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1、Chapter Thirty-Three,Externalities,Externalities,An externality is a cost or a benefit imposed upon a consumer or a firm by actions taken by others. The cost or benefit is thus generated externally to the consumer or the firm. An externally imposed benefit is a positive externality. An externally im
2、posed cost is a negative externality.,Examples of Negative Externalities,Air pollution. Water pollution. Loud parties next door. Traffic congestion. Second-hand cigarette smoke suffered by a non-smoker. Increased health insurance premia due to alcohol or tobacco consumption.,Examples of Positive Ext
3、ernalities,A well-maintained property next door that raises the market value of your own property. A pleasant cologne or scent worn by the person seated next to you. Improved driving habits that reduce accident risks. A scientific advance.,Externalities and Efficiency,The crucial feature of an exter
4、nality is that it impacts a third party; that is, somebody who is not directly a participant in the activity which produces the external cost or benefit.,Externalities and Efficiency,Externalities cause Pareto inefficiency; typically too much scarce resource is allocated to an activity which causes
5、a negative externality too little resource is allocated to an activity which causes a positive externality.,Externalities and Property Rights,An externality will be taken to be a purely public commodity. A commodity is purely public if it is consumed by everyone (nonexcludability), and everybody con
6、sumes the entire amount of the commodity (nonrivalry in consumption). E.g. a broadcast television program.,Inefficiency & Negative Externalities,Consider an example of two agents, A and B, and two commodities, money and smoke. Both smoke and money are goods for Agent A. Money is a good and smoke is
7、a bad for Agent B. Smoke is a purely public commodity.,Inefficiency & Negative Externalities,Agent A is endowed with $yA. Agent B is endowed with $yB. Smoke intensity is measured on a scale from 0 (no smoke) to 1 (maximum concentration).,Inefficiency & Negative Externalities,OA,1,0,Smoke,mA,yA,Money
8、 and smoke are both goods for Agent A.,Inefficiency & Negative Externalities,OA,1,0,Smoke,mA,yA,Money and smoke are both goods for Agent A.,Better,Inefficiency & Negative Externalities,OB,1,0,Smoke,mB,yB,Money is a good and smoke is a bad for Agent B.,Better,Inefficiency & Negative Externalities,OB,
9、1,0,Smoke,mB,yB,Money is a good and smoke is a bad for Agent B.,Inefficiency & Negative Externalities,What are the efficient allocations of smoke and money?,Inefficiency & Negative Externalities,OA,1,0,Smoke,mA,yA,OB,1,0,Smoke,mB,yB,Inefficiency & Negative Externalities,OA,1,0,Smoke,mA,OB,1,0,Smoke,
10、mB,yA,yB,Inefficiency & Negative Externalities,OA,1,0,Smoke,mA,OB,1,0,Smoke,mB,yA,yB,Inefficiency & Negative Externalities,OA,1,0,Smoke,mA,OB,1,0,Smoke,mB,yA,yB,Inefficiency & Negative Externalities,OA,1,0,Smoke,mA,OB,1,0,Smoke,mB,yA,yB,Efficient allocations,Inefficiency & Negative Externalities,Sup
11、pose there is no mechanism by which money can be exchanged for changes in smoke level. What then is Agent As most preferred allocation? Is this allocation efficient?,Inefficiency & Negative Externalities,OA,1,0,Smoke,mA,OB,1,0,Smoke,mB,yA,yB,Efficient allocations,Inefficiency & Negative Externalitie
12、s,OA,1,0,Smoke,mA,OB,1,0,Smoke,mB,yA,yB,Efficient allocations,As choices,Inefficiency & Negative Externalities,OA,1,0,Smoke,mA,OB,1,0,Smoke,mB,yA,yB,Efficient allocations,As most preferred choice is inefficient,Inefficiency & Negative Externalities,Continue to suppose there is no mechanism by which
13、money can be exchanged for changes in smoke level. What is Agent Bs most preferred allocation? Is this allocation efficient?,Inefficiency & Negative Externalities,OA,1,0,Smoke,mA,OB,1,0,Smoke,mB,yA,yB,Efficient allocations,Bs choices,Inefficiency & Negative Externalities,OA,1,0,Smoke,mA,OB,1,0,Smoke
14、,mB,yA,yB,Efficient allocations,Bs most preferred choice,Inefficiency & Negative Externalities,OA,1,0,Smoke,mA,OB,1,0,Smoke,mB,yA,yB,Efficient allocations,Bs most preferred choice is inefficient,Inefficiency & Negative Externalities,So if neither A nor B can trade money for changes in smoke intensit
15、y, then the outcome is inefficient. Either there is too much smoke (As most preferred choice) or there is too little smoke (Bs choice).,Externalities and Property Rights,Ronald Coases insight is that most externality problems are due to an inadequate specification of property rights and, consequently, an absence of markets in which trade can be used to internalize external costs or benefits.,Externalities and Property Rights,Causing a producer of an externality to bear the full external cost or to enjoy the full external benefit is called internalizing t
