1. Mr. Bernstein Module 74: Introduction to Externalities January 9, 2015
AP Economics
Mr. Bernstein
Module 74:
Introduction to Externalities
January 9, 2015

2. AP Economics Mr. Bernstein
The Economics of Pollution
Environmentalists argue unregulated electricity producers overpollute because they do not consider harmful effects
Producers argue regulation interferes with ability to produce at lowest cost
Economists view as topic for cost-benefit analysis where the socially optimal level is where Marginal Social Costs (MSC) intersect with Marginal Social Benefits (MSB)

3. AP Economics Mr. Bernstein
The Economics of Pollution
MSC curve is
upward sloping
MSB curve is
downward sloping
(~ cleanup cost savings?)
Will society
reach OOPT?
NO!
(Note optimal pollution is not 0)

4. AP Economics Mr. Bernstein
The External Costs of Pollution
Negative Externality is an uncompensated cost that a firm or individual imposes on others
Pollution from an Ohio River electricity plant lands on Jersey residents who do not benefit from the electricity
The unregulated market does not care about the pollution costs and produces until MSB = 0

5. AP Economics Mr. Bernstein
The External Costs of Pollution
Society would
gain the entire
shaded triangle if
pollution is reduced
from Qmkt (MSB=0) to
Qopt
MSC and MSB
of pollution
Qopt
MSB
MSC
MSC=MSB
Qmkt
$1000
Qty of Pollution Emitted (tons)

6. AP Economics Mr. Bernstein
Private Solutions to Externalities
Coase Theorem
Ronald Coase (1960)
Requires clearly defined property rights plus minimal transactions costs
A private solution can be worked out (ie $$ settlement)
Hurdles include communication problems, high legal costs, delaying tactics