Presentation on theme: "Externalities Externality—the behavior of one agent (person or firm) affects another agent in a way that is external to markets. negative externalities,"— Presentation transcript:
1 ExternalitiesExternality—the behavior of one agent (person or firm) affects another agent in a way that is external to markets.negative externalities, e.g.,chewing tobacco (disease andsoiling),alcohol (drunk driving),road salt (cardamage),and antibiotics (disease resistantbacteria).positive externalities, e.g.,HPV vaccine (disease),and education (better citizens).
2 19th & Early 20th Century Chewing Tobacco Mail Pouch paid barn owners $1 to $2 a year and painted the rest of the barn as well.Founded in 1879The founders of Mail Pouch came up with the idea when they noticed that people liked chewing the clippings of stogie wrappers.
3 19th and Early 20th Century Chewing Tobacco Quotes from Richard Kluger’s, Ashes to AshesChewing Tobacco:“splendidly suited” to 19th Century outdoor lifeIn early 20th Century:Messy: spit aimed at “ubiquitous cuspidor(s)” hit “carpets, walls, draperies, and trousers. ”Dangerous: “spreader of tuberculosis and other contagions.”
7 The Market for Chewing Tobacco Social CostPCTFor each pouch of chewing tobacco produced, the social cost includes the private costs of producing the chewing tobacco plus the cost to those bystanders adversely affected by the spit from that pouch.SMKTSocial cost ofproducing Q’Dexternal costPrivate cost ofproducing Q’Q’Q* QMKTQCTQMKT> Q*Market Failure: Negative externalities cause markets toproduce a larger quantity than isefficient.
8 Correcting the Market Failure Social CostSTax(T)PCTPCTSMKTSMKTPTexternal costPMKTPMKTtaxDDQ*QMKTQCTQTQNTQCTChanging incentives so people (or firms) take account of the external effects of their behaviors is called internalizing the externality.The government can internalize the externality by imposing a tax on chewing tobacco (assume that tobacco companies pay it).QT will equal Q* if the tax (per pouch) = the negative externality (per pouch).
9 Market for LoJack (LJ) S (private cost)PLJExternal benefit (the value of in prob. that other cars will be stolen)DWLPMKTSocial valueD(private value)QMKTQ*QLJPositive externalities cause markets to produce a smaller Q than is efficient.
10 Correcting the Market Failure External benefitPLJPLJSSubsidySSsSocialPMKTPMKTvaluePSDDQMKTQ*QLJQLJQMKTQSThe government can internalize the externality by giving a subsidy to the producer of LoJack.QS will equal Q* if the subsidy (per LoJack) = the positive externality (per LoJack).
11 Correcting the Market Failure Alteratively, economists Ayres and Nalebuff “urge regulators to require insurers to give discounts to LoJack users.” Suppose the government requires insurers to give discounts of $200 to people who purchase LoJack.External benefitPLJPLJSS$200P’SocialPMKTPMKTvalueD’DDQMKTQ*QLJQLJQMKTQ’