CHAPTER 4 Environmental Pollution B Pitafi3 1 POLLUTION A producer of tires Toxic gases released from factory Nearby residential neighborhood Negative effects from toxic gases B Pitafi3 2 POLLUTION Externality Action of one person affects someone else negatively negative externality positively positive externality and no compensation is provided B Pitafi3 3 EXTERNALITIES Negative production externalities Producer affects others negatively Positive production externalities Producer affects others positively Negative consumption externalities Consumer affects others negatively Positive consumption externalities Consumer affects others positively B Pitafi3 4 EXTERNALITIES Negative production externalities Producer affects others negatively Examples Toxic emission from a production facility Traffic congestion near a large factory Noise from a production plant B Pitafi3 5 EXTERNALITIES Positive production externalities Producer affects others positively Examples Research new technology iPhone Farm vegetation as air filter Infrastructure development B Pitafi3 6 EXTERNALITIES Negative consumption externalities Consumer affects others negatively Examples Smoking Noisy parties B Pitafi3 7 EXTERNALITIES Positive consumption externalities Consumer affects others positively Examples Education Flu shots B Pitafi3 8 POLLUTION Negative production externality Producer affects others negatively Imposes costs on others Health costs Property damage Inconvenience B Pitafi3 9 POLLUTION Negative production externality Producer affects others negatively Imposes cost on others Producer does not pay this cost This is External Cost Producer only pays the cost of producing tires This is Private Cost 3 10 B Pitafi POLLUTION Marginal Cost The cost of producing one more unit Borne by the producer Marginal Private Cost MPC Supply Borne by others Marginal External Cost MEC Borne by the society producer others Marginal Social Cost MSC MPC MEC 3 11 B Pitafi POLLUTION Marginal Private Cost MPC The supply curve Price S MPC 5 1 2 3 4 5 6 Quantity 3 12 B Pitafi POLLUTION MSC MPC MEC Price 10 S MPC MEC 5 1 2 3 4 5 6 Quantity 3 13 B Pitafi POLLUTION Marginal Benefit The benefit of consuming one more unit Experienced by the consumer Marginal Private Benefit MPB Demand Experienced by others Marginal External Benefit MEB Experienced by the society consumer others Marginal Social Cost MSB MPB MEB 3 14 B Pitafi POLLUTION Marginal Private Benefit MPB The demand curve Price 5 D MPB MSB 1 2 3 4 5 Quantity 3 15 B Pitafi POLLUTION MSC MPC MEC Price MSC Social Optimum Efficient MSB MSC S MPC 10 MEC Loss MSB Equilibrium 5 D MPB MSB 1 2 3 4 5 Quantity 3 16 B Pitafi POLLUTION At the equilibrium quantity MSC exceeds MSB Loss for society inefficiency To avoid the loss reduce the quantity to where MSC equals MSB This is the efficient socially optimal quantity 3 17 B Pitafi PIGOUVIAN TAX METHOD Impose a tax on the producer equal to MEC Pigouvian tax The producer now must pay MEC as well as MPC The producer s marginal cost is now MPC MEC The producer s supply curve is now MPC MEC The equilibrium moves to the efficient quantity 3 18 B Pitafi PIGOUVIAN TAX METHOD MSC MPC MEC S MPC MEC Price Social Optimum Efficient MSB MSC Tax MEC 10 MEC S MPC Equilibrium 5 D MPB MSB 1 2 3 4 5 Quantity 3 19 B Pitafi PROPERT Y RIGHTS METHOD Toxic gases released from factory Nearby residential building affected The building owner sues the factory owner If the property rights are clearly established A court will order the factory owner to pay for the cost experienced by the building owner MEC 3 20 B Pitafi PROPERT Y RIGHTS METHOD The producer now must pay MEC as well as MPC The producer s marginal cost is now MPC MEC The producer s supply curve is now MPC MEC The equilibrium moves to the efficient quantity 3 21 B Pitafi PROPERT Y RIGHTS METHOD MSC MPC MEC S MPC MEC Price Social Optimum Efficient Producer pays MEC MSB MSC 10 MEC S MPC Equilibrium 5 D MPB MSB 1 2 3 4 5 Quantity 3 22 B Pitafi PROPERT Y RIGHTS METHOD If property rights are established enforced Efficient quantity will be achieved A Pigouvian tax is not necessary Coase theorem If the cost of enforcement is more than the external cost then the victims will not enforce The producer will not be ordered to pay MEC Efficient quantity will not be achieved 3 23 B Pitafi CAP AND TRADE METHOD MSC MPC MEC Price Social Optimum Efficient MSB MSC S MPC 10 MEC 5 Equilibrium D MPB MSB 1 2 Cap 3 4 5 Quantity 3 24 B Pitafi CAP AND TRADE METHOD Government sell permits equal to the efficient quantity the cap Producers must buy a permit equal to the quantity they want to produce Producers can sell the permits to others if they like A market develops Cap trade system Permit market Emission trading Pollution trading 3 25 B Pitafi