Negative and Positive Externalities in Production and ConsumptionNegative Production Externalities: Environmental PollutionOf course, there are millions of other possible examples of polluting production processes. Los Angeles, obviously, is a great place to worry about this. Air quality is constantly in the news and water quality issues are gaining in priority. Noise polPositive Production Externalities: Technology SpilloversNegative Consumption Externalities:Positive Consumption Externalities:Private Solutions to ExternalitiesThe Coase TheoremWhy Private Solutions Sometimes Don’t WorkPublic Policies for ExternalitiesRegulationPigovian Taxes and SubsidiesTradeable PermitsEconomists versus Environmental Advocates1UNIVERSITY OF CALIFORNIA, LOS ANGELES Department of Economics Economics 1 Cameron Lecture 8 In last day’s lecture, we explored a digression on the gains from international trade, based on improvements in a country’s overall social surplus (consumer surplus plus producer surplus). We studied how the opening-up of trade will result in imports of goods for which a country has a comparative disadvantage (which will lower the price of these goods to consumers and producers). Trade will result in exports of goods for which a country has a comparative advantage ( yielding higher prices of these goods for consumers and producers). While trade increases total surplus, there will by some winners and some losers. However, the gains to the winners will exceed the losses to the losers, making the country as a whole better off, if you ignore the distributional consequences. Policies to restrict imports (we considered import tariffs and import quotas) both have the effect of protecting domestic producers from lower world prices. These policies restore some of the producer surplus lost due to trade, at the expense of some of the consumer surplus gained from trade. Tariffs convert some of this lost consumer surplus into government revenue, but quotas pass it along to foreign suppliers in the form of higher prices. Either strategy results in some “deadweight loss” in the form of consumer surplus that is neither transferred to producers nor collected by the domestic government as tariff revenue. More domestic surplus is lost with quotas than with tariffs. IN THE NEWS: The US is right now considering whether to institute tariffs or quotas on imported steel, citing harm to the US steel industry. Administrative: Midterm will be Thursday, October 25, and will cover material up to and including this lecture (October 18). Format will be the usual: 20 multiple choice questions worth 2 points each and 7 short answer questions, usually requiring a diagram, worth 5 points each, for a total of 75 points (for a 75 minute exam). Reminder: Quiz section grades will be scaled to have equal means across TAs. This protects you from any disadvantage from having a TA who gives more difficult quizzes or grades more stringently. -------------- Today’s reading: Mankiw Chapter 10: Externalities Negative and Positive Externalities in Production and Consumption An “externality” is essentially the same thing as a “spillover effect.” It is when the process of producing or consuming some commodity has an effect on somebody other than just the immediate parties to the transaction (i.e. on “innocent bystanders.” I think the military calls it “collateral damage.”) We’ll introduce you to the concept of different kinds of externalities by using a set of illustrative examples. Negative Production Externalities: Environmental Pollution This is the type of externality that gets the most press. For Example: Energy Use. Very few production processes are entirely pollution-free. If any sort of fossil fuel is used in the processing or shipping of the good, carbon is released into the atmosphere, and scientists are pretty convinced that human-generated carbon buildup in the atmosphere is starting to have tangible effects on the world’s climate. This is a pretty far-reaching externality. Even if you produce things entirely with electricity, externalities are not avoided. Perhaps that electricity comes from a fossil-fuel-burning generating plant. If it comes from a hydroelectric dam, the impoundment of water behind the dam changes the ecosystem that used to exist in the river above and below the dam. Glen Canyon Dam, which created Lake Powell, supplies a lot of power to the Western Area Power Authority, for example. Yet in recent years, it has become increasingly apparent that managing the flow regime at this dam for maximum power production - seems to have adverse effects on endangered species such as the Humpback Chub and Flannelmouth Sucker - alters the size and configuration of sand bars, affecting the enjoyment of whitewater rafters and recreational fishers. - threatens cultural sites (rock paintings, shrines, and burial grounds) of local aboriginal peoples2If the operators of the Glen Canyon dam need only consider the costs and benefits of their management decisions that pertain to producers and consumers of electricity, then these other consequences are “externalities.” Note that the RELEVANT supply curve is the one that includes the external costs created by production of electricity, not just the costs of operating the dam and maintaining transmission lines. If dam operators take account only of their private costs and the WTP conveyed by electricity consumers, then Q1 will be produced at price P1. At this quantity and price, you should now be able to identify the consumer surplus to electricity consumers and the producer surplus to electricity producers. But what is overlooked by these to parties is the (c x Q1) area of external costs imposed on other parties. If electricity producers could be induced to take account of external costs, the market equilibrium would be at Q2. Total surplus to electricity producers and consumers would be smaller, since price would be P2 and fewer units of electricity would be bought and sold, however, there would be no external costs on other members of society. Why are firms (and consumers!) often inclined to resist being forced to internalize externalities in their markets? THEIR surpluses will be reduced, and someone else (who was previously bearing the externality) will gain. Of course, there are millions of other possible examples of polluting production processes. Los Angeles,