ECO2030 1nd Edition Lecture 24 Outline of Last Lecture I Externalities Outline of Current Lecture II III IV V VI Review of Externalities Technological spillovers Command and control Cap and Trade Benefits of Corrective taxes and Cap and Trade Current Lecture Quiz next wednesday or friday probably Friday Practice questions on ASULearn Review Social Cost total costs to society Private external costs The social Cost curve is always above the supply curve in the case of a negative externality Can think of it as a leftward shift in the supply curve higher input costs The Optimum quantity maximizes total welfare by eliminating the external cost This is called Internalizing the externality It is how Government can address market failures due to externalities by changing incentives policies taxes etc so that people firms account for the externality P Optim um External Cost Social Cost Private Supply External Cost Private Cost Equilibriu m Q Optimum Q Market Demand Private Value Q These 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 Positive externalities external benefit e g education represented by the social value curve Social Value curve Private value External Benefit Therefore Social value is higher than Private value P Social Value curve is above the demand curve to the right For positive externalities the optimum quantity is greater than the market equilibrium Government can correct the market failure by internalizing the externality Equilibri e g Subsidize it chap loans um scholarships public education other incentives External Benefit Opti mum Supply Private Cost Social Value Private Value External Demand Benefit Private Q Negative externalities markets Q Market Value Q produce more than social optimum Optimum quantity Government can tax Positive externalities market quantity is less than socially desired Government can subsidize Technology spillovers industrial policy and patent protection Technology spillover a positive externality The impact of one firms research and production efforts on other firms access to technological advance Government can internalize the externality by subsidizing by the amount of the technological spillover Industrial policy Governments try to intervene in the economy by trying to promote technology by helping companies Problem it is hard to predict which industry should be supported Patent law Protect the rights of inventors by giving them exclusive use of their inventions for a period of time Incentive to invent because of profit If there is a technology spillover there will be no incentive to invent Public policies towards externalities Command and Control policies Regulate behavior of firms directly Direct Regulation of amount of pollution Market based policies Aim to provide incentives for firms to make decisions to deal with problems on their own Corrective taxes and subsidies Pigovian taxes and subsidy Tax per unit emissions Tradable pollution permits Cap and Trade A market based solution to limit pollution gives firms the right to pollute depending on the amount of permits they have A set amount of permits sets the pollution amount Companies that can reduce emissions cheaply will do so and sell their permits to those who cannot Leads to economic efficiency Regulation Regulate behavior of firms directly Cannot completely eliminate pollution Need programs to enforce regulations EPA They tell firms what the maximum pollution is and require firms to adopt certain technologies to reduce emissions Corrective taxes Persuade private decision makers to internalize the external costs of negative externalities Puts a price on the ability to pollute This reduces pollution more efficiently lower cost to society Also raises revenue for the government that can be invested back into the people Gas tax corrective tax 3 negatives externalities of driving congestion pollution accidents a Corrective gas tax results in less traffic safer roads and less pollution The gas tax may actually have to be about 2 10 per gallon to cover the externalities Tradable Pollution permits Allows firms to trade pollution allowances permits become a new scarce resource There is a new market for permits The firms WTP depends on their cost of reducing pollution The advantage Results in an efficient allocation of emissions lowest cost to society Firms have options to buy or sell permits creates additional revenue Reducing pollution with pollution permits or corrective taxes Both force firms to internalize the externality pay for their pollution Corrective taxes provide revenue for the government Pollution permits create a market for permits