L23

1
L23

• Externalities

2
Road map

• 1) Consumers choice
• 2) Equilibrium, Producers
• (Pareto efficiency)
• 3) Market Failures
• - fixed cost monopoly and oligopoly
• - externalities and public goods
• - asymmetric information

3
Externalities

• So far utilities on own actions only
• Reality we are not islands
• An externality is a cost or a benefit imposed
  upon someone by actions taken by others.
• - benefit - positive externality.
• - cost - negative externality.

4
Examples of Negative Externalities

• Air or water pollution.
• Loud parties next door.
• Traffic congestion.
• Second-hand cigarette smoke.
• Increased insurance premiums due to alcohol or
  tobacco consumption.
• Bad smell!

5
Examples of Positive Externalities

• A well-maintained property.
• High human capital
• A pleasant cologne or scent worn by the person
  seated next to you.
• A scientific advance.

6
Todays questions

• Efficiency of interactions with externalities
• Too much or too little activity with externality?
• How can we reestablish Pareto efficiency?
• taxes
• creating markets
• social norms

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Example Negative externality

• Two producers steel mill and fishery
• A steel mill produces steel
• It can also choose the level of pollution
• The pollution adversely affects a nearby
  fishery

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Steel mill problem
9
Steel mill problem
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Fishery problem
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Pareto efficient production
12
Pareto efficient production
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Conclusion 1

• When negative externality too much activity in
  decentralized markets
• You will show in PS that when externality if
  positive too little activity.

14
Implementation Pigouvian Tax

• Problem information!

15
Creation of missing markets
16
Property rights (Coase Theorem)
17
Social norms moral cost

• Social norm do not pollute
• Moral cost
• Many norms can be explained using efficiency
  argument