19 Externalities The market tends to overproduce. Spillover CostsSpillover Benefits The market tends...

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19 Externalities he market tends to overproduce. Spillover Costs Spillover Benefits The market tends to underproduce
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Transcript of 19 Externalities The market tends to overproduce. Spillover CostsSpillover Benefits The market tends...

19 Externalities

The market tends to overproduce.

Spillover Costs Spillover Benefits

The market tends to underproduce.

200 400 600

30

60

90

Pollution (tons)

Cle

an

-up

cost

(00

0$

)The Economics of Pollution

Company A produces 40,000 units and emits 600 tons of pollution. Clean-up is costly.

100

30,000

300

30,000

0

Pollution(tons)

Clean-upcost

MCper ton

$90,000

$40,000

$10,000

200

400

$0600

200 400 600

200

400

600

Pollution (tons)

Marg

inal b

en

efit

($)

The marginal “benefit” of pollution is the cost of cleaning-up an extra ton.

Marginal “Benefit” of Pollution

MB: Company A

MB: Company B

Company B has higher clean-up costs.

20,00040,00060,000

200

400

600

Pollution (tons)

MC

and

MB

($

)

Costs and benefits of pollution for the economy as a whole.

Costs and Benefits of Pollution

MBMC

30,000 tons of pollution is optimal.

the benefit from an extra ton of pollution is offset by the cost

without regulation, companies will emit 60,000 tons

200 400 600

200

400

600

Pollution (tons)

Marg

inal b

en

efit

($)

A standard might require all companies to cut emissions to 300 tons.

Environmental Standards

MB: Company A

MB: Company B

The marginal and total cost for Company B is higher.

$150

$300

A

CompanyClean-up

costMC

per ton

$22,500

$45,000B

200 400 600

200

400

600

Pollution (tons)

Marg

inal b

en

efit

($)

Alternatively, the government could impose a tax of $200 per ton.

Emission Taxes

Each firm chooses an optimal level of pollution

Total pollution is the same but at lower cost.

$200

$200

A

CompanyClean-up

costMC

per ton

$40,000

$20,000B

Clean-up cost

Emissions tax

Total

$0

600tons

400tons

200tons

0tons

$120,000

$120,000

$20,000 $80,000 $180,000

Clean-up cost

Emissions tax

Total

$0

600tons

400tons

200tons

0tons

$120,000

$120,000

$10,000 $40,000 $90,000

Firms Choose How Clean to Be

Firm A

Firm B

Marketable Pollution Permits

The government allocates permits to firms.

Firms are allowed to buy and sell permits.

Permits encourage the lowest cost clean-up to be done first.

Environmental groups can buy permits to reduce pollution.

Marginal Benefit of Transactions

2 4 6 8 10 12

4

8

12

$20

16Pri

ce

Quantity

$8

$8

$4

$5

Marginal benefit of 2nd unit is $16.

Marginal benefit of 5th unit is $9.

Quantity

Pri

ce

100 200 300 400 500

5

10

15

20

25

30

35

40

$2,625

$2,250

$2,250

External Costs (Before a Tax)

Large consumer and producer surplus if

government pays for the clean-up.

Consumer Surplus

Producer Surplus

ExternalCost

Net benefit = $1,875

Quantity

Pri

ce

100 200 300 400 500

5

10

15

20

25

30

35

40

Marginal Benefits and Costs

Marginal benefit of 100th unit is $20.

Marginal cost of 100th unit is

$7.50.

Consumer Surplus

Producer Surplus

ExternalCost

Quantity

Pri

ce

100 200 300 400 500

5

10

15

20

25

30

35

40

Marginal Benefits and Costs

Consumer Surplus

Producer Surplus

ExternalCost

200 = optimal quantity

$10 = optimal tax

Marginal benefit of 200th unit is $10.

Marginal cost of 200th unit is $10.

Quantity

MC

& M

B

100 200 300 400 500

5

10

15

20

25

30

35

40

Marginal cost

Marginal benefit

Marginal Benefits and Costs

Quantity

Pri

ce

100 200 300 400 500

5

10

15

20

25

30

35

40

Tax on External Costs

$10

With the tax,consumers and

producers cover the external costs.