Externalities
Chapter 10
Market Efficiency-Market Failure
Recall that,Adam Smith’s,invisible hand”
of the marketplace leads self-interested
buyers and sellers in a market to
maximize the total benefit that society can
derive from a market,
But market failures can still happen.
Market failure results from market power
and externality
Market Failures,Externalities
When a market outcome affects parties other
than the buyers and sellers in the market,
side-effects are created called externalities.
Externalities cause markets to be inefficient,
and thus fail to maximize total surplus.
when a person engages in an activity that
influences the well-being of a bystander and
yet neither pays nor receives any
compensation for that effect,an externality
arises.
When the impact on the bystander is
adverse,the externality is called a
negative externality.
When the impact on the bystander is
beneficial,the externality is called a
positive externality.
Market Failures,Externalities
Examples of
Negative Externalities
Automobile exhaust
Cigarette smoking
Barking dogs (loud pets)
Loud stereos in an apartment building
Immunizations
Restored historic buildings
Research into new technologies
Examples of
Positive Externalities
The Market for Aluminum...
Quantity of
Aluminum
0
Price of
Aluminum
QMARKET
Demand
(private value)
Supply
(private cost)
Equilibrium
The Market for Aluminum
and Welfare Economics
The quantity produced and consumed in the
market equilibrium is efficient in the sense that
it maximizes the sum of producer and
consumer surplus.
If the aluminum factories emit pollution (a
negative externality),then the cost to society of
producing aluminum is larger than the cost to
aluminum producers.
For each unit of aluminum produced,the
social cost includes the private costs of the
producers plus the cost to those bystanders
adversely affected by the pollution.
QMARKE
T
Pollution and the Social
Optimum...
Quantity of
Aluminum
0
Price of
Aluminum
Demand
(private value)
Supply
(private cost)
Social cost
Qoptimum
Cost of
pollution
Equilibrium
Optimum
Negative Externalities
in Production
The intersection of the demand curve and
the social-cost curve determines the
optimal output level.
The socially optimal output level is less
than the market equilibrium quantity.
Achieving the Socially
Optimal Output
Internalizing an externality involves
altering incentives so that people take into
account the external effects of their actions,
The government can internalize an
externality by imposing a tax on the
producer to reduce the equilibrium
quantity to the socially desirable quantity,
Positive Externalities in Production
When an externality benefits the bystanders,
a positive externality exists.
The social costs of production are less than
the private cost to producers and consumers.
A technology spillover is a type of positive
externality that exists when a firm’s
innovation or design not only benefits the
firm,but enters society’s pool of
technological knowledge and benefits society
as a whole.
Quantity
of Robots
0
Price
of Robot
QOPTIMUM
Demand
(private value)
Supply (private cost)
Social cost
QMARKET
Value of
technology
spillover
Equilibrium
Optimum
Positive Externalities in Production
The intersection of the demand curve and
the social-cost curve determines the
optimal output level.
The optimal output level is more than the
equilibrium quantity.
The market produces a smaller quantity
than is socially desirable,
The social costs of production are less than
the private cost to producers and
consumers.
Positive Externalities in Production
Internalizing Externalities,
Subsidies
Government many times uses subsidies as
the primary method for attempting to
internalize positive externalities.
Technology Policy
Government intervention in the economy that
aims to promote technology-enhancing
industries is called technology policy.
Patent laws are a form of technology policy that
give the individual (or firm) with patent
protection a property right over its invention,
The patent is then said to internalize the
externality.
Internalizing
Production Externalities
Taxes are the primary tools used to
internalize negative externalities.
Subsidies are the primary tools used to
internalize positive externalities.
Quantity of
Education
0
Price of
Education
Q
MARKE
T
Demand(private value)
Social
value
Q
OPTIMUM
(b) Positive Consumption Externality
Supply
(private cost)
Quantity
of Alcohol
0
Price
of Alcohol
Q
MARKET
Demand
(private value)
Supply
(private cost)
Social value
Q
OPTIMUM
(a) Negative Consumption Externality
Consumption Externalities
Consumption Externalities
and Market Inefficiency
Negative externalities in production or
consumption lead markets to produce a
larger quantity than is socially desirable.
