Ch. 21

 

Terms

 

Negative and positive externalities

Social and private costs

Coase theorem

Taxes and subsidies

 

Unfortunately all forms of consumption create pollution or waste, so the question is "What is the optimal level of waste?" rather than "How can we eliminate all pollution?" Another way of asking the question is "What pollution may be avoidable? Or "Are there alternative technologies which can be used? " "Are there ways of structuring manufacturing/consumption so that less pollution is created?"

 

externalities – something a producer and/or consumer creates which they either do not have to pay for, or do not benefit from. Think of something with a spill-over effect

 

In the case of an externality, the market solution is inefficient (price and quantity are distorted and either too high or too low). As such it generally makes sense for the government to intervene, to improve efficiency.

 

Some examples of externalities:

Negative externality – pollution (global warming)  (acts that cause negative externalities often involve destruction of common resources)

positive externality –  basic research, education (pp. 403-406) (many goods with positive externalities are also public goods)

 

1. Externalities can be both positive and negative.

2. Externalities can occur both during production and consumption.

 

The classic example is the bee hive and the apple orchard.

 

Two manufacturers on a river

- a plant upstream which uses water for cooling and then sends the water back into the stream at a hotter temperature.

- a fishery downstream which sees its fish population dying because the water is too warm.

 

What is the impact of an externality?

 

The factory does not consider the dying fish, which are reducing the fishery's revenues, as a cost of production, since they don't feel it.

 

Can show the optimal solution to an externality graphically.

 

A negative externality in production suggests that the private costs are lower than the social costs. Because the producer makes decisions based on his/her supply curve (private cost), this leads to a quantity which is higher than the efficient quantity and a price which is lower than the efficient price. The question remains, how can society assure that negative externalities are reduced and positive externalities are encouraged?

 

Do we need laws to control externalities? In most cases, yes, although other solutions do exist.

 

Social codes, private solutions

 

Do you think social codes work well to control externalities?

 

Noise? Pollution? Restoration of old buildings?

 

Coase was an economist who argued that negative externalities could be resolved privately:

 

1. if we have well defined property rights

2. if we can easily identify who is being affected by the negative externality, as well as who is causing it.

3. those who are causing the externality and those affected by it can resolve the problem through negotiations, with one side compensating the other side monetarily.

 

Coase concludes that if these three assumptions hold, it doesn't matter whether we ask the producer of the externality to pay, or ask the person experiencing the externality to pay, the outcome will be the same.

 

Put another way, it doesn't matter who has the initial property rights, the same solution will be reached and the person experiencing the externality and the person creating the externality can come up with a monetary solution.

 

Let’s look at the case of global warming –

 

1. We do not really have well defined property rights.

2. The entire world, including humans and non-humans are going to be affected, although some groups more than others. For instance, people on islands, which may be flooded, will be affected first. Contributors to global warming are also spread all over, although some countries (such as the US) more to global warming than others do.The number of persons (not to mention non-persons) affected by the externality is huge. Some of those who will be affected have not even been born yet!

3. Even if it were possible, would having those who are causing global warming compensate those who will be hurt by it be the appropriate response?

 

Clearly then, Coase's theorem is of limited use in the case of global warming.

 

Economists have also come up with other ways of addressing externalities:

 

Negative externalities can be reduced by:

1. Regulations - or as the book says "command and control."

2. Taxes

3. Auctions.

 

Positive externalities can be increased by:

1. Public provision of a good.

2. Subsidies

3. Other economic rewards such as patents.

 

How does a tax work?

Show graphically.

In the case of a negative externality, a tax actually increases efficiency!

How does a subsidy work?

Can also show graphically.

 

Which of the various solutions proposed is preferred?

 

While in theory economists have come up with a series of what seem to be simple solutions, the problem is not only that we do not know how high the social cost/benefit is, but also that in the real world solutions may be far more complex, due to income inequality and other factors. Concerning the first point, what is the social cost of automobile emissions? What is the social benefit of finding a cure for a disease?  Deciding on the correct tax or subsidy level may be difficult, deciding on when to outlaw something versus when to restrict it is difficult, deciding when something should be provided by the public versus the private sector is also sometimes difficult.

 

How does regulation/banning work? It is most effective if you feel that no amount of an activity is acceptable. It doesn't always eliminate the problem though, because consumers and producers may choose to ignore the law, and risk getting caught. For regulations to work they generally have to also have large fine attached and a regulatory agency at work to catch those who violate the rules.

 

When you want to reduce something but allow economic signals to dictate outcomes taxes or auctions are better.

 

How about in the case of global warming? The problem is that this needs to be addressed within an international framework, rather than within a national context. Yet, some big players, such as the US, refuse to agree to the international proposals that have been put forward.

 

In the case of a public good with positive externalities, when you feel that the private sector will not provide a good (because there the private gains are too small), then the public sector should set in. In terms of private solutions, recall that in the case of subsidies, the price is lowered and the quantity increased, while in the case of patents, the opposite is true. This again raises ethical concerns. In the case of AIDs drugs, it may be more ethical to finance research through subsidies or government provision, rather than allowing a firm to patent the drug and charge a high price. In other cases, when the private sector is likely to be efficient at producing something, patents may help encourage positive externalities/public goods.

 

What does Waring have to say about the environment?

 

1. We need to value the environment, rather than just exploiting resources for economic gain.

2. We need to find qualitative measures for monitoring the environment, so that policy makers can be aware of when

What solutions to environmental problems exist, other than the ones proposed in a standard economics book, which include government regulation or market solutions. What does Waring suggest? What did the article we read about Hummers suggest?

Community activism is another solution, which may or may not take place within the context of the government. Waring provides the example of her community refusing to allow gold mining in their region, as an example of first a grass roots and then a government position that led to a particular environmental outcome. The environmental extremists, whom we read about earlier in the semester,