ECON 201 1st Edition Lecture 16Outline of Last Lecture I. Public Goods and Common ResourcesII. Important Characteristics of Goodsa. Definition of excludabilityb. Definition of rivalry in consumptionIII. The Different Kinds of GoodsIV. Public Goodsa. Definition of free riderb. Definition of cost-benefit analysisV. Analyzing a Real-World Economic SituationVI. Common ResourcesVII. The Tragedy of the Commons: A Parablea. Definition of the Tragedy of the CommonsVIII. Policy Options to Prevent Overconsumption of Common ResourcesOutline of Current Lecture I. Efficient Marketsa. Definition of market failureb. Definition of market powerII. Externalitiesa. Definition of externalityIII. Negative Externalitiesa. Definition of negative externalityIV. Internalizing the ExternalityV. Positive Externalitiesa. Definition of positive externalityb. Definition of social valuec. Definition of private valued. Definition of external benefitVI. Summary of Effects of ExternalitiesCurrent LectureI. Efficient MarketsThese 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.As a brief recap, efficient markets are competitive markets that maximize total surplus and allocate the work in a community. There are two assumptions about an efficient market: buyers and sellers must have all of the information and there is no market failure. Market failure is when the market fails to allocate the society’s resources efficiently. This can be caused by a market power or an externality. A market power is when a single buyer or seller has substantial influence on market price while an externality is the effect of a third party. II. ExternalitiesExternalities are the uncompensated impacts of a market exchange on the well-being of a bystander; this is also known as the “spillover” or “third party” effects. Externalities can be negative or positive, depending on the impact of the bystander. These come about when self-interested buyers and sellers neglect the external costs or benefits of their actions, resulting in amarket outcome that is not efficient. This leads to consumption externalities and production externalities, respectively, and these also can be either positive or negative. III. Negative ExternalitiesNegative externalities are externalities that result in a negative impact on the bystander. Examples of negative externalities include smog from factories, second-hand cigarette smoke, noise pollution, and texting while driving. In all of these examples, a bystander can be negativelyaffected due to an uncompensated impact of an exchange. To understand how negative externalities affect a market, look at the graphs below. In the graph on the left, the supply curve shows theprivate opportunity costs and the demand curve shows the private value. In this example, the market equilibrium (25 gallons) maximizes the consumer surplus and the producer surplus. In the graph on the right, the negative externality adds an external cost and shifts the supply curve. Now, the price has increased because this curve factors in both the private and the external cost; this is known as the social cost. The graph below shows the new socially optimal equilibrium.Due to the negative externality, the price has increased and the socially optimal quantity is now 20 gallons. The market equilibrium (previously 25 gallons) is greater than the socially optimal equilibrium. To rectify this solution, the government could impose a tax on sellers of $1 per gallon. IV. Internalizing the ExternalityTo internalize an externality means to alter incentives so that people can consider the external effects of their actions. This can be done by implementing market based solutions or by using a command-and-control approach. When market participants must pay social costs, then the market equilibrium equals the socially optimal equilibrium. V. Positive ExternalitiesPositive externalities are externalities that result in a positive impact on the bystander. Examples of positive externalities include vaccines, research and development, and education. Every positive externality has a social value; the social value combines the two benefits of an externality: the private value and external benefit. The private value is the benefit gained by sellers, also known as willingness to pay; the external benefit is the value of the positive impact on bystanders. In the graph below, the external benefit shifts the demand curve and results in a change in equilibrium. The market equilibrium (previously 20 gallons) is less than the socially optimal equilibrium (25 gallons). To internalize this externality, the government could impose a subsidy of $10 per flu shot. VI. Summary of Effects of ExternalitiesIf it is a negative externality, then the market quantity will be larger than socially desirable. To internalize this externality, the government can impose a tax on goods. If it is a positive externality, then the market quantity will be smaller than socially desirable. To internalize this externality, the government can subsidize the