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

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)

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)

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

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)

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