© 2010 Pearson Education CanadaChapter 10 - 1 Chapter 10 Acid Rain on Others’ Parades © 2010...

© 2010 Pearson Education CanadaChapter 10 - 1

Chapter 10

Acid Rain on Others’ Parades

© 2010 Pearson Education Canada


Acid Rain on Others’ Parades

Externalities, Carbon

Taxes,

Free Riders & Public

Goods


LEARNING OBJECTIVES

10.1 Identify how government subsidies can

internalize positive externalities to create

smart social choices

10.2Describe how externalities make smart

private choices different from smart social

choices

10.3Explain the rule for coordinating private

choices that cause negative externalities

with smart social choices

continued…


10.4 Identify how government policies can

internalize externalities for polluters

to create smart social choices

10.5 Explain how positive externalities create

the free-rider problem and cause

markets

to fail


HANDCUFFING THE INVISIBLE HANDMARKET FAILURE WITH EXTERNALITIES

Negative or positive externalities make smart private choices different from smart social choices.


MARKET FAILURE WITH EXTERNALITIES

• Smart choices require that all

additional benefits and additional

opportunity costs — including externalities —

are counted

– negative externalities (external costs) costs to society from your private choice that affect others, but you do not pay

– positive externalities (external benefits) benefits to society from your private choice that affect others, but others do not pay you for

continued…


• Negative externalities

Social Costs

Private (Opportunity)

Costs

External (Opportunity)

Costs+=

continued…


• Positive externalities

Social Benefits

Private Benefits

External Benefits+=

continued…


• Externalities occur when no clear property rights

• With externalities, prices don’t reflect all social

costs and benefits, preventing markets from

coordinating private smart choices with social

smart choices

• Externalities cause market failures

– produce too many things with negative externalities (pollution, traffic jams)

– produce too few things with positive externalities (vaccinations, education)


WHY RADICAL ENVIRONMENTALISTS DISLIKE ECONOMISTS

NEGATIVE EXTERNALITIES & EFFICIENT POLLUTION

To coordinate smart private choices that generate negative externalities with smart social choices, choose the quantity of output where marginal social cost equals marginal social benefit.



• “Efficient pollution” balances additional

environmental benefits with additional

opportunity costs of reduced living standards

• Socially desirable amount of pollution is not

zero

– at some point additional opportunity costs of reductions in pollution are greater than additional benefits

continued…


• Smart choice rule: choose quantity of output

where marginal social cost equals marginal

social benefit

continued…

Marginal Social Cost

(MSC)

Marginal Private

Cost

Marginal External

Cost+=

Marginal Social Benefit

(MSB)

Marginal Private Benefit

Marginal External Benefit

+=


Figure 10.1 Demand, Supply & Externalities

Demand Supply

Outp

ut

MPB MSB Outp

ut

MPC MSC

1 $140 $140 1 $50 $ 80

2 $120 $120 2 $60 $ 90

3 $100 $100 3 $70 $100

4 $ 80 $ 80 4 $80 $110

5 $6 0 $ 60 5 $90 $120


• Markets overproduce products/services with

negative externalities

– price too low because does not include external costs


LIBERATING THE INVISIBLE HAND POLICIES TO INTERNALIZE THE

EXTERNALITY

Government policies can force polluters to pay the marginal external costs of their pollution.

As a result, polluters internalize externalities/costs

into their private choices, creating smart social choices.



• Without property rights to the environment, businesses have incentives to save money and improve profits by ignoring external costs like pollution and global warming

• Governments can remedy market failures from externalities by creating social property rights to environment, making polluting illegal, penalizing polluters– emissions tax

tax to pay for external costs of emissions

continued…


Figure 10.2 Pulp Market with $30/T Emissions Tax

Demand Supply

Outpu

t

MPB MSB Outpu

t

MPC MPC +

Tax

1 $140 $140 1 $50 $ 80

2 $120 $120 2 $60 $ 90

3 $100 $100 3 $70 $100

4 $ 80 $ 80 4 $80 $110

5 $ 60 $ 60 5 $90 $120


– carbon taxemissions tax on carbon-based fossil fuels

– cap-and-trade systemlimits emissions businesses can release into environment

• Internalize the externality

transform external costs into costs producer

must pay privately to government

continued…


• By giving pollution a price reflecting marginal

external cost of damage done, smart private

choices become smart social choices

• Carbon taxes and cap-and-trade systems are

smart policies for efficient pollution, but

may also be inequitable, hurting lower-

income consumers most


WHY LIGHTHOUSES WON’T MAKE YOU RICH

FREE-RIDING ON POSITIVE EXTERNALITIES

Market clearing price too high for buyers to be willing to buy socially best quantity of output, and too low for sellers to be willing to supply.

Positive externalities create a free-rider problem when neither buyers nor sellers are paid for external benefits their exchange creates.


