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KRUGMAN'SMICROECONOMICS for AP*
Externalities and Public Policy
Margaret Ray and David Anderson
Micro:
Econ:
39
75
Module
What you will learnin this Module:• How external benefits and costs
cause inefficiency in markets.
• Why some government policies to deal with externalities, such as emissions taxes, tradable emissions permits, and Pigouvian subsidies, are efficient, although others, including environmental standards, are not.
Arthur Cecil Arthur Cecil PigouPigou
Policies Toward Pollution
• Environmental Standards (emissions testing; sewage treatment)
• Emissions Taxes
• Tradable Emissions Permits
Production, Consumption, and Externalities
• Private versus social benefits
• Private versus social costs
Externalities
A Pigouvian tax is a tax levied on a market A Pigouvian tax is a tax levied on a market activity that generates negative activity that generates negative externalities (or a subsidy for a positive externalities (or a subsidy for a positive externality. The tax or subsidy is intended externality. The tax or subsidy is intended to correct the market outcome. In the to correct the market outcome. In the presence of negative externalities, the presence of negative externalities, the social cost of a market activity is not social cost of a market activity is not covered by the private cost of the activity. covered by the private cost of the activity. In the presence of positive externalities, In the presence of positive externalities, the social benefit of a market activity is the social benefit of a market activity is not covered by the private benefit of the not covered by the private benefit of the activity.activity.
Positive Externalities
When the production and consumption of a good provides benefits to third parties, that good is said to provide positive externalities to society. Qty home
improvements
Price, MSB
MPB MSB
S
Popt
QoptQmkt
Pmkt SubsidyPcons
Positive Externalities
• We can see that the market We can see that the market under-produces goods that under-produces goods that generate positive generate positive externalities. In other words, externalities. In other words, we don’t get enough of a good we don’t get enough of a good thing. thing.
• This is inefficient and produces This is inefficient and produces deadweight loss just like price deadweight loss just like price controls and monopoly. This controls and monopoly. This represents benefits that would represents benefits that would be enjoyed by society if the be enjoyed by society if the socially optimal, not the socially optimal, not the market, output was produced.market, output was produced.
• The area of the deadweight The area of the deadweight triangle is above the supply triangle is above the supply curve, with base of (Qcurve, with base of (Qoptopt - Q - Qmktmkt), ), and height of (Pand height of (Pmsbmsb – P – Pmktmkt),),
Qty home improvements
Price, MSB
MPB MSB
S
Popt
QoptQmkt
Pmkt SubsidyPcons
Positive Externalities
• How could policy How could policy eliminate the eliminate the deadweight loss?deadweight loss?
• We could provide We could provide a subsidy (called a subsidy (called a Pigouvian a Pigouvian subsidy) on each subsidy) on each unit of home unit of home improvement improvement goods demandedgoods demanded Qty home
improvements
Price, MSB
MPB MSB
S
Popt
QoptQmkt
Pmkt SubsidyPcons
Negative Externalities
When the production and consumption of a good creates costs to third parties, that good is said to create negative externalities to society. Qty electricity
Price, MSC
MPC
D
MSC
Popt
Qopt Qmkt
Pmkt
Tax
Pfirm
Negative Externalities
• We can see that the market We can see that the market over-produces goods that over-produces goods that generate negative generate negative externalities. In other externalities. In other words, we get too much of words, we get too much of a bad thing. a bad thing.
• This is inefficient and This is inefficient and produces deadweight loss produces deadweight loss just like price controls and just like price controls and monopoly. This represents monopoly. This represents additional costs that would additional costs that would not be incurred by society not be incurred by society if the socially optimal, not if the socially optimal, not the market, output was the market, output was produced.produced.
Qty electricity
Price, MSC
MPC
D
MSC
Popt
Qopt Qmkt
Pmkt
Tax
Pfirm
Negative Externalities - Examples• Smokers ignore the unintended but harmful Smokers ignore the unintended but harmful
impact of impact of toxic ‘passive smoking’ on non-smokers
• Acid rain from power stations in the UK can Acid rain from power stations in the UK can damage the forests of Norwaydamage the forests of Norway
• Air pollutionAir pollution from road use and traffic congestion from road use and traffic congestion
• The social costs of drug and alcohol abuseThe social costs of drug and alcohol abuse
• External costs of scraping the seabed External costs of scraping the seabed for for supplies of gravelsupplies of gravel
Negative Externalities - Examples
• External costs of traveling by taxiExternal costs of traveling by taxi
• The The environment damageenvironment damage caused by the caused by the intensive use of fertilizers in agricultureintensive use of fertilizers in agriculture
• The external costs of The external costs of cleaning up from cleaning up from litterlitter and the and the dropping of chewing gumdropping of chewing gum
• The external costs of the The external costs of the miles that food miles that food travels from producer to the final travels from producer to the final consumerconsumer
Network Externalities
•When more people use When more people use Facebook or Twitter, it Facebook or Twitter, it becomes more valuable to becomes more valuable to you. you.
A network externality exists when the value to an individual of a good or service depends on how many other people use the same good or service.
Figure 75.1 In Pursuit of the Efficient Quantity of PollutionRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers
Figure 75.2 Environmental Standards versus Emissions TaxesRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers
Figure 75.3 Positive Externalities and ConsumptionRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers
Figure 75.4 Negative Externalities and ProductionRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers