ECONOMICS 11:

EXTERNALITIES
TF: EDDY SANTOS
EXTERNALITIES - EXAMPLES
Externalities cause prices to be non reflective of the value of a good

that
goods 1benefits to society
services
confer

9 e.g
Education
¡
J
Give examples of goods with positive externalities.
Give examples of goods with negative externalities because of pollutions
T
¡ factory
e.g
to
goods 1services that
cost
hnter additions
to society
incentives externalities
gov't altar punitive
Internalize the externality promote
to discourage
negative ones 2
EXAMPLE

externalities imperfect
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f MI
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inpatient
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ginesPIfientifeitis MF is the subopfgmfeaetfd.ae

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us negative
g externalities 3
 5 taxi

¡ The government auctions off 500 units of pollution rights. They sell for $50 per unit, raising a total revenue of
$25000. What is the equivalent tax of this policy?
50peruni

4
RECALL:
costs
S
P social
S
¡ Greater consumption of alcohol leads to Cprivatecost
more motor vehicle accidents, and thus,
imposes costs on people who do not drink g
and drive.
negative exl fityddded cost 1 I additional
a. Illustrate the market for alcohol, labeling cost
the demand curve, the social-value curve, Yociety
the supply curve, the social-cost curve, the c
i
market equilibrium level of output, and the i
i
efficient level of output. socialcost_private cost
additional I 1
b. Shade the area that corresponds to the cost to 1 I
DWL (why is there a DWL?) steeietysocial I I
en

iii iii
ud
iii
iii costs iii l
Qoptinae
i
Q Q
E 5a
value
why consider private
partilipants consider addition valve 4costs
I

partEF
CS
socialprice
p
2.5 2.5 witetenvingYtner
4
5
25
µ0 4 a t p
Tk_
µf
Ha's
3
2.5 s Csocial wit
4.4
2
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i
l S Cprivate cost
Q T4 M8 1.5 r
f
2 c tax
revenue
DCprivate 4social
value
i
took
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d
lots of
os 4.5 3
6

Gov't Revenue T Q 1 3
EXAMPLE

bit complicated
A
discuss this
let us 3
on
Thursday

7
 Q at BP supply
¡ A market is described by the following supply and Q c dP cdemand
demand equations:
¡ Qs = a + bP Assume cost is reflected in the
a
¡ Qd = c – dP
supply equation
a BP
Here, a, b, c, d > 0, and c > a.
Q
private cost
A ¡ Suppose that each production of a good in this curve
market incurs a cost x to society. What is the loss p Eg g
in efficiency by producing at the market-clearing
quantity? p E Fo t social costcurve
and cost te
b ¡ Calculate the corrective tax T that can force the
themanketequilibr.am
market to produce at the socially-optimal cost curve
outcome. Q atbP a private value curve
Q c dP Cprivat
dp
8

at bp c
p c equil Price
 b
¡ A market is described by the following supply and
demand equations:
Q a t Ift
a Kid t bCc A
¡ Qs = a + bP
¡ Qd = c – dP
Here, a, b, c, d > 0, and c > a.
¡ Suppose that each production of a good in this
Q adt
bid Cemil qty
market incurs a cost x to society. What is the loss
outcome
in efficiency by producing at the market-clearing
quantity?
The socially optimal
social St
¡ Calculate the corrective tax T that can force the
market to produce at the socially-optimal
P
o
1 g
p
x

c privatwifene
outcome.
P c DP
g E x x 9

i P t x
¡ A market is described by the following supply and Pop F x i Is
demand equations:
¡
¡
Qs = a + bP
Qd = c – dP
Port I E xx Ea
Here, a, b, c, d > 0, and c > a.
Qopt c d
I f x Fa
¡ Suppose that each production of a good in this
market incurs a benefit x to society. What is the
Suwefor
loss in efficiency by producing at the market-
Pz
clearing quantity?
Popt i p E I
¡ Calculate the corrective subsidy T that can force T i
the market to produce at the socially-optimal
t T pz to
outcome. p
I i Th
P2 p CQ Qopt
10

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EXAMPLE

¡ Suppose a railway was mistakenly placed along the path

of a farm. Every time a train passes by the farm, it costs
P300 worth of damages to the crop. The operational
cost of the train is P100 for the first train run, but
doubles for each succeeding run.
¡ Additionally, suppose further that the revenue of each
train run is P300.
¡ Predict the amount of trains the railway company will
operate if it does not take into account negative
externalities.
¡ Predict the amount of trains the railway company will run
if the local government requires it to pay for the crop
damage.

11