FREE-RIDING ON POSITIVE EXTERNALITIES

• Public goods

provide external benefits consumed

simultaneously by everyone; no one can be

excluded

– public goods like lighthouses and national defence are extreme examples of positive externalities

– free-ridersomeone who does not have to pay for external benefits

continued…


• Smart choice rule: choose quantity of output

where marginal social cost equals marginal

social benefit

• Because of free-rider problem

– markets underproduce products/services with positive externalities

– price charged to buyers is too high

– price received by sellers is too low

– market price does not incorporate external benefits


Figure 10.3 Post-Secondary Market

Demand Supply

Outp

ut

MPB MSB Outp

ut

MPC MSC

100 $7000 $1000

0

100 $2500 $2500

200 $6000 $

9000

200 $3000 $3000

300 $5000 $

8000

300 $3500 $3500

400 $400

0

$

7000

400 $400

0

$400

0

500 $3000 $

6000

500 $4500 $4500

600 $200

0

$

5000

600 $500

0

$500

0

700 $1000 $

4000

700 $5500 $5500


WHY YOUR TUITION IS CHEAP (REALLY!)SUBSIDIES FOR THE PUBLIC GOOD

Government policies can reward businesses and individuals creating positive

externalities. As a result, they internalize the externalities/ rewards, turning smart private choices into

smart social choices.


SUBSIDIES AND PUBLIC GOODS

• Government policy tools to get all to voluntarily choose output where marginal social benefit equals marginal social cost– subsidy

payment to those creating positive externalities

– public provisiongovernment provision products/services with positive externalities, financed by tax revenue

• Subsidies and public provision remove the wedge positive externalities drive between prices for buyers and for sellers, inducing voluntary choice of output best for society

continued…


Figure 10.4 Post-Secondary Market with $3000 Subsidy

Demand Supply

Outpu

t

MPB MSB Outpu

t

MPC MPC —

Subsidy

100 $7000 $1000

0

100 $2500 -$500

200 $6000 $

9000

200 $3000 $0

300 $5000 $

8000

300 $3500 $500

400 $4000 $

7000

400 $4000 $1000

500 $3000 $

6000

500 $4500 $2500

600 $200

0

$

5000

600 $500

0

$2000

700 $1000 $

4000

700 $5500 $2500


Chapter 10Refresh Slides



1. What is a negative externality? a positive

externality?

2. Talking in large lecture halls is a problem

both for instructors who can’t concentrate

and attentive students who can’t hear. Can

you explain this problem in terms of

externalities? Why is this problem hard to

solve?

continued…


1. Many condominiums have strict rules about

the colour of window-coverings. Why do

these rules arise? Is it fair to restrict the

choices of property owners in this way?



1. What is the rule for finding efficient

combinations of output and pollution?

2. If the marginal external cost of pollution in

Figure 10.1 were $60 per tonne instead of

$30 per tonne, what would be the smart

choice for society of pulp output? What

would be the smart price of a tonne of

pulp?

continued…


1. What position on DDT do you support (see

story from Economics Out There, page

245)? What additional information do you

need before you decide?


POLICIES TO INTERNALIZE THE EXTERNALITY

1. What is a carbon tax, and how does it “internalize the externality” for a polluting business?

2. Some environmental groups try to expose businesses that pollute while supporting environmentally friendly businesses by posting information and photos on public websites (for example, www.secrecyistoxic.ca). Explain the strategy and how this may “internalize the externality” for the polluters even without government action.continued…


1. While carbon taxes and cap-and-trade

systems have the same objective,

governments and political parties differ in

which policy they support. What are the

positions of the Conservatives, the Liberals,

the NDP, and the Green Party? Which

position makes the most sense to you?


FREE-RIDERS & POSITIVE EXTERNALITIES

1. What is the free-rider problem? Why is

free-riding a problem?

2. Smart students often don’t like group projects.

Explain why, using the concept of free-riding.

3. Two physically identical houses can have

very different values depending on their

neighbourhoods. How do positive (or negative)

externalities help explain property values?


SUBSIDIES & PUBLIC GOODS

1. What should the amount of a smart government subsidy be equal to? Why?

2. What if the government gave the $3000 subsidy from Figure 10.4 directly to students instead of to schools? Construct a table like Figure 10.3 and discover whether the students’ private choices would still be the same as the smart choice for society? [Hint: The Marginal Private Benefit column shows willingness to pay. Create a new column showing willingness to pay with the subsidy (Marginal Private Benefit + Subsidy).]

continued…


3. Some European countries have free tuition for post-secondary education. If you were a member of parliament who wanted to defend this policy (knowing that any money needed to support education had to be raised by new taxes), what arguments would you make? If you wanted to defend the Canadian system, where students must pay some tuition, what arguments would you make?

© 2010 Pearson Education CanadaChapter 10 - 1 Chapter 10 Acid Rain on Others’ Parades © 2010...

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