Copyright eStudy.us 2010 michael.roberson@eStudy.us Externality – the uncompensated impact of one person’s actions on the well-being of a bystander Negative Externality - is detrimental to third parties Pollution New House (back lot zoned for sewage plant) Positive Externality - is beneficial to third parties Vaccine Education and Technology spillover New House (back lot zone for a golf course) Internalizing the externality – creating incentives to take account for the external effects of an action S1 S0 Optimum External Cost (Pollution) S0 Optimum External Benefit (Education) D1 D0 D0 Illustration - S0 is inefficient (excludes pollution cost to society, policy moves supply to the efficient S1 position Illustration - D0 is inefficient (excludes social benefit of vaccine to society, policy moves demand to the efficient D1 position with includes private + social benefit Public Policies Toward Externalities Command and Control Policies: Regulation – government make behavior required or forbidden Market Based Policy: Corrective Taxes and Subsidies – a tax designed to induce private decision makers to take account of the social costs that arise from a negative externality Gas tax (Congestion, Accidents, Pollution) Tobacco tax (Health and Worker Productivity) Roads and bridges? Market Based Policy: Tradable Pollution Permits– issue permits to pollute (rations pollution to a socially optimal level by allowing market signals to determine efficient resource allocation) Short term: Paper mill can easily reduce pollution then sell permits to a steal company have trouble reducing pollution provides for most efficient short term allocation of resource while reducing pollution Both industries have a long term incentive to reduce pollution Corrective Tax Pollution Permits Price of Pollution Price of Pollution P P Q Quantity of Pollution Q Quantity of Pollution Private Solutions Toward Externalities Moral codes Social sanctions Charity (income tax deduction for gifts to universities (education and technology)) Self-interest / Contract (orchard and bee keeper) Coase Theorem – the proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own. Disk’s dog spot barks and disturbs Jane AT&T (Cingular) vs Sprint/Nextel in NASCAR Private solutions don’t always work. Transaction cost (cost that parties incur in the process of agreeing to and following through on a bargain) can prevent a solution.