ) ( , )f f ff x p f TC f x
f s
Pareto efficient production( , , ) ( , ) ( , )s s f fs f x p s TC s x p f TC f x
Pareto efficient production2 2( , ) ( 1)sTC s x s x $2sp
2( , )fTC f x f xf $3fp
When negative externality – too much activity in decentralized markets
You will show in PS that when externality if positive – too little activity.
Conclusion 1
Problem: information!
Implementation: Pigouvian Tax
( , ) ( , )s s ss x p s TC s x x
Creation of missing markets
( , ) ( , )s s s xs x p s TC s x p x
( , ) ( , )ff f xf x p f TC f x p x
Property rights (Coase Theorem)
( , ) ( , ) ( )s s s xs x p s TC s x p x x
( , ) ( , ) ( )ff f xf x p f TC f x p x x
Social norm: “do not pollute” Moral cost Many norms can be explained using
efficiency argument
Social norms: moral cost
( , ) ( , )s ss x p s TC s x x
( )x
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