Econ 2610 Principles of Microeconomics Yogesh Uppal Email

Econ 2610: Principles of Microeconomics Yogesh Uppal Email: yuppal@ysu. edu

Chapter 11 Externalities and Property Rights

External Costs and Benefits l External cost is a cost of an activity that is paid by people other than those who pursue the activity l l Also called a negative externality External benefit is a benefit of an activity received by a third party l Also called a positive externality

Externalities Affect Resource Allocation l Externalities reduce economic efficiency l l Solutions to externalities may be efficient When efficient solutions to externalities are not possible, government intervention or other collective action may be used

Honeybee Keeper – Scenario 1 l Phoebe harvests and sells honey from her bees l Bees pollinate the apple orchards l l No payments made to Phoebe The bees provide a free service to the local farmers l Phoebe is giving away a service l Private costs are equal to private benefits § Social costs are less than social benefits When external benefits exist, maximizing private profits produces less than the social optimum

Honeybee Keeper – Scenario 2 l l l Phoebe harvests and sells honey from her bees Neighboring school and nursing homes are bothered by bee stings The bees are a nuisance to the neighbors l Phoebe is not paying all the costs of her honeybees l Private costs are equal to private benefits § Social costs are greater than social benefits When external costs exist, maximizing private profits produces more than the social optimum

External Costs External Cost 1. 3 Private MC D 12, 000 Quantity (tons/year) Price ($000 s / ton) No External Cost Social MC $1, 000/ton 2. 3 2. 0 Private MC 1. 3 D 8, 000 12, 000 Quantity (tons/year) Deadweight loss from pollution = $2 M/yr Social Optimum Private Equilibrium

Positive Externality for Consumers Deadweight loss from positive externality XB Price MBPVT + XB MC MBSOC MBPVT Social Demand Private Equilibrium QPVT Quantity QSOC Social Optimum

Effects of Externalities With externalities, private market outcomes do not achieve the largest possible economic surplus Cash is left on the table

Abercrombie the Polluter – Scenario 1 l Abercrombie’s company dumps toxic waste in the river l l l Abercrombie could install a filter to remove the harm to Fitch l l l Fitch cannot fish the river No one else is harmed Filter imposes costs on Abercrombie Filter benefits Fitch Parties do not communicate

Abercrombie's Filter Options With Filter Without Filter Abercrombie's Gains $100 / day $130 / day Fitch's Gains $100 / day $50 / day Total Gains does not$200 day § Abercrombie install/the filter $180 / day § Marginal cost of filter to Abercrombie is $30 per day § The marginal benefit to Fitch is $50 per day § There is a net welfare loss of $20 per day

Abercrombie the Polluter – Scenario 2 l Communications changes the outcome l l Fitch pays Abercrombie between $30 and $50 per day to use the filter Net gain in total surplus of $20 per day With Filter Without Filter Abercrombie's Gains $100 / day $130 / day Fitch's Gains $100 / day $50 / day Total Gains $200 / day $180 / day

The Coase Theorem l l If people can negotiate the right to perform activities that cause externalities, they can always arrive at efficient solutions to problems caused by externalities l Negotiations must be costless Sometimes those harmed pay to stop pollution l The case of Abercrombie and Fitch Sometimes polluter buys the right to pollute l Abercrombie pays Fitch if the value of polluting is greater than the harm to Fitch The adjustment to the externality is usually done by the party with the lowest cost

Abercrombie the Polluter – Scenario 3 l Abercrombie’s company produces toxic waste l l Laws prohibit dumping the waste in the river UNLESS Fitch agrees New gains matrix Without With Filter Abercrombie's Gains $100 / day $150 / day Fitch's Gains $100 / day $70 / day Total Gains $200 / day $220 / day

Examples of Legal Remedies for Externalities l l Noise regulations (cars, parties, honking horns) Most traffic and traffic-related laws l l Car emission standards and inspections Zoning laws Building height and footprint regulations (sunshine laws) Air and water pollution laws

Three Cases Free Speech l. First Amendment recognizes the value of open communications l Hard to identify speech that has a net cost l. Some l l limitations Yelling "fire" in a crowded theatre Promote the violent overthrow of the government Planting Trees l Government subsidizes trees on private property Decreases chances of flooding and landslides l Net reduction of CO 2 in the atmosphere Basic Research § Millions of dollars spent by federal government yearly § Externalities of new knowledge l

Optimal Amount of Negative Externalities MC & MB MC Optimal amount of pollution MC = MB MB Q Quantity of Pollution

Taxing a Negative Externality Pollution Tax $1, 000 / ton Social MC 2. 3 2. 0 XC Private MC 1. 3 D Private MC + Tax 2. 0 Private MC 1. 3 D 8, 000 12, 000 Quantity (tons/year) Social Optimum Price ($000 s / ton) No Pollution Tax Private Equilibrium Quantity (tons/year) After Tax Equilibrium Before Tax Equilibrium

Subsidizing a Positive Externality 14 MC XB 10 8 Social Demand Subsidy Price ($ / ton) No Subsidy 14 10 8 Subsidized Demand Private Demand 12 16 Quantity (000 s tons/year) MC Private Demand 12 16 Quantity (000 s tons/year)

Tragedy of Commons l When use of a communally owned resource has no price, the costs of using it are not considered l Use of the property will increase until MB = 0

Property Rights and the Tragedy of Commons Blackberries in the Park l. Sweetness increases as the berry ripens l. Blackberries are common property l Berries will be eaten before they are fully ripe Other Examples l Timber on remote public land Whales in open oceans l. Worldwide l l Decrease appreciation of its flavor Drinking slowly increases appreciation l If l. Harvesting l Shared Milkshakes l Milkshakes chill taste buds pollution two people share the milkshake, it is a common good l They will drink faster than if it were a private good