Presentation on theme: "Chapter 5 EXTERNALITIES"— Presentation transcript:
1 Chapter 5 EXTERNALITIES When actions spillover to affect3rd parties
2 5 Chapter Outline and Learning Objectives CHAPTER 5.1Externalities and Economic EfficiencyIdentify examples of positive and negative externalities and use graphs to show how externalities affect economic efficiency.5.2Private Solutions to Externalities: The Coase TheoremDiscuss the Coase theorem and explain how private bargaining can lead to economic efficiency in a market with an externality.5.3Government Policies to Deal with ExternalitiesAnalyze government policies to achieve economic efficiency in a market with an externality.5.4Four Categories of GoodsExplain how goods can be categorized on the basis of whether they are rival or excludable, and use graphs to illustrate the efficient quantities of public goods and common resources.
3 ExternalityA benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service.
4 A sign of market failure EXTERNALITIESA sign of market failureSo far, we have only looked at situations where our decisions have had no influence on othersWhat happens if our actions do affect others, yet we don’t take this into account?
5 ExternalitiesEXTERNALITIES - Results of consumption/production decisions that affect 3rd parties (ie. Not those consuming/producing)Externalities - could be positive (external benefit)or negative (external cost)
6 Why do externalities matter? Inefficient allocation of resources occur when externalities are present.Examples:1) Negative externality (pollution, noise)2) Positive externality (education, health care)
7 Solving the Externalities Problem: Private Solutions Coase Theorem: If transactions costs are low, private bargaining will result in an efficient solution to the problem of externalities.
8 Solving the Externalities Problem What can we do to solve this problem?Property Rights - social arrangements that govern the use,ownership, and disposal of factors of production, goods and services- these are legally enforceable2) Also, we could INTERNALIZE THE EXTERNALITYThis is done by adjusting the marginal cost/benefit of agood/service so efficient allocation is achieved.2 ways to do this:1) Corrective Tax (Pigovian Tax)2) Corrective Subsidy (Pigovian Subsidy)
10 Four Categories of Goods Private good. A good that is both rival and excludable.Public good. A good that is both nonrivalrous and nonexcludable.Free riding Benefiting from a good without paying for it.Quasi-public goods. Goods that are excludable but not rival.Common resource. A good that is rival but not excludable.
11 How does corrective tax help reduce negative externality How does corrective tax help reduce negative externality? Will do example in class. How does subsidy help increase positive externality? Will do example in class.
12 Know these Definitions Coase theoremCommand-and-control approachCommon resourceExcludabilityExternalityFree ridingMarket failurePigovian taxes and subsidiesPrivate benefitPrivate costPrivate goodProperty rightsPublic goodRivalrySocial benefitSocial costTragedy of the commonsTransactions costs