The document discusses externalities and market failures in microeconomics. It defines key terms like externality, internalizing externalities, and corrective taxes. It provides examples of negative externalities like pollution and positive externalities like education. It explains how externalities can lead to market failures and discusses government interventions like taxes, regulations, and tradable permits to internalize externalities when markets fail to allocate resources efficiently.

1. Exam 2
Chapters 6 -11
!
Tuesday
Nov. 11th

2. Microeconomics
Lecture 10
!
Externalities

3. Key Terms

4. Key Terms
externality
internalizing the externality
corrective tax
Coase theorem
transaction costs

8. Externality

9. Externality
Benefits or Costs
to someone else
- Third Party-
!
Positive or Negative

10. Negative Externality
Personal
Private
Me
Social
Public
Everybody
Else
Benefits
Costs
Personalize the benefit
Socialize the cost

11. Negative Externality
Personal
Private
Me
Social
Public
Everybody
Else
Benefits
Costs
Personalize the benefit
Socialize the cost

12. Negative Externality
Personal
Private
Me
Social
Public
Everybody
Else
Benefits
Costs
Personalize the benefit
Socialize the cost

13. Negative Externality
Personal
Private
Me
Social
Public
Everybody
Else
Benefits
Costs
Personalize the benefit
Socialize the cost

14. Positive Externality
Personal
Private
Me
Social
Public
Everybody
Else
Benefits
Costs
Socialize the benefit
Personalize the cost

15. Positive Externality
Personal
Private
Me
Social
Public
Everybody
Else
Benefits
Costs
Socialize the benefit
Personalize the cost

16. Positive Externality
Personal
Private
Me
Social
Public
Everybody
Else
Benefits
Costs
Socialize the benefit
Personalize the cost

17. Positive Externality
Personal
Private
Me
Social
Public
Everybody
Else
Benefits
Costs
Socialize the benefit
Personalize the cost

18. Rule

19. Rule
Align
benefits and costs

20. Market Failure

21. Market Failure
Markets don’t always
produce the most
desirable economic
outcomes

22. Negative Externality

23. Negative Externality
Pollution
Second-Hand Smoke
Litter
Congestion
Boom Cars

24. Positive Externality

25. Positive Externality
Trust
Ideas
Improvements

27. Negative Externality

28. Negative Externality
Too much of the good is
produced because
someone else is paying
part of the costs

29. Positive Externality

30. Positive Externality
Too little of the good is
produced because
producer doesn’t receive
all the benefits

31. Internalize the Externality

32. Internalize the Externality
altering incentives so
people consider the effects
of their actions

33. Government
Intervention

34. Government
Intervention
Subsidize Positives
!
Tax and Regulate Negatives

35. Government Regulation

36. Government Regulation
Command and Control
Incentive-Based
Optimal level of pollution?
Coupons to pollute

37. $
Cost
0% 50% 100%
The cost to make things perfectly pure is infinite.
Therefore there is an optimal amount of cleanliness
where marginal benefits equal marginal costs.

38. Externalities
& Market Failures

39. Externalities
& Market Failures
Lack of Property Rights

41. 100
90
80
70
60
50
40
30
20
10
0
Demand
Permits to Drive
0 1 2 3 4 5 6 7 8 9 10

42. 100
90
80
70
60
50
40
30
20
10
0
Demand
Permits to Drive
0 1 2 3 4 5 6 7 8 9 10

43. 100
90
80
70
60
50
40
30
20
10
0
Demand
Permits to Drive
0 1 2 3 4 5 6 7 8 9 10

44. 100
90
80
70
60
50
40
30
20
10
0
Demand
Permits to Drive
0 1 2 3 4 5 6 7 8 9 10

45. 100
90
80
70
60
50
40
30
20
10
0
Demand
Permits to Drive
0 1 2 3 4 5 6 7 8 9 10

46. 100
90
80
70
60
50
40
30
20
10
0
Demand
Permits to Drive
0 1 2 3 4 5 6 7 8 9 10

47. 100
90
80
70
60
50
40
30
20
10
0
Demand curve will set the price
Demand
Permits to Drive
Set the quantity
!
0 1 2 3 4 5 6 7 8 9 10

48. 100
90
80
70
60
50
40
30
20
10
0
Demand
Tax Driving
0 1 2 3 4 5 6 7 8 9 10

49. 100
90
80
70
60
50
40
30
20
10
0
Demand
Tax Driving
0 1 2 3 4 5 6 7 8 9 10

50. 100
90
80
70
60
50
40
30
20
10
0
Demand
Tax Driving
0 1 2 3 4 5 6 7 8 9 10

51. 100
90
80
70
60
50
40
30
20
10
0
Demand
Tax Driving
0 1 2 3 4 5 6 7 8 9 10

52. 100
90
80
70
60
50
40
30
20
10
0
Demand
Tax Driving
0 1 2 3 4 5 6 7 8 9 10

53. 100
90
80
70
60
50
40
30
20
10
0
Demand
Tax Driving
0 1 2 3 4 5 6 7 8 9 10

54. 100
90
80
70
60
50
40
30
20
10
0
Demand curve will set the quantity
Demand
Tax Driving
Set the price
!
0 1 2 3 4 5 6 7 8 9 10

55. Property Rights
reduce
contention
and create wealth

56. Transaction Costs

57. Transaction Costs
Costs in time and
resources to negotiate and
enforce an agreement

58. Coase Theorem

59. Coase Theorem
Solve contention
with property rights
if transaction costs
are low