Spillover Effects: External effects of economic activity which have an

impact on outsiders who are not producing or consuming a product

Aka “Externalities” Can take the form of costs or benefits

7.2 Spillover Effects and Market Failure

Some things we have for free: air Spillover Costs are negative external effects of

producing or consuming a product that fall on outsiders, not market participants e.g. Environmental Pollution

Producers making products only focus on private costs as they make supply decisions

Thus prices of products made are insufficient to pay for both private and spillover costs

Spillover Costs & Benefits

$1.50 per liter for a quantity of 6 million liters of gasoline Due to environmental damage created by both

production/consumption of gasoline, there are spillover costs S1: supply curve for only private costs of producing gasoline S2: supply curve for public and private costs of gasoline Without gov’t intervention, equilibrium: where D1 meets S1 To account for spillover costs, the gov’t

may impose an excise tax of $1/L Thus, supply curve shifts from S1 to S2,

moving equilibrium to where D1 meets S2

Spillover Costs of Gasoline

Spillover Costs, Excise Tax

Taxes are a way of dealing with spillover costs Federal & provincial excise taxes are also on alcohol

and cigarettes Taxes on these items can reduce spillover costs, such

as: The public damage caused by an impaired driver Health-related effects of second hand smoke

Other Spillover Effects

Policy makers take into account the future costs of higher global temperatures, and based on that, issue a carbon tax.

Carbon Tax: Excise tax levied on a wide range of products to

counteract spillover costs associated with carbon emissions.

Applied to anything whose production and consumption requires significant transportation of materials

Carbon Emissions

Spillover Benefits: Positive external effects of producing or consuming a product e.g. Education, since society as a whole gains from this

service Without gov’t intervention in market for engineering

education, equilibrium occurs where D0 meets S If spillover benefits are determined to be $2000

per student, government can create a subsidy for students pursuing a career in engineering

Thus, demand curve shifts from D0 to D1, new equilibrium point is where D1 meets S

Spillover Benefits

Spillover Benefits, Student Subsidy

Extreme Case: there are some products for which private benefits and spillover benefits cannot be separated

Public Good: A product whose benefits cannot be restricted to

certain individuals While some consumers pay for a product, others get a

“free ride” e.g. Lighthouse – all boats benefit, regardless if they

help pay for it

Public Goods

No one owns the internet, and the price of accessing the internet is not a lot, especially if you access it from school/work

There are many sites and organizations that provide resources that can help you, which gives it many of the features of a public good

Is Internet a Public Good?