ECN 112 Chapter 9 Lecture Notes

ECN 112 Chapter 9 Lecture Notes

9.1 Negative Externalities: Pollution

A. Externalities in Our Daily Lives

An externality is a cost or benefit that arises from production that falls on someone other than the producer; or a cost or benefit that arises from consumption that falls on someone other than the consumer.

1. Negative Production Externalities—an example of which is pollution.

2. Positive Production Externalities—an example of which is producing honey using bees next to an apple orchid.

3. Negative Consumption Externalities—an example of which is smoking in a closed space.

4. Positive Consumption Externalities—an example of which is education.

B. Private Costs and Social Costs

1. The starting point is distinguishing between private costs and social costs:

a. A private cost of production is a cost borne by the producer of a good or service.

b. Marginal cost is the cost of producing an additional unit of a good or service.

c. Marginal private cost (MC) is the cost of producing an additional unit of a good or service that is borne by the producer of the good or service.

d. Marginal external cost is the cost of producing an additional unit of a good or service that falls on people other than the producer.

e. Marginal social cost (MSC) is the marginal cost incurred by the entire society—by the producer and by everyone else on whom the cost falls. MSC = MC + marginal external cost.

2. Valuing an External Cost

Economists use market prices to put a dollar value on the cost of pollution or other activities that produce external costs.

3. External Cost and Output

The MSC curve lies above the MC curve and both marginal cost and marginal social cost increase as output increases.

C. Production and Pollution: How Much?

1. Without regulation, the market equilibrium (determined by the demand and supply curves) determines the quantity of output produced. This equilibrium is inefficient because not all costs are being counted.

2. To determine the efficient allocation of resources, you must count all the costs (private and external). Efficiency occurs when marginal benefit equals marginal social cost.

3. An unregulated market creates a deadweight loss.

D. Property rights are legally established titles to the ownership, use, and disposal of factors of production and goods and services that are enforceable in the courts. By assigning property rights, it is possible to reduce the inefficiency created by an externality.

E. The Coase Theorem

The Coase theorem is the proposition that if property rights exist, only a small number of parties are involved, and transactions costs are low, then private transactions are efficient and the outcome is not affected by who is assigned the property right.

1. Transactions costs are the opportunity costs of conducting a transaction.

F. Government Actions in the Face of External Costs

The government uses three main methods to cope with external costs:

1. Emissions charges are per unit pollution fees charged by the EPA in the United States to polluters.

2. Marketable permits are pollution limits assigned to firms by the government. Firms can buy and sell these permits depending on their needs.

3. Taxes are an incentive for polluters to cut back on the amount of the external costs they produce.

4. The effects of these government actions change the equilibrium. If the government can impose a tax that exactly equals the marginal external cost, the market supply curve becomes the same as the marginal social cost curve and the market equilibrium is efficient.

9.2 Positive Externalities: Knowledge

A. Private Benefits and Social Benefits

1. To study the economics of knowledge, we must distinguish between private benefits and social benefits:

a. A private benefit is a benefit that the consumer of a good or service receives.

b. Marginal benefit is the benefit from an additional unit of a good or service.

c. Marginal private benefit (MB) is the benefit from an additional unit of a good or service that the consumer of that good or service receives.

d. Marginal external benefit is the benefit from an additional unit of a good or service that people other than the consumer of the good or service enjoy.

e. Marginal social benefit (MSB) is the marginal benefit enjoyed by society—by the consumers of a good or service and by everyone else who benefits from it. MSB = MB + marginal external benefit.

2. The MSB curve lies above the MB curve and both marginal benefit and marginal social benefit decrease as output increases.

3. Without government intervention, society underproduces a good that generates an external benefit. A deadweight loss occurs.

B. Government Actions in the Face of External Benefits

1. Public provision is the production of a good or service by a public authority that receives the bulk of its revenue from the government.

2. A subsidy is a payment that the government makes to the private producer that depends on the level of output. The subsidy reduces the producer’s costs and increases the production of the good.

3. A voucher is a token that the government provides to households that can be used to buy specified goods or services.

4. A patent or copyright is a government-sanctioned exclusive right granted to the inventor of a good, service, or productive process to produce, use, and sell the invention for a given number of years. A patent or copyright is the legal device used to guarantee intellectual property rights, the property rights of the creators of knowledge and other discoveries.