Lecture 4 The Environment and Market Failure Externalities

1
Lecture 4The Environment and Market Failure -
Externalities

• AEDE/NR 531
• Spring Quarter, 2006

2
Definitions

• Externality
• Def
• Externality Cost
• Def
• Social Value

3
Private Market

• Private markets maximize social value in the
  absence of externalities.
• Private markets DO NOT maximize social value in
  the presence of an externality.
• MPC
• MPB

4
Markets with All Costs and Benefits

• MEC
• Marginal External Cost
• MSC

5
Types of externalities
6
How do externalities effect welfare
P
MPC
PP
MPB
Q
QP
7
Total Surplus at Private Equilibrium
MSC
P
MPC
PS
PP
MEC
MPB
Q
QP
QS
8
Total Surplus at Social Equilibrium
MSC
P
MPC
PS
PP
MEC
MPB
Q
QP
QS
9
How to Achieve the Social Equilibrium - Tax
MSC
P
MPC
PT
PS
PP
TaxMEC
MPB
Q
QS
Q
Q
10
How to Achieve the Social Equilibrium - Tax
MSC
P
MPC
PC
PS
PP
TaxMEC
MPB
Q
Q
11
How to Achieve the Social Equilibrium - Tax
MSC
P
MPC
PC
PP
MPB
Q
Q
12
Who Pays What Portion of a Tax
MSC
P
MPC
Consumer Burden
PC
PP
Producer Burden
MEC
MPB
Q
QS
13
How Does the Burden of the Tax Change as the
Slopes of the Demand and Supply Curve Change?
P
MPC
PC

• Tax PC PP
• The larger (in abs. value) the slope of the
  demand curve is, the more the burden is put on
  consumers

Tax
PP
MPB
Q
QS
14
How Does the Burden of the Tax Change as the
Slopes of the Demand and Supply Curve Change?
P
MPC
PC
Tax
MPB
PP
The smaller (in abs. value) the slope of the
demand curve is, the more the burden is put on
consumers
Q
QS