9Internalizing the Externality Altering incentives so that people take account of the external effects of their actions.
10Private Solutions Moral codes. Private charities. Contracts (Coase theorem)
11Coase TheoremIn the absence of transactions costs, private economic actors can solve the problem of externalities among themselves.
12Public Policies to Deal with Externalities Regulation specifying maximum allowable level of a negative externality.Taxes (for negative externalities) & subsidies (for positive externalities).Permits (licenses).
13Pigovian TaxesArthur Pigou ( ), Professor of Economics, Cambridge UniversityTax the good that creates the negative externality.Reduces Q to optimal level.
14How would you model a subsidy paid to providers of a positive externality?
19SummaryWhen a transaction between a buyer and a seller directly affects a third party, the effect is called an externality.Negative externalities cause the socially optimal quantity in a market to be less than the equilibrium quantity.Positive externalities cause the socially optimal quantity in a market to be greater than the equilibrium quantity.
20SummaryWhen private parties cannot adequately deal with externalities, then the government steps in.The government can either regulate behavior or internalize the externality by using Pigovian taxes or by issuing pollution permits.
21FirmPollutionLevelUnit cost to reduceA70 units$20B80$25C50$10The government gives each firm 40 tradable pollution permits to reduce aggregate pollution level to 120 units.1. What is the total cost of reducing pollution?2. What would be the cost if the permits were not tradable?
29BEIJING, March 4 (Reuters) - China is to change its constitution to protect private property in a revolutionary manoeuvre that waters down its core Communist ideology to raise the status of entrepreneurs once deemed the running dogs of capitalism. Five decades after seizing power, nationalising private property and waging bloody campaigns against landlords, China's parliament is set to amend the state constitution to add the words, "private property obtained legally is inviolable". One aim of the amendments, to be ratified during the annual session of the National People's Congress that opens on Friday, is to give further impetus to the burgeoning private sector that is fuelling China's breakneck economic growth.