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Externalities Spillover Costs & Spillover Benefits

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Presentation on theme: "Externalities Spillover Costs & Spillover Benefits"— Presentation transcript:

1 Externalities Spillover Costs & Spillover Benefits
Chapter 10 (pages )

2 Switzerland & Garbage 35 Liter Swiss Trash Bag

3 EXTERNALITIES An externality is the uncompensated impact of one person or firm’s actions on another person/society Both positive externalities & negative externalities exist All externalities are considered market failures (inefficient) That is, markets with externalities do not maximize total surplus (welfare) Governments can correct externalities with taxes or subsidies

4 Factory B Factory A

5 Negative Externalities
Automobile exhaust Cigarette smoking Barking dogs Loud stereos in an apartment building Noisy Students Neighbor’s poorly maintained property

6 Positive Externalities
Immunizations Restored historic buildings Research into new technologies Neighbor’s well maintained property Volunteering

7 Spillover Costs & Spillover Benefits
Spillover Costs- external costs not included in supply curve (MC) External costs exist with ALL negative externalities MC is understated => which leads to overproduction Spillover Benefits-external benefits not included in demand curve (MB) External benefits exist with ALL positive externalities MB is understated => which leads to underproduction MC MB

8 Graphing Externalities
When graphing negative externalities use MC & MB curves Then add any spillover cost or benefit to existing curve Marginal Social Cost (MSC) = MC + spillover cost (external cost) Marginal Social Benefit (MSB) = MB + spillover benefit (external benefit) MB MC Negative Externality MSC MB MC MSB Positive Externality

9 Internalizing Externalities
Internalizing an externality involves altering incentives to improve market outcomes (i.e. to increase total welfare) Government Solutions Taxes or Subsidies Laws (immunization laws, pollution laws) Patents Free market Solution: Trading pollution credits => i.e. cap & trade

10 Internalizing Negative Externalities
Aluminum Cans Assume this Factory Pollutes MSC Impose Tax = spillover cost Shifts Supply Curve left Reach social optimal output MC Q2 P2 E2 MB Total Cost = Total Benefit Total Cost = MSC (MCP + MCS) Total Welfare is Maximized!

11 WORKSHEET Electric Cars Large SUV Production

12 Subsidizing Positive Externalities
Assume these cars have external benefits Electric Cars Impose Subsidy = spillover benefit Shifts demand curve right Reach social optimal output Total Cost = Total Benefit

13 Bottled Water What is the real cost? Start 20 minutes in…

14 Documentary Demand Section 12 min. Recycle Section

15 Only 11 states have recycle deposits laws
Only 20% of U.S. water bottles are recycled

16 Internalizing Negative Externalities
Impose Tax = spillover cost This puts a price on “external costs” Reach socialy optimal Q2 MSC = MCp + MCs (internal & external) Bottled Water MSC MC Q2 P2 E2 MB

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