Positive externalities in production or
consumption lead markets to produce a
larger quantity than is socially desirable.
Private Solutions to Externalities
Government action is not always needed
to solve the problem of externalities.
Types of private solutions
– Moral codes and social sanctions
– Charitable organizations
– Integrating different types of businesses
– Contracting between parties
The Coase Theorem
The Coase Theorem states that if private
parties can bargain without cost over the
allocation of resources,then the private
market will always solve the problem of
externalities on its own and allocate
resources efficiently.
The Coase Theorem
The Coase Theorem says that private
economic actors can solve the problem of
externalities among themselves,Whatever
the initial distribution of rights,the
interested parties can always reach a
bargain in which everyone is better off
and the outcome is efficient.
CoaseTheorem,More Example
A and B are roommate,A like rock music and B prefer quiet,Suppose A’s willingness
to pay for music is $50 while B’s willingness to pay for quiet is $40.
Think about the institutional arrangement as follows:
– I,A has the right to play music
– II,B has the right to require quiet
What will happen if A’s value for music is $40 while B’s value for quiet is $50?
Some Important Concept,
– Property rights
– Coasian Bargaining
– Transaction Cost
Coase Theorem is the guideline for us to figure out the right reason for market
inefficiencies.
– Wrong reasons,Externality itself,unjustable property rights,wrong distribution of property
rights
– Right reasons,ambiguous initial property rights,bargaining failure (transaction cost too
high),restrictions on transfer of property rights.
Another example,宿舍熄灯安排
Equity
Efficiency,transaction cost,credibility of admittance(difficult to enforce a contract),
multiperson,information.
Why Private Solutions
Do Not Always Work
Transaction costs are the costs that parties
incur in the process of agreeing to and
following through on a bargain.
Sometimes the private solution approach
fails because transaction costs can be so
high that private agreement is not possible.
Public Policy toward Externalitoies
When externalities are significant and
private solutions are not found,
government may attempt to solve the
problem through,,,
… command-and-control policies.
… market-based policies.
Command-and-Control Policies
Usually take the form of regulations,
– Forbid certain behaviors.
– Require certain behaviors.
Examples:
– Requirements that all students be immunized.
– Stipulations on pollution emission levels set
by the Environmental Protection Agency
(EPA).
Market-based Policies
Government uses taxes and subsidies to
align private incentives with social
efficiency.
Pigovian taxes are taxes enacted to correct
the effects of a negative externality.
Examples of Regulation
versus Pigovian tax
If the EPA decides it wants to reduce the
amount of pollution coming from a
specific plant,The EPA could…
– tell the firm to reduce its pollution by a
specific amount (i.e,regulation).
– levy a tax of a given amount for each unit of
pollution the firm emits (i.e,Pigovian tax).
Market-based Policies
Tradable pollution permits allow the
voluntary transfer of the right to pollute
from one firm to another,
A market for these permits will eventually
develop.
A firm that can reduce pollution at a low
cost may prefer to sell its permit to a firm
that can reduce pollution only at a high
cost,
The Equivalence of Pigovian
Taxes and Pollution Permits...
Quantity of
Pollution
0
Price of
Pollution
P
Q
Demand for
pollution rights
Pigoviantax
(a) Pigovian Tax
2.,..which,together
with the demand curve,
determines the quantity
of pollution.
1,A Pigovian
tax sets the
price of
pollution...
Quantity of
Pollution
0 Q
Demand for
pollution rights
Supply of
pollution permits
(b) Pollution Permits
Price of
Pollution
P
2.,..which,together
with the demand curve,
determines the price
of pollution.
1,Pollution
permits set
the quantity
of pollution...
Summary
When a transaction between a buyer and a
seller directly affects a third party,the
effect is called an externality.
Negative externalities cause the socially
optimal quantity in a market to be less
than the equilibrium quantity.
Positive externalities cause the socially
optimal quantity in a market to be greater
than the equilibrium quantity.
Summary
Those affected by externalities can sometimes
solve the problem privately.
The Coase theorem states that if people can
bargain without a cost,then they can always
reach an agreement in which resources are
allocated efficiently.
