POptimumEquilibriumSupply (Private Cost)Demand (Private Value)QExternal CostQ Optimum Q MarketSocial Cost (Private + External Cost) ECO2030 1nd Edition Lecture 24Outline of Last Lecture I. ExternalitiesOutline of Current Lecture II. Review of ExternalitiesIII. Technological spilloversIV. Command and controlV. Cap and TradeVI. Benefits of Corrective taxes and Cap and TradeCurrent LectureQuiz 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 negativeexternality)○ Can think of it as a leftward shift in the supply curve (higher input costs)● The Optimum quantity, maximizes totalwelfare (by eliminating the externalcost)● This is called Internalizing theexternality● It is how Government can addressmarket failures due to externalities bychanging incentives (policies, taxes etc)so that people/firms account for theexternalityThese 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.POptimumEquilibriumSupply (Private Cost)Demand (Private Value)QExternal BenefitQ Market Q OptimumSocial Value (Private Value + External Benefit)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 thanPrivate value● Social Value curve is above thedemand curve (to the right)● For positive externalities - the optimumquantity is greater than the marketequilibrium● Government can correct the marketfailure by internalizing the externality○ e.g. Subsidize it (chap loans,scholarships, public education,other incentives)● Negative externalities - marketsproduce more than social optimumquantity○ Government can tax● Positive externalities - market quantity is less than socially desired○ Government can subsidizeTechnology 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 peopleGas 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