ECON 202 1nd Edition Lecture 18 Outline of Last Lecture I. Efficiency of Marketsa. Tax Incidence and Efficiencyb. Elasticity and Deadweight LossII. Market Inefficienciesa. Externalitiesi. Negative ExternalityOutline of Current Lecture III. Market Inefficienciesa. Externalitiesi. Negative Externalityii. Positive Externalityiii. Pigorian Taxes and SubsidiesCurrent LectureEfficiency of MarketsMarket InefficienciesMarket Failure – situation in which a market, left on its own, FAILS to allocate resources efficiently.1. Externalities – The Third Party Problem2. Public Goods – The Free Rider ProblemExternalities – costs and benefits resulting from market activity that affect people other than buyers and sellers (third parties)Example: Negative Externality – market activity results in a cost for a third party; results in OVERPRODUCTION of the good being producedPollution Market Example: Suppose for each unit of a good produced it generates $5 of waterpollutionThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute. DS1S2PP*Q*QEfficientDWLThe demand curve in this example is the social benefitS1 is the marginal internal cost of a customer buying a unit of the good.S2 is the marginal social cost of a customer buying a unit of the good. The marginal social cost is the marginal internal cost + the marginal cost for third parties.This means that Q* is being produced instead of Qefficient, so there is an OVERPRODUCTION of thegood.Example: Positive Externality – market activity results in an external benefit for a third party; results in UNDERPRODUCTION of a goodFlu Shot Market:The Supply curve in this example is the social cost.DInternal – the marginal internal benefit of a customerbuying a unit of the good.DSocial – the marginal social benefit of a customerbuying a unit of the good. The marginal social benefitis the marginal internal benefit + the marginal benefitfor third partiesThis means that Q* is being produced instead of Qefficient, so there is an UNDERPRODUCTION of the good.Pigorian Taxes and Subsidies – in the presence of Externalities well-designed taxes or subsidies can reduce inefficiency by internalizing external costs or benefitsExample: an excise tax designed to correct for negativeexternalitySet a Pigorian Tax = Marginal External Cost This will give you an efficient outcomeExample: a per-unit subsidy designed to correct forpositive externalitiesDSocialS1DInternalPQ*QEfficientDWLDS1S + taxPTax=MECQMarketQEfficientDSD+
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