When private parties cannot adequately deal
with externalities,then the government steps
in.
The government can either regulate behavior
or internalize the externality by using Pigovian
taxes.
Exercise #10
Problems and applications
– #2,#3,#4,#9
经济学可以更有趣
为什么西北的印第安人对土地私有产权有明确规定而大草原地区的印第安人则没有?
为什么有时候小岛上的人禁止别人使用他们的私人码头是非法的？
思考：为什么我们担心鲸会灭绝而从来不担心鲫鱼会灭绝？为什么老虎会灭绝而猪不会？
思考：为什么地中海地区的污染比美国大盐湖地区严重的多？
经济学可以更有趣
满怀好意的政策不一定有好的结果
因为有了汽车安全标准的存在并依从其规范，是否有更多的生命已经被挽救或者将要被挽救，却仍是一个微妙的问题。当提供更大的安全性后，某些个人将减少驾驶的谨慎性。那么，经济学家的标准模型将预言：驾驶较不安全轿车的个人将会更为谨慎地开车，而驾驶更安全轿车的个人将会较少谨慎地开车。
例如我们注意到，在轿车已经按要求装备安全装置的时期内，事故的数量上升了，
而驾车者的死亡率却并未上升。这些数据再次与此观点相一致，即个人有可能更加毫无顾忌地驾驶，因为他们的轿车上装有所要求的安全装置。
另一个证据显示出类似的结果。在德克萨斯州所做的一项交通事故调查中发现：车体重量少于三千磅的轿车占所有汽车注册总数的不到 20％，这些轿车的驾驶者占出事轿车总量的 13％和受伤总数的 16％。另一方面，重量在四千到五千磅的轿车占注册总数的 31％，但是此类车超过出事总量的 57％和受伤总数的 51％。轿车越是安全，
占有者的驾驶习惯越是不够谨慎。
大多数人都不能接受用钱来衡量人的生命，但是实际上我们每天都在用钱来衡量。
国家高速公路交通安全管理委员会发现，如果你开的是一辆超小型轿车，并且与一辆车身较大的轿车相撞，你的死亡风险比大车驾驶者的风险高 8.2倍。如果你开的是一辆中型轿车，并且与一辆大车相撞，你的死亡风险仅比大车驾驶者的风险高 1.3倍。
汽车保险者也正是由此做出反应。例如国家农业保险公司对多数大型轿车给予 15％
的折扣率，而对许多小型轿车征收 15％的附加费。因此有了这样的交换：要想获得较为节省燃料的车型，你必须承担更大的伤害和死亡风险。
经济学可以更有趣
你去移动充值时成了幸运儿 ——赢得了一张某天李宇春演唱会的门票，免费但是不能转让，而同一天还有你喜欢的歌手李宗盛的演唱会。李宗盛的演唱会门票是 100元，你最多愿意支付的价格是 150元。当你对李宇春演唱会的评价高于哪个价格时你应该去看李宇春的演唱会？
(A) 50 (B) 100 (C) 150 (D) 250
老美的成绩
有人就上述问题做了抽样调查，结果是,270名修了经济学课程的学生只有 7.4%答对了； 88名从未学过经济学的学生有 17.2%答对了； 199名专业经济学家中 21.6%选择了正确答案,25.1%人认为看李宇春演唱会的机会成本是 0,25.6%认为是 100,27.6%认为是 150.
为什么深圳、上海等地方的人总是急匆匆不愿意搭理路边问路的人而很多小城市的人则有人情味得多？
思考题：如何逃命
假如你是一位英雄，手中的剑已折断，后有一帮坏人（土匪、强盗 …… ）追杀你。幸运的是，你骑着马，而他们却没有。
不幸的是，你的马已经筋疲力尽，而他们将最终会追上你。幸好你有一把弓，
可惜你只有 10支箭。值得庆幸的是，作为一位英雄，你总是百发百中，从未失过手；
糟糕的是，后面有 40个坏人，他们以一定间隔在你身后横向排开一队，以最快的速度向前冲。他们离你很近，已经到了射程之内。
你如何逃命？
Chapter 10
Market Efficiency-Market Failure
Recall that,Adam Smith’s,invisible hand”
of the marketplace leads self-interested
buyers and sellers in a market to
maximize the total benefit that society can
derive from a market,
But market failures can still happen.
