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Chapter 35
Externalities (About the externalities (So far, we have…
Chapter 35
Externalities
About the externalities
So far, we have implicitly assumed that forms bear al the costs and benefits associated with the production process
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production externality: when the choice of one firm affect the production possibilities of another firm
Externalities can be negative if the effects on the other firm are bad or positive if the effects on the other firm are good
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Coase Theorem
If property rights are well defined, then under certain conditions, a market for the externality will result in the Pareto effcient allocation of the externality regardless of who hold the property rights
Notice that while x* is the same regardless of who holds the property rights, π s and π f are not the same
Higher profits will be realised by the party that holds the property rights
The problem with externalities is the absence of a market for them
If property rights are defined by the government, a market can arise to correct the externality
Positive externalities
If firms are independent, the positive externality is underproduced relative to the efficient allocation
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If property rights over the externality are well defined, a market can arise for the externality that can correct the problem
