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What is an externality? How can externalities exist that require no market correction?
SLIDES 1,2,11,13
An externality is the effect of one party’s economic activities on another party that is not taken into account by the price system. It reflects missing markets!
nExternalities can occur between any two economic actors.
nExternalities can be beneficial or harmful.
nOne of the most famous beneficial externalities between firms- involves one firm producing honey and the other producing apples (James Meade, 1952).
nBees- feed on apple blossoms, which increases the production of honey, and
nBees- pollinate apple crops, which increases the production of apples.
nAn externality is the effect of one party’s economic activities on another party that is not taken into account by the price system. It reflects missing markets!
nExternalities can occur between any two economic actors.
nExternalities can be beneficial or harmful.
nOne of the most famous beneficial externalities between firms- involves one firm producing honey and the other producing apples (James Meade, 1952).
nBees- feed on apple blossoms, which increases the production of honey, and
nBees- pollinate apple crops, which increases the production of apples.
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What is the relationship between externalities and public goods? That is, when do externalities also become public goods? How do the various aspects of public goods associated with asymmetric information affect private resolution of externalities through the Coase theorem?
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List and discuss three problems that might arise when using the Coase theorem.
- Externalities may persist because of unresolved disputes
- about who has legal rights. Property rights must be defined ex ante.
- There may be a dispute about the value of damage, or about
- whether damage was at all incurred.
- There is a problem of asymmetric information because on the
- complainants know the value of the loss.
- The idea of transactions costs refers to a broad category of costs that arises in the
- course of attempting to establish market conditions of exchange between “buyers” and “sellers”.
- Do non-smokers in general attempt to pay smokers not to
- smoke? Or do smokers pay to be allowed to smoke?
- à The transactions cost of creating the markets predicted by
- the Coase
- theorem appear to be too high.
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How can licenses be used to resolve the tragedy of the commons?
- Private ownership can rescue a society from the tragedy of
- commons. A private owner has an interest in maximizing the value of using the
- aquarium.
- nPrisoner’s dilemma: Anticipating the aquarium is crowded, no
- visitor might move to the aquarium.
- nIf the aquarium is privately owned, the owner would maximize
- profits by selling a visit that we can call “noncrowded visit”.
- nThe private owner will recognize that visitors’ willingness
- to pay to visit the aquarium depends on the # of other visitors at the aquarium
- at the time.
- nHe would internalize the crowding externalities by charging
- an admission fee for visiting the aquarium.
- à e.g. a $4 admission fee would maximize the
- profits, which makes the crowd size be 5 visitors (where $6-$4=$2).
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Are the following statements true or false? Explain why.a. If your consumption of cigarettes produces negative externalities for your partner(which you ignore), then you are consuming more cigarettes than is Pareto-efficient.b. It is generally efficient to set an emission standard allowing zero pollution.c. A tax on cigarettes induces the market for cigarettes to perform more efficiently.d. A ban on smoking is necessarily efficient.
1-15
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Suppose the government issues tradable pollution permits. Is it better for economic efficiency to distribute the permits between polluters or to auction them?
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Use examples to answer whether the externalities related to common resources are generally positive or negative. Is the free-market use of common resources greater or lessthan the socially optimal use?
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Does your personal list of externalities include cases for which the large size of the affected group prevents voluntary resolution of the externalities?
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Education is often viewed as a good with positive externalities. (a) Explain howeducation might produce positive external effects; (b) Suggest a possible action of thegovernment to induce the market for education to perform more efficiently.
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What are the similarities and dissimilarities between the Coase private-resolution forexternalities and the Pigovian tax-subsidy solution through government? Do limitationson the Coase solution apply to Pigovian taxes and subsidies?
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Summarize the public-policy means available to governments to resolve externalityproblems and the influences affecting the choice by government from the alternatives.
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The political principal-agent problem suggests that political decision makers sensitive topolitical support may not use public policy to perfectly internalize externalities. Discussthis statement.
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A chemical producer dumps toxic waste into a river. The waste reduces the population offish, reducing profits for the local fishery industry by $150,000 per year. The firm couldeliminate the waste at a cost of $100,000 per year. The local fishing industry consists ofmany small firms.(a) Apply the Coase Theorem to explain how costless bargaining will lead to a sociallyefficient outcome, no matter to whom property rights are assigned (either to the chemicalfirm or the fishing industry).(b) Verify the Coase Theorem if the cost of eliminating the waste is doubledto $200,000(with the benefit for the fishing industry unchanged at $150,000).(c) Discuss the following argument: “A community, held together by ties of obligationand mutual-interest can manage the local pollution problems.”
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