ECON 1116 14 NovemberWelfare Theorem- The societal value of the marginal unit is equal to the marginal price- The societal cost of the marginal unit is equal to the marginal price- MCsoc = MVsoc when in market is in equilibriumExternalities- An external cost (or negative externality or spillover cost) is a cost that accrues to a party outside the market transaction- An external benefit (or positive externality or spillover benefit) is a benefit that accrues to a party outside the market transaction- Implications:o The parties transacting do not consider externalities when making their decisionso Market prices will not reflect the full social costs or benefits at the margino Inefficient allocation of resources Too much provision of a good that provides an external cost Too little provision of a good that provides an external benefit- There is a missing “externalities market”o This market would feasibly “internalize the externality”- Two means by which to account for externalities:1. Private solutionsa. Agents voluntarily participateb. Akin to providing missing market2. Imposed solutions a. Government interventionb. Impose taxes and subsidies- Example: every citizen has the right not to consume pollutiono If production generates pollution, then to sell a unit the producer must Bear the production cost Buy the right not to consume pollution from the public The market price of the right not to consume pollution will be the marginal value of that right: i.e. the marginal pollution costo Thus, the producer now faces the full social cost of producing (including pollution)- Example: producers have the right to generate pollutiono If production generates pollution, then the producer Bears the production cost Forgoes the opportunity to sell the pollution right to the general public (an opportunity cost)- Private solutionso The efficient outcome will be obtained if Property rights are defined and enforced over the right to benefit from or impose the costs of an externalityECON 1116 14 November Agents are free to trade efficiently in these rights (i.e., no transaction costs)o The initial allocation of the property rights is not important for obtaining the efficient outcome The allocation only affects the final distribution of wealth- If citizens hold the right not to consume pollution, they will have feasibly sold this right to producers, and thus they gain the permit-selling wealth- If producers hold the right to pollute, they will have feasibly sold this right to the public, and thus they gain the permit-selling wealth Coase Theorem- Private arrangements will be negotiated to ensure that externalities are internalizedo Efficiency will be secured through private bargaining over rights to impose externalitieso If there is a social surplus available, private parties will find a way to attain ito Property rights Cost of identifying and enforcing property rights is often a large impediment to private agreementso Transactions and bargaining Costs will also provide barrier to efficiency People don’t have good valuation of pollution (they don’t reallyknow how to gauge how much its presence or absence means to them) There is little incentive for the individual to act, and must act as a group—which can often be quite difficulto Successful private solutions? Cap and trade agreements- Companies are given the right to produce a certain amount of pollution, and may sell the right to produce a unit of pollution to other companies- Technically, there is government involvement in these solutions, but only insofar as they define the market- Alternatives to private solutionso Regulation by command Legislate technology to be used Legislate caps on output of products Unfortunately, there is no way to ensure that the “cheap” method of abatement is usedo Regulation by taxation Impose a tax equal to the marginal external damage from pollution at the efficient quantity of the good’s productionECON 1116 14 November- Pigouvian tax—need to know about private costs and benefits; cannot measure pollution directly, can only manipulate the output of a good - Production and tax costs- Redetermine optimal output given new
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