1. Price of steel p1p1 p2p2 0Q2Q2 Q1Q1 This framework does not capture the harm done to the fishery, however. The steel firm sets PMB=PMC to find its privately optimal profit maximizing output, Q 1. Q STEEL D = PMB = SMB S=PMC SMC = PMC + MD MD Figure 2 Negative Production Externalities The socially optimal level of production is at Q 2, the intersection of SMC and SMB. The yellow triangle is the consumer and producer surplus at Q 1. The marginal damage curve (MD) represents the fisherys harm per unit. The social marginal cost is the sum of PMC and MD, and represents the cost to society. The red triangle is the deadweight loss from the private production level. The steel firm overproduces from societys viewpoint.

2. Q CIGARETTES Price of cigarettes 0Q2Q2 D=PMB Q1Q1 p1p1 S=PMC=SMC SMB=PMB-MD MD p2p2 The yellow triangle is the surplus to the smokers (and producers) at Q 1. This framework does not capture the harm done to non-smokers, however. The smoker sets PMB=PMC to find his privately optimal quantity of cigarettes, Q 1. The MD curve represents the nonsmokers harm per pack of cigarettes. The social marginal benefit is the difference between PMB and MD. The socially optimal level of smoking is at Q 2, the intersection of SMC and SMB. The smoker consumes too many cigarettes from societys viewpoint. The red triangle is the deadweight loss from the private production level. Figure 3 Negative Consumption Externalities

3. Q STEEL Price of steel 0Q2Q2 D = PMB SMB Q1Q1 p1p1 S = PMC SMC = PMC + MD MD p2p2 But there is room to bargain. The steel firm gets a lot of surplus from the first unit. 12 This bargaining process will continue until the socially efficient level. There is still room to bargain. The steel firm gets a bit less surplus from the second unit. Thus, it is possible for the steel firm to bribe the fishery in order to produce the first unit. The reason is because any steel production makes the fishery worse off. Thus, it is possible for the steel firm to bribe the fishery in order to produce the next unit. If the fishery had property rights, it would initially impose zero steel production. While the fishery suffers only a modest amount of damage. While the fishery suffers the same damage as from the first unit. Figure 5 Negative Production Externalities and Bargaining: Giving the Fish People Property Rights The gain to society is this area, the difference between (PMB - PMC) and MD for the second unit. The gain to society is this area, the difference between (PMB - PMC) and MD for the first unit.

4. Figure 6 Negative Production Externalities and Bargaining: Steel Producers Have Property Rights Q STEEL Price of steel 0Q2Q2 D=PMB=SMB Q1Q1 p1p1 S = PMC SMC = PMC + MD MD p2p2 The fishery gets a lot of surplus from cutting back steel production by one unit. This level of production maximizes the consumer and producer surplus. If the steel firm had property rights, it would initially choose Q 1. While the steel firm suffers a larger loss in profits. The gain to society is this area, the difference between MD and (PMB-PMC) by cutting back 1 unit. While the steel firm suffers only a modest loss in profits. The gain to society is this area, the difference between MD and (PMB - PMC) by cutting another unit. This bargaining process will continue until the socially efficient level. Thus, it is possible for the fishery to bribe the steel firm to cut back another unit. Thus, it is possible for the fishery to bribe the steel firm to cut back. The fishery gets the same surplus as cutting back from the first unit.

5. Q STEEL Price of steel 0Q2Q2 D = PMB = SMB Q1Q1 p1p1 S=PMC SMC=PMC+MD p2p2 The steel firm initially produces at Q 1, the intersection of PMC and PMB. Imposing a tax shifts the PMC curve upward and reduces steel production. S=PMC+tax Imposing a tax equal to the MD shifts the PMC curve such that it equals SMC. The socially optimal level of production, Q 2, then maximizes profits. Figure 7 Corrective (Pigouvian) Taxation

6. Q STEEL Price of steel 0Q2Q2 D = PMB = SMB Q1Q1 p1p1 S = PMC SMC = PMC + MD p2p2 The firm has an incentive to produce Q 1. Yet the government could simply require it to produce no more than Q 2. Figure 9 Quantity Regulation

7. Table 2 The U.S. is currently responsible for nearly 25% of the planets carbon dioxide emissions. Japan contributes only 5% of annual emissions. Developing counties like China and India emit large quantities of greenhouse gasses.