Econ 100.

2
Discussion Class 8
3/8/18
JC Punongbayan
 Outline
• Housekeeping:
– Exam 1: Results of Exam 1 today
– Exam 2: Let me know by 11:59 PM today who will be unable
to take it on Sunday, March 18 (send excuse letter/slip)
– Exercise Set 1: Please get unclaimed papers
– Exercise Set 2: By next week
• Externalities (cont.)
– E.g., Road congestion
– E.g., Dengvaxia
– E.g., TRAIN
 Outline
• Market efficiency &
failure.
• Story:
– Markets are great (social
welfare)
– But markets become less
great when gov’t intervenes
where it shouldn’t
(taxation, protectionism)
– But there are instances
where gov’t intervention is
justified (e.g., externalities)
 Externalities and welfare
• Thus, analogies:
• Taxes & positive externalities: There’s ___
(more/less) economic activity than there should be.
 MB__MC (>/</=)
• Subsidies & negative externalities: There’s ___
(more/less) economic activity than there should be.
 MB__MC (>/</=)
• Difference:
• Taxes/subsidies are _____.
• Positive/negative externalities are _____.
 APPLICATION

“Induced demand” for driving

(Will building more roads reduce congestion?)
Price of
driving AC(R)

AC(R’)
P1

Source:
P2 Duranton &
Turner [2009]

P(Q)
Quantity of driving
(vehicle-kilometers
Q1 Q2 traveled [vkt])
DWL of a negative externality
P
Ssocial

a
Sprivate
P1 g
b
c d
P2 f
e

D
Q
Q1 Q2
DWL of a positive externality
P
S

a
b

d e
P1 c
Dsocial
P2
f

Dprivate
Q
Q2 Q1
 APPLICATION

Dengvaxia scare
(What happens to people’s welfare when parents fear vaccines?)
Price of
vaccines

c
b
a e S
P1 d f
g h i j k
P2
l m n
P3 DS
o
DP
DP2
Units of vaccines
Q3 Q2 Q1
• Positive externality: there’s too little of an activity.
• To increase it, impose a corrective subsidy.
o Remove the gap between the private and social
demand curves.
• Negative externality: there’s too much of an activity.
• To lessen it, impose a corrective tax.
o Remove the gap between the private and social supply
curves.
 Public solutions to externalities
• Here, Principle 7 applies. Corrective policies.
– In case of a positive externality, impose a
corrective subsidy.
• E.g., Free tuition law?
– In case of a negative externality, impose a
corrective tax.
• E.g., TRAIN’s excise tax on petroleum & automobiles
• E.g., Sin tax law
• E.g., Coal tax
Cigarette excise

Petroleum excise
Auto excise
 Q1
• In this market for plastics, P
each unit produced results in 32
an external cost of how much?
28
• At what level of Q is the social
Social Cost
optimum achieved? 24
• At what level of Q is the 20
market equilibrium achieved? Private Cost
• To reach social optimum, gov’t 16
could impose a __ of how 12
much per unit?
8
• This corrective action will lead Demand
to gov’t revenues of how 4
much?
100 200 300 400 500 Q
 Q2
Suppose that flu shots create a
positive externality equal to
$12 per shot. Further suppose
that the government offers a $5
per-shot subsidy to producers.
• What is the relationship
between the equilibrium
quantity and the socially
optimal quantity of flu shots
produced? (Which is larger?)
• Is the subsidy enough?
 Public solutions to externalities
• Quantity restrictions also work (e.g., pollution permits)