Market failure results from market power
and externality
Market Failures,Externalities
When a market outcome affects parties other
than the buyers and sellers in the market,
side-effects are created called externalities.
Externalities cause markets to be inefficient,
and thus fail to maximize total surplus.
when a person engages in an activity that
influences the well-being of a bystander and
yet neither pays nor receives any
compensation for that effect,an externality
arises.
When the impact on the bystander is
adverse,the externality is called a
negative externality.
When the impact on the bystander is
beneficial,the externality is called a
positive externality.
Market Failures,Externalities
Examples of
Negative Externalities
Automobile exhaust
Cigarette smoking
Barking dogs (loud pets)
Loud stereos in an apartment building
Immunizations
Restored historic buildings
Research into new technologies
Examples of
Positive Externalities
The Market for Aluminum...
Quantity of
Aluminum
0
Price of
Aluminum
QMARKET
Demand
(private value)
Supply
(private cost)
Equilibrium
The Market for Aluminum
and Welfare Economics
The quantity produced and consumed in the
market equilibrium is efficient in the sense that
it maximizes the sum of producer and
consumer surplus.
If the aluminum factories emit pollution (a
negative externality),then the cost to society of
producing aluminum is larger than the cost to
aluminum producers.
For each unit of aluminum produced,the
social cost includes the private costs of the
producers plus the cost to those bystanders
adversely affected by the pollution.
QMARKE
T
Pollution and the Social
Optimum...
Quantity of
Aluminum
0
Price of
Aluminum
Demand
(private value)
Supply
(private cost)
Social cost
Qoptimum
Cost of
pollution
Equilibrium
Optimum
Negative Externalities
in Production
The intersection of the demand curve and
the social-cost curve determines the
optimal output level.
The socially optimal output level is less
than the market equilibrium quantity.
Achieving the Socially
Optimal Output
Internalizing an externality involves
altering incentives so that people take into
account the external effects of their actions,
The government can internalize an
externality by imposing a tax on the
producer to reduce the equilibrium
quantity to the socially desirable quantity,
Positive Externalities in Production
When an externality benefits the bystanders,
a positive externality exists.
The social costs of production are less than
the private cost to producers and consumers.
A technology spillover is a type of positive
externality that exists when a firm’s
innovation or design not only benefits the
firm,but enters society’s pool of
technological knowledge and benefits society
as a whole.
Quantity
of Robots
0
Price
of Robot
QOPTIMUM
Demand
(private value)
Supply (private cost)
Social cost
QMARKET
Value of
technology
spillover
Equilibrium
Optimum
Positive Externalities in Production
The intersection of the demand curve and
the social-cost curve determines the
optimal output level.
The optimal output level is more than the
equilibrium quantity.
The market produces a smaller quantity
than is socially desirable,
The social costs of production are less than
the private cost to producers and
consumers.
Positive Externalities in Production
Internalizing Externalities,
Subsidies
Government many times uses subsidies as
the primary method for attempting to
internalize positive externalities.
Technology Policy
Government intervention in the economy that
aims to promote technology-enhancing
industries is called technology policy.
Patent laws are a form of technology policy that
give the individual (or firm) with patent
protection a property right over its invention,
The patent is then said to internalize the
externality.
Internalizing
Production Externalities
Taxes are the primary tools used to
internalize negative externalities.
Subsidies are the primary tools used to
internalize positive externalities.
Quantity of
Education
0
Price of
Education
Q
MARKE
T
Demand(private value)
Social
value
Q
OPTIMUM
(b) Positive Consumption Externality
Supply
(private cost)
Quantity
of Alcohol
0
Price
of Alcohol
Q
MARKET
Demand
(private value)
Supply
(private cost)
Social value
Q
OPTIMUM
(a) Negative Consumption Externality
Consumption Externalities
Consumption Externalities
and Market Inefficiency
Negative externalities in production or
consumption lead markets to produce a
larger quantity than is socially desirable.
