PEco Module 8

• Externalities are the uncompensated impact of one person’s actions on the well-being of a bystander, which can be negative or positive, depending on whether the impact on the bystander is adverse or beneficial.
• Externalities are the benefits or costs received by neither the seller nor the buyer but by third parties.
• In contrast to corrective taxes, firms have no incentive for further reduction beyond the level specified in a regulation.
• If a cleaner technology becomes available, the tax gives firms an incentive to adopt it.
• Corrective taxes are better for the environment because they give firms incentive to continue reducing pollution as long as the cost of doing so is less than the tax.
• Private benefits and external benefits together constitute social benefits.
• Private costs and external costs together constitute social costs.
• Markets may fail to allocate resources efficiently and government may improve market outcomes due to externalities.
• Examples of negative externalities include pollution, noise, and congestion.
• Welfare economics is the analysis of a negative externality.
• In a negative externality, the benefits or costs received by neither the seller nor the buyer but by third parties are not captured in the market.
• Market equilibrium in a negative externality is not socially optimal.
• Internalizing the externality involves altering incentives so that people take account of the external effects of their actions.
• In our example, the $1/gallon tax on sellers makes seller’s costs equal social costs.
• When market participants must pay social costs, market equilibrium is socially optimal.
• Imposing the tax on buyers would achieve the same outcome as internalizing the externality; market quantity would be equal optimal quantity.
• The socially optimal quantity maximizes welfare.
• Examples of market based policies include corrective taxes and subsidies.
• Corrective taxes and subsidies align private incentives with society’s interests, make private decision-makers take into account the external costs and benefits of their actions, and move the economy toward a more efficient allocation of resources.
• The ideal corrective subsidy equals the external benefit.
• In the presence of a positive externality, the social value of a good includes private value, which is the direct value to buyers, and external benefit, which is the value of the positive impact on bystanders.
• A corrective tax is a tax designed to induce private decision-makers to take account of the social costs that arise from a negative externality, also called Pigouvian taxes after Arthur Piguo.
• The ideal corrective tax equals the external cost.
• At any higher quantity, the cost of the last unit exceeds its social value.
• At any lower quantity, the social value of additional units exceeds their cost.
• Examples of command and control policies include limits on quantity of pollution emitted and requirements that firms adopt a particular technology to reduce emissions.
• A corrective subsidy is a subsidy designed to induce private decision-makers to take account of the social benefits that arise from a positive externality, also called Pigouvian subsidies after Arthur Piguo.
• Public policy can be implemented through command and control policies, which regulate behavior directly, or through market based policies, which provide incentives so that private decision-makers will choose to solve the problem on their own.