Externalities Chapter 10
Externalities Chapter 10
Market Efficiency-Market Failure Recall that: Adam snmith's invisible hand of the marketplace leads self-interested buyers and sellers in a market to maximize the total benefit that society can derive from a market But market failures can still happen o Market failure results from market power and externality
Market Efficiency-Market Failure • Recall that: Adam Smith’s “invisible hand” of the marketplace leads self-interested buyers and sellers in a market to maximize the total benefit that society can derive from a market. • But market failures can still happen. • Market failure results from market power and externality
Market failures: Externalities When a market outcome affects parties other than the buyers and sellers in the market Side-effects are created called externalities o Externalities cause markets to be inefficient and thus fail to maximize total surplus o when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect, an externality arises
Market Failures: Externalities • When a market outcome affects parties other than the buyers and sellers in the market, side-effects are created called externalities. • Externalities cause markets to be inefficient, and thus fail to maximize total surplus. • when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect, an externality arises
Market failures: Externalities o When the impact on the bystander is adverse, the externality is called a negative externality. When the impact on the bystander is beneficial, the externality is called a positive externalit ity
• When the impact on the bystander is adverse, the externality is called a negative externality. • When the impact on the bystander is beneficial, the externality is called a positive externality. Market Failures: Externalities
Examples of Negative externalities ● utomobile exhaust ° Cigarette smoking Barking dogs (loud pets o Loud stereos in an apartment building
Examples of Negative Externalities • Automobile exhaust • Cigarette smoking • Barking dogs (loud pets) • Loud stereos in an apartment building
Examples of Positive externalities ● Immunizations o Restored historic buildings o Research into new technologies
• Immunizations • Restored historic buildings • Research into new technologies Examples of Positive Externalities
The market for aluminum ●●● Price of Aluminum Supply (private cost) Equilibrium Demand (private value) 0 Q MARKET Quantity of Aluminum
The Market for Aluminum... Quantity of Aluminum 0 Price of Aluminum QMARKET Demand (private value) Supply (private cost) Equilibrium
The market for aluminum and welfare economics The quantity produced and consumed in the market equilibrium is efficient in the sense that it maximizes the sum of producer and consumer surplus If the aluminum factories emit pollution (a negative externality), then the cost to society of producing aluminum is larger than the cost to aluminum producers For each unit of aluminum produced, the social cost includes the private costs of the producers plus the cost to those bystanders adversely affected by the pollution
The Market for Aluminum and Welfare Economics • The quantity produced and consumed in the market equilibrium is efficient in the sense that it maximizes the sum of producer and consumer surplus. • If the aluminum factories emit pollution (a negative externality), then the cost to society of producing aluminum is larger than the cost to aluminum producers. • For each unit of aluminum produced, the social cost includes the private costs of the producers plus the cost to those bystanders adversely affected by the pollution
Pollution and the social Optimum Price of Cost of Social cost Aluminum pollution Supply (private cost) Optimum Equilibrium Demand private value) 0 Quantity of optimum MARKe Aluminum T
QMARKE T Pollution and the Social Optimum... Quantity of Aluminum 0 Price of Aluminum Demand (private value) Supply (private cost) Social cost Qoptimum Cost of pollution Equilibrium Optimum
Negative Externalities in production The intersection of the demand curve the social-cost curve determines the e and optimal output level The socially optimal output level is less than the market equilibrium quantity
Negative Externalities in Production • The intersection of the demand curve and the social-cost curve determines the optimal output level. • The socially optimal output level is less than the market equilibrium quantity
