1. Externalities and Environmental Policy Chapter 5

2. Externalities 1. Hubbard, p.138: “Externality- A cost or benefit that affects someone who is not directly involved in the production, or consumption of a good or service. Negative externality- the impact is adverse (smoking). Positive externality- the impact is beneficial (Immunization).

3. Private Versus Public Cost or Benefit) 2. A private cost is incurred by the individual seller taking part in some economic activity. A private benefit realized by the individual buyer taking part in some economic activity. For example, you realize (incur) either a benefit or a cost when you buy a pizza for lunch. The benefit occurs when your hunger is satisfied and the cost is incurred when you pay for it.

4. Public Benefits Versus Public Costs 3. Public ( social) benefits or costs are the sum of the benefits realized or costs incurred by all members of society. Public(social) benefits = private benefit + external benefit (Education) Public (social) cost = private cost + External cost (Cigarette consumption)

5. Externalities 4. External costs = social costs – private costs External costs in production External cost in consumption External benefits= social benefits – private benefits External benefits in production External benefits in consumption

6. 5. Negative Externality in the Production of Aluminum Price of Aluminum Cost of pollution Marginal Social cost =MSC Marginal Private cost=MPC opt Tons of aluminum QQ D=MPB=MSB p

7. 5. Negative Externality in Consumption Qty of alcohol Price of Alcohol Cost of alcohol MSB MPB opt QQ MPC=MSC p

8. 5. External Benefit in Production Price of Robot Value of technology spillover MSC MPC opt Qty of robots QQ MPB=MSB p

9. Positive Externality in Consumption Qty of Education Price of Education Benefits of education MSB MPB opt QQ MPC=MSC p

10. Public policies Toward Externalities Regulation The Clean Air Act, 1970 and amended in 1977 and 1990 The Clean Water Act, 1972 and amended in 1977 Taxes and subsidies Tax Polluters Subsidize pollution abatement Create tradable pollution permits (emission trading or cap and trade which is a form of carbon pricing right to emit pollutants) Note: (Coase Theorem- The argument that if transactions costs are low, private bargaining will result in an efficient solution to the problem of externalities p. 141).