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Externalities (Private Solutions to Externalities (Coase Theorem…
Externalities
Private Solutions to Externalities
Contracts
Moral Codes/Social Sanctions
Charities
Coase Theorem
Individuals can solve the problem of externalities on their own if they can bargain with relatively little cost
Negative
At equilibrium, demand curve is below social-cost curve
reducing production and consumption will raise total economic well-being
Markets produce larger quantity than is socially desirable
Positive
social value of good exceeds private value
social-value curve lies above demand curve
Markets produce smaller quantity than is socially desirable
Public Policies toward externalities
Command and Control
Regulation
Corrective taxes and subsidies
Corrective taxes are better at reducing pollution because they do so at a lower cost to society
May also be better for environment since provide incentive to reduce pollution
Corrective taxes ENHANCE economic efficiency
Set price to determine quantity
Tradable pollution permits
Initial allocation of permits doesn't matter as long as there is a free market for pollution rights
Set quantity to determine price
Internalizing externality: altering incentives so that people take external factors into account