Positive externalities in production or
consumption lead markets to produce a
larger quantity than is socially desirable.
Private Solutions to Externalities
Government action is not always needed
to solve the problem of externalities.
Types of private solutions
– Moral codes and social sanctions
– Charitable organizations
– Integrating different types of businesses
– Contracting between parties
The Coase Theorem
The Coase Theorem states that if private
parties can bargain without cost over the
allocation of resources,then the private
market will always solve the problem of
externalities on its own and allocate
resources efficiently.
The Coase Theorem
The Coase Theorem says that private
economic actors can solve the problem of
externalities among themselves,Whatever
the initial distribution of rights,the
interested parties can always reach a
bargain in which everyone is better off
and the outcome is efficient.
CoaseTheorem,More Example
A and B are roommate,A like rock music and B prefer quiet,Suppose A’s willingness
to pay for music is $50 while B’s willingness to pay for quiet is $40.
Think about the institutional arrangement as follows:
– I,A has the right to play music
– II,B has the right to require quiet
What will happen if A’s value for music is $40 while B’s value for quiet is $50?
Some Important Concept,
– Property rights
– Coasian Bargaining
– Transaction Cost
Coase Theorem is the guideline for us to figure out the right reason for market
inefficiencies.
– Wrong reasons,Externality itself,unjustable property rights,wrong distribution of property
rights
– Right reasons,ambiguous initial property rights,bargaining failure (transaction cost too
high),restrictions on transfer of property rights.
Another example,宿舍熄灯安排
Equity
Efficiency,transaction cost,credibility of admittance(difficult to enforce a contract),
multiperson,information.
Why Private Solutions
Do Not Always Work
Transaction costs are the costs that parties
incur in the process of agreeing to and
following through on a bargain.
Sometimes the private solution approach
fails because transaction costs can be so
high that private agreement is not possible.
Public Policy toward Externalitoies
When externalities are significant and
private solutions are not found,
government may attempt to solve the
problem through,,,
… command-and-control policies.
… market-based policies.
Command-and-Control Policies
Usually take the form of regulations,
– Forbid certain behaviors.
– Require certain behaviors.
Examples:
– Requirements that all students be immunized.
– Stipulations on pollution emission levels set
by the Environmental Protection Agency
(EPA).
Market-based Policies
Government uses taxes and subsidies to
align private incentives with social
efficiency.
Pigovian taxes are taxes enacted to correct
the effects of a negative externality.
Examples of Regulation
versus Pigovian tax
If the EPA decides it wants to reduce the
amount of pollution coming from a
specific plant,The EPA could…
– tell the firm to reduce its pollution by a
specific amount (i.e,regulation).
– levy a tax of a given amount for each unit of
pollution the firm emits (i.e,Pigovian tax).
Market-based Policies
Tradable pollution permits allow the
voluntary transfer of the right to pollute
from one firm to another,
A market for these permits will eventually
develop.
A firm that can reduce pollution at a low
cost may prefer to sell its permit to a firm
that can reduce pollution only at a high
cost,
The Equivalence of Pigovian
Taxes and Pollution Permits...
Quantity of
Pollution
0
Price of
Pollution
P
Q
Demand for
pollution rights
Pigoviantax
(a) Pigovian Tax
2.,..which,together
with the demand curve,
determines the quantity
of pollution.
1,A Pigovian
tax sets the
price of
pollution...
Quantity of
Pollution
0 Q
Demand for
pollution rights
Supply of
pollution permits
(b) Pollution Permits
Price of
Pollution
P
2.,..which,together
with the demand curve,
determines the price
of pollution.
1,Pollution
permits set
the quantity
of pollution...
Summary
When a transaction between a buyer and a
seller directly affects a third party,the
effect is called an externality.
Negative externalities cause the socially
optimal quantity in a market to be less
than the equilibrium quantity.
Positive externalities cause the socially
optimal quantity in a market to be greater
than the equilibrium quantity.
Summary
Those affected by externalities can sometimes
solve the problem privately.
The Coase theorem states that if people can
bargain without a cost,then they can always
reach an agreement in which resources are
allocated efficiently.
