Demand (private value) 0 QOPTIMUM QMARKET Quantity of Aluminum
In the presence of a negative externality, such as pollution, the social cost of the good exceeds the private cost. The optimal quantity, QOPTIMUM, is therefore smaller than the equilibrium quantity, QMARKET.
• Government
– May protect the interests of bystanders (neglected in the market)
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Externalities
PowerPoint Slides prepared by: Andreea CHIRITESCU Eastern Illinois University
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Externalities
• Market equilibrium (under externality)
– Buyers and sellers neglect the external effects of their actions when deciding how much to demand or supply – Fails to maximize the total benefit to society as a whole, that is inefficient allocation of resources (market failure)
lower crime rate, dissemination of technology
– Social value
• Higher than private value(“willingness to pay”)
– Social value curve
• Above demand curve
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Figure 2
Pollution and the Social Optimum
Price of Aluminum External Cost Social cost (private cost and external cost) Supply (private cost) Optimum Equilibrium
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Figure 1
The Market for Aluminum
Price of Aluminum Supply (private cost)
Equilibrium
Demand (private value)
0 QMARKET Quantity of Aluminum
The demand curve reflects the value to buyers, and the supply curve reflects the costs of sellers. The equilibrium quantity, QMARKET, maximizes the total value to buyers minus the total costs of sellers. In the absence of externalities, therefore, the market equilibrium is efficient.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
of the external effects of their actions
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Externalities & Market Inefficiency
• Positive externalities
– Education
• Private benefits– higher productivity & wages • Externalities: better government (better vote),
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Externalities & Market Inefficiency
• Negative externalities
– Market equilibrium quantity is not optimum
• Optimum quantity (maximize total welfare) is
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Externalities & Market Inefficiency
• Negative externalities
– Cost to society (eg. producing aluminum)
• Larger than the cost to the producers
– Social cost
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Externalities & Market Inefficiency
• Welfare economics: a recap (Ch 7)Байду номын сангаас
– Demand curve – value to consumers
• The willingness to pay
– Supply curve – cost to suppliers
smaller than the market equilibrium quantity
• Government– correct market failure
– Internalizing the externality
• Altering incentives for people to take account
• The willingness to supply
– Equilibrium quantity and price
• Efficient • Maximizes sum of producer and consumer
surplus
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.