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Externalities Spillover Costs & Spillover Benefits Chapter 10 (pages 203-208)

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Presentation on theme: "Externalities Spillover Costs & Spillover Benefits Chapter 10 (pages 203-208)"— Presentation transcript:

1 Externalities Spillover Costs & Spillover Benefits Chapter 10 (pages 203-208)

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 A Factory B

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 MB MC

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 MB MC MSB Positive Externality MSC

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 Impose Tax = spillover cost Shifts Supply Curve left Reach social optimal output Total Cost = Total Benefit Total Cost = MSC (MC P + MC S ) Total Welfare is Maximized! Assume this Factory Pollutes Aluminum Cans MSC --------------- -------------------- Q2Q2 P2P2 E2E2 MC MB

11 Large SUV Production Electric Cars WORKSHEET

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

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

14 Documentary 1)Demand Section 12 min. 2)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 output @ Q2 MSC = MCp + MCs (internal & external) Bottled Water MSC --------------- -------------------- Q2Q2 P2P2 E2E2 MC MB


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