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