Econ 100AChapter 18Externalities, Commons, and Public Goods*1.Externalities2.The Inefficiency of Competition with Externalities3.Market Structure and Externalities4.Allocating Property Rights to Reduce Externalities5.Common Property6.Public GoodsExternalitiesAnexternalityoccurs if• someone’s consumption or production activities hurt or help others outside a market• the well-being of a consumer or the production capability of a firm are affected directlyby the actions of other consumers or firms, rather than indirectly through changes inpricesA firm whose production process lets off fumes that harm its neighbors is creating anexternality for which there is no marketThe firm is not causing an externality when it harms a rival by selling extra output that lowersthe market priceExternalities may either help or harm others:• An externality that harms someone is anegative externality•Apositive externalitybenefits others• An action may confer positive externalities on some people and negative externalitieson others: wind chimes.An atmospheric scientist reports that cleaning up the air in Los Angeles over the last decade,while helping people breathe, caused radiation levels to increase 1½ times more rapidly thanthey would have risen if the air had remained dirty.Application: Michael Jordan’s Positive ExternalitiesMichael Jordan raised sales throughout the NBAJordan’s presence• increased ticket revenues at away games throughout the league by $2.5 million duringthe 1991-1992 regular season• local television advertising revenues rose by $2.4 million at these gamesThese increased ticket and local television advertising receipts reflect a positive externality:they went to the home team rather than to the Bulls.Jordan’s presence increased national television advertising by• $6.6 million during the regular season• by $13.9 million during the playoffs.Jordan also boosted the earnings of NBA Properties, which licenses NBA paraphernalia suchas clothing and videos, by $15.1 million.*Based on Jeffrey M. Perloff,Microeconomics(© Addison Wesley Longman, 1999). Thesenotes are © Jeffrey M. Perloff.National TV revenues and NBA Properties’ earnings are shared equally by all teams, so mostof this increase was a positive externality for other teams.In total, the value of Jordan’s positive externalities was $40.3 million.Inefficiency of Competition with ExternalitiesCompetitive firms and consumers do not have to pay for the harms of their negativeexternalities, so they create excessive amountsAssume:• competitive paper market• firms produce paper andgunk(by-products): air and water pollution that harm peoplewho live near paper mills• Each ton of paper produced increases the amount of gunk by 1 unit• only way to decrease the volume of gunk is to reduce the amount of papermanufactured• Paper firms do not have to pay for the harm from the pollution they causeprivate cost: the cost to the firm of production only, not including externalities:• direct costs of labor, energy, and wood pulp• but not the indirect costs of the harm from gunksocial cost: the private cost plus the cost of the harms from externalitiesSupply-and-Demand AnalysisFigure 18.1 illustrates thata competitive market produces excessive pollution because thefirms’ private costs are less than the social costCompetitive equilibrium:• firms consider only their private costs• market supply curve is the aggregateprivate marginal costcurve,MCp• competitive equilibrium,ec, is determined by the intersection of the market supplycurve and the market demand curve for paper• Because of pollution, competitive equilibrium doesnotmaximize welfare, and hence isnotPareto efficientmarket failureresults from competitive forces that equalize the price andprivate marginal costrather thansocial marginal costSocial optimum:wheresocial marginal cost(MCs) curve hits the demand curveWelfare:• sum of CS andsocial producer surplus(based on thesocial marginal costcurve)•Welfare is maximized where price equals social marginal costReducing ExternalitiesBecause competitive markets produce too many negative externalities, governmentintervention may benefit societyIn developed countries expenditures on environmental protection as a percentage of GDPrange between a fifth of a percent to one percent:• 0.2% in Italy• 0.4% in Portugal and the United Kingdom• 0.5% in France• 0.6% in the United States and Spain• 0.7% in Sweden• 0.8% in Germany and Switzerland• 1.0% in Austria, Denmark, and JapanThe world’s poorest countries spend little if anything on pollution controlConsequently, emissions relative to economic output are higher in developing countries thanin Western nations:• China emitted 2,095 metric tons of carbon per million dollars of GDP• Soviet Union, 1,517• India, 602• Mexico, 586In contrast, in developing countries:• United States, 279• Great Britain, 216• Japan, 101Governmentdirectcontrols:• restricting the amount of pollution that firms may produce:emissions standard• taxing for pollution created:emissions feeoreffluent chargeGovernmentindirectcontrols:• quantity restrictions• taxes on outputs or inputsEmissions StandardPaper mill-gunk example, Figure 18.1, illustrates how an all-knowing government uses anemissions standardto reduce pollution• Government achieves social optimum by restricting paper mills to produce no morethan 84 units of gunk or paper per day• Because output and pollution move together, regulating either works.Unfortunately, the government usually does not know enough to regulate optimallyGovernment needs to know:• marginal social cost curvedemand for paper curve• how pollution varies with outputEven if the government knows enough to set the optimal regulation, it must enforce thisregulation to achieve the social optimumThough the U.S. Environmental Protection Agency (EPA) sets federal smog standards, 33metropolitan areas — including Baltimore, Boston, Chicago, Houston, Los Angeles,Milwaukee, New York, and Philadelphia — fail to meet these standardsSee: http://www.epa.gov/oar/oaqps/greenbk/onc.htmlEmissions FeeGovernment imposes costs on polluters by taxing their output or the amount of pollutionproduced• Figure 18.2: knowledgeable government sets the output taxt(Q)=MCg• Figure 18.2 illustrates the manufacturers’ after-tax marginal cost,MCs=MCp+t(Q)• Output tax causes a manufacturer tointernalize the externality: to bear the cost of
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