Lectures_micro / Microeconomics_presentation_Chapter_17
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Private Solutions to Externalities
The implication of Coase’s analysis is that externalities need not lead to inefficiency because individuals have an incentive to find a way to make mutually beneficial deals that lead them to take externalities into account when making decisions. When individuals do take externalities into account, economists say that they internalize the externality.
Why can’t individuals always internalize externalities?
Transaction costs prevent individuals from making efficient deals.
Private Solutions to Externalities
Examples of transaction costs include the following:
The costs of communication among the interested parties—costs that may be very high if many people are involved.
The costs of making legally binding agreements that may be high if doing so requires the employment of expensive legal services.
Costly delays involved in bargaining—even if there is a potentially beneficial deal, both sides may hold out in an effort to extract more favorable terms, leading to increased effort and forgone utility.
Policies Toward Pollution
Environmental standards are rules that protect the environment by specifying actions by producers and consumers. Generally such standards are inefficient because they are inflexible.
An emissions tax is a tax that depends on the amount of pollution a firm produces.
Tradable emissions permits are licenses to emit limited quantities of pollutants that can be bought and sold by polluters.
Taxes designed to reduce external costs are known as Pigouvian taxes.
Marginal bene!t to individual polluter
MBB
MBA
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Quantity |
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of |
Environmental |
Without |
pollution |
standards |
government |
emissions |
forces both |
action, each |
(tons) |
plants to cut |
plant emits 600 |
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emission by |
tons. |
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half |
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Marginal bene!t to individual polluter
Emissions tax
Plant A has a lower marginal bene!t of pollution and reduces emissions by 400 tons
Quantity of pollution emissions
(tons) Plant B has a higher
marginal bene!t of pollution and reduces emissions by only 200 tons
Policies Toward Pollution
When the quantity of pollution emitted can be directly observed and controlled, environmental goals can be achieved efficiently in two ways: emissions taxes and tradable emissions permits.
These methods are efficient because they are flexible, allocating more pollution reduction to those who can do it more cheaply.
An emissions tax is a form of Pigouvian tax, a tax designed to reduce external costs.
The optimal Pigouvian tax is equal to the marginal social cost of pollution at the socially optimal quantity of pollution.
Production, Consumption, and Externalities
When there are external costs, the marginal social cost of a good or activity exceeds the industry’s marginal cost of producing the good.
In the absence of government intervention, the industry typically produces too much of the good.
The socially optimal quantity can be achieved by an optimal Pigouvian tax, equal to the marginal external cost, or by a system of tradable production permits.
Consumption
(a) Positive Externality
Price, marginal social bene!t of #u shot
Marginal external bene!t
E
MKT
Q |
Q |
Quantity of |
MKT |
OPT |
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#u shots |
Price to producers after subsidy
Optimal Pigouvian subsidy
Price to consumers after subsidy
(b) Optimal Pigouvian Subsidy
of
S
EMKT
Q |
Q |
Quantity of |
MKT |
OPT |
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#u shots |
Private Versus Social Benefits
The marginal social benefit of a good or activity is equal to the marginal benefit that accrues to consumers plus its marginal external benefit.
Private Versus Social Benefits
A Pigouvian subsidy is a payment designed to encourage activities that yield external benefits.
A technology spillover is an external benefit that results when knowledge spreads among individuals and firms. The socially optimal quantity can be achieved by an optimal Pigouvian subsidy equal to the marginal external benefit.
An industrial policy is a policy that supports industries believed to yield positive externalities.
Private Versus Social Costs
The marginal social cost of a good or activity is equal to the marginal cost of production plus its marginal external cost.