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Week 7: Externalities and Price Controls - Coggle Diagram
Week 7: Externalities and Price Controls
Externalities
Occur when social (internal + external) costs exceed private (internal costs)
Consider the true cost of diving
Private costs: fuel, insurance, car, rego
Social costs: pollution, traffic, fixing roads, accidents, etc
When theres a difference between the social and private then there are externalities
Can be positive or negative
External costs are negatives
They arise from market failures or inefficient markets
External benefits are positive
The costs or benefits of market activity that affects a third party
Correcting negative externalities
Internalizing externalities
Individual involved in the activity takes account for social costs
Force individual to pay external costs
Tax production
Regulate production
This actions will reduce overall production, shifting supply curve to the left
In this case the market equilibrium is a market inefficiency as it is not considering social costs
When internalizing the externalities, the internal supply curve shifts to the left creating a social supply curve, lowering demand, and finding a new equilibrium called social optimum
The deadweight loss created by this shift is overproduction
If an externality exists and is not correct it will always incur a deadweight loss for society
Dynamic pricing
Price varies based on supply and demand
The Coase Theorem
The Coase Theorem creates an incentive for individuals to take steps to improve the situation
Whenever theres an externality, theres a party which inflicts it and a party in which the harm of the externality is inflicted on. By using this theorem, both parties are better off.
At no cost, people can negotiate the
right
to perform activities that cause externalities, then they can always arrive at efficient solutions to the problems caused by externalities
For this to be efficient transaction cost needs to be low
The optimal amount of pollution is not zero
Marginally thinking, the optimal amount of pollution in society is not zero
On the Y axis we see the marginal cost and benefit of pollution abatement and on the X axis we see the degree of air cleanliness
The bar to the right represents 100% of air cleanliness
The red marginal cost curve is upwards sloping, meaning the more clean we want the air to be the more it will cost
As we move within the marginal cost curve towards cleaner air, the curve gets steeper, making us spend a lot of money but not getting results.
The marginal benefit curve (blue), looks like a demand curve, when the air is really dirty we get big benefits from spending money to get air cleaner.
Iw we move along this curve towards cleaner and cleaner air, the benefit or satisfaction society gets from cleaning air more and more is not as big
When the Marginal benefit and marginal cost curves intercept equilibrium is created. The optimal quantity of pollution is where mc = mb
Positive Externalities
Benefits experienced by third parties
"Not enough of the good is produced"
"Society benefits more than the individual"
Education, vaccinations, eating healthy
Correcting for positive externalities
Help individuals realize external benefits
Financing or subsidizing consumption of the good
Laws requiring consumption
Education
Vaccination
Demand curve represents the internal benefit
The supply curve represents the supply of this positive good, and if demand will increase, then the price suppliers charge will be steeper.
government will need to create incentives for th demand to still grow regardless of suppliers charging more.
When external benefits are realized, demand curve actually shifts to the right, creating a social demand curve that represents the actual benefit from the positive externalities. D Social represents external and internal benefits
This creates a new equilibrium, a new social optimum level of consumption, representing social and internal benefits. At this point the social optimum is more expensive that market equilibrium, creating a trade off
The government will have to subsidize. This will eliminate the deadweight loss from underproduction
Private and Public Goods
Differentiated with 2 characteristics
Excludable
It is possible to prevent who have not paid from getting access to the product
Rival
The good can't be enjoyed by more than one person at a time
Different Kinds of Goods
Private
Excludable
Rival
Club
Not rival
Excludable
Public
Not rival
Not excludable
Army, roads
Common Resource
Not excludable
Rival
Hunting, fishing
Common property
Tragedy of the commons
The tendency for a resource that has no price to be used until its marginal benefit equal zero
Examples: air, water, shared popcorn at movies
Each individuals fails to a account for the fact that his use of the good has a small negative effect
