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Premium CH 10 Externalities
Premium CH 10 Externalities
N. GREGORY MANKIW
PRINCIPLES OF
ECONOMICS
Eight Edition
CHAPTER
Externalities
Premium PowerPoint Slides by:
V. Andreea CHIRITESCU
Eastern Illinois University
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
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• What is an externality?
• Why do externalities make market outcomes
inefficient?
• What public policies aim to solve the
problem of externalities?
• How can people sometimes solve the
problem of externalities on their own? Why
do such private solutions not always work?
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Externalities
• ‘Markets are usually a good way to
organize economy activity’
– In absence of market failures, the
competitive market outcome is efficient,
maximizes total surplus
• Externality: one type of market failure
– The uncompensated impact of one
person’s actions on the well-being of a
bystander
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Externalities
• Negative externality
– Impact on the bystander is adverse
• Positive externality
– Impact on the bystander is beneficial
• Self-interested buyers and sellers
– Neglect the external costs or benefits of
their actions
– So the market outcome is not efficient
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 4
management system for classroom use.
Externalities
• ‘Government action can sometimes
improve upon market outcomes’
– Why markets sometimes fail to allocate
resources efficiently
– How government policies can potentially
improve the market’s allocation
– What kinds of policies are likely to work
best
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 5
management system for classroom use.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 6
management system for classroom use.
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Negative Externalities
• Examples of negative externalities
• Air pollution from a factory
• The neighbor’s barking dog
• Late-night stereo blasting from the dorm room
next to yours
• Noise pollution from construction projects
• Health risk to others from second-hand
smoke
• Talking on cell phone while driving makes the
roads less safe for others
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2 One solution:
D tax sellers $1/gallon,
1 would shift S curve
up $1.
0
0 10 20 25 30 Q
(gallons)
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Externalities
• Internalizing the externality:
– Altering incentives so that people take into
account the external effects of their
actions
– In our example, the $1/gallon tax on
sellers makes sellers’ costs = social costs.
• If market participants pay social costs
– Market equilibrium = social optimum
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Positive Externalities
• Examples of positive externalities
• Being vaccinated against contagious
diseases protects not only you, but people
who visit the salad bar or produce section
after you
• Research and development creates
knowledge others can use
• People going to college raise the population’s
education level, which reduces crime and
improves government
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 13
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Positive Externalities
• With a positive externality
– The social value of a good includes
• Private value – the direct value to buyers
• External benefit – the value of the positive
impact on bystanders
• The socially optimal Q maximizes welfare:
• At any lower Q, the social value of
additional units exceeds their cost.
• At any higher Q, the cost of the last unit
exceeds its social value.
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Social value
20 = private value
+ $10 external benefit
10
D
0 Q
0 10 20 25 30
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 25
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 26
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 38
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Summary
• When a transaction between a buyer and seller
directly affects a third party, the effect is called
an externality.
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Summary
• Governments pursue various policies to remedy
the inefficiencies caused by externalities.
– Regulating behavior
– Internalizes an externality using corrective taxes
– Issue permits (similar results to imposing
corrective taxes on polluters)
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Summary
• According to the Coase theorem, if people can
bargain without cost, then they can always
reach an agreement in which resources are
allocated efficiently.
– In many cases, however, reaching a bargain
among the many interested parties is difficult, so
the Coase theorem does not apply.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 46
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