When private parties cannot adequately deal
with externalities,then the government steps
in.
The government can either regulate behavior
or internalize the externality by using Pigovian
taxes.
Exercise #10
Problems and applications
– #2,#3,#4,#9
经济学可以更有趣
为什么西北的印第安人对土地私有产权有明确规定而大草原地区的印第安人则没有?
为什么有时候小岛上的人禁止别人使用他们的私人码头是非法的？
思考：为什么我们担心鲸会灭绝而从来不担心鲫鱼会灭绝？为什么老虎会灭绝而猪不会？
思考：为什么地中海地区的污染比美国大盐湖地区严重的多？
经济学可以更有趣
满怀好意的政策不一定有好的结果
因为有了汽车安全标准的存在并依从其规范，是否有更多的生命已经被挽救或者将要被挽救，却仍是一个微妙的问题。当提供更大的安全性后，某些个人将减少驾驶的谨慎性。那么，经济学家的标准模型将预言：驾驶较不安全轿车的个人将会更为谨慎地开车，而驾驶更安全轿车的个人将会较少谨慎地开车。
例如我们注意到，在轿车已经按要求装备安全装置的时期内，事故的数量上升了，
而驾车者的死亡率却并未上升。这些数据再次与此观点相一致，即个人有可能更加毫无顾忌地驾驶，因为他们的轿车上装有所要求的安全装置。
另一个证据显示出类似的结果。在德克萨斯州所做的一项交通事故调查中发现：车体重量少于三千磅的轿车占所有汽车注册总数的不到 20％，这些轿车的驾驶者占出事轿车总量的 13％和受伤总数的 16％。另一方面，重量在四千到五千磅的轿车占注册总数的 31％，但是此类车超过出事总量的 57％和受伤总数的 51％。轿车越是安全，
占有者的驾驶习惯越是不够谨慎。
大多数人都不能接受用钱来衡量人的生命，但是实际上我们每天都在用钱来衡量。
国家高速公路交通安全管理委员会发现，如果你开的是一辆超小型轿车，并且与一辆车身较大的轿车相撞，你的死亡风险比大车驾驶者的风险高 8.2倍。如果你开的是一辆中型轿车，并且与一辆大车相撞，你的死亡风险仅比大车驾驶者的风险高 1.3倍。
汽车保险者也正是由此做出反应。例如国家农业保险公司对多数大型轿车给予 15％
的折扣率，而对许多小型轿车征收 15％的附加费。因此有了这样的交换：要想获得较为节省燃料的车型，你必须承担更大的伤害和死亡风险。
经济学可以更有趣
你去移动充值时成了幸运儿 ——赢得了一张某天李宇春演唱会的门票，免费但是不能转让，而同一天还有你喜欢的歌手李宗盛的演唱会。李宗盛的演唱会门票是 100元，你最多愿意支付的价格是 150元。当你对李宇春演唱会的评价高于哪个价格时你应该去看李宇春的演唱会？
(A) 50 (B) 100 (C) 150 (D) 250
老美的成绩
有人就上述问题做了抽样调查，结果是,270名修了经济学课程的学生只有 7.4%答对了； 88名从未学过经济学的学生有 17.2%答对了； 199名专业经济学家中 21.6%选择了正确答案,25.1%人认为看李宇春演唱会的机会成本是 0,25.6%认为是 100,27.6%认为是 150.
为什么深圳、上海等地方的人总是急匆匆不愿意搭理路边问路的人而很多小城市的人则有人情味得多？
思考题：如何逃命
假如你是一位英雄，手中的剑已折断，后有一帮坏人（土匪、强盗 …… ）追杀你。幸运的是，你骑着马，而他们却没有。
不幸的是，你的马已经筋疲力尽，而他们将最终会追上你。幸好你有一把弓，
可惜你只有 10支箭。值得庆幸的是，作为一位英雄，你总是百发百中，从未失过手；
糟糕的是，后面有 40个坏人，他们以一定间隔在你身后横向排开一队，以最快的速度向前冲。他们离你很近，已经到了射程之内。
你如何逃命？
