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1、 Price, $ S （Private and Social Cost） D （Social Value） D （Private Value） Q* QE Historic Homes and BuildingsConsider alcohol, which creates a negative externality in consumption where the value to society is less than the value to consumers （because of car wrecks, injuries to others, and violence）. t

2、 D （Private Value） D （Social Value） QE Q* AlcoholBut, we can achieve the efficient market outcome by taxing consumption of alcohol. This explains why alcohol is one of the most highly taxed goods.Consider education, which creates a positive externality in consumption. That is, educations value to so

3、ciety is greater than the value to private consumers. More education equates with a better informed populace, better government, better behavior, and better citizenship. S D （Social Value） Q* QE Education We can internalize the externality by subsidizing education. This explains why education is one

4、 of the most highly subsidized goods.Now, go back to the first two examples. What could the government do to internalize the externality created by the consumption of historic homes and buildings? What could the government do to internalize the externality created by the production of paper?Actually

5、, there are three options:The Environmental Protection Agency （EPA） could:1. Prohibit pollution all together by setting quotas （q = 0）.2. Regulate paper quantity to be q = qE.3. Tax paper production.Economists prefer the tax. This is because:1. The tax raises revenue.2. With regulations, firms have

6、no incentive to reduce Q below the regulated level. With taxes, factories have incentives to develop better/cleaner technologies.3. The tax is just as effective but more efficient than the quota. That is, both get equal reductions in pollution, but the tax reduces pollution most efficiently.Consider

7、 the following example:International Paper （IP） and Little Pigeon River Paper Mill （LPRPM） each dump 200 tons of pollution in rivers. The cost of reducing a unit of pollution is $100 for IP and $20 for LPRPM. The government wants to reduce pollution by 200. Let T = 50. Then, LPRPM will reduce pollut

8、ion by 200 and IP will reduce pollution by 0. The total cost of pollution reduction is 200（20） = 4,000. If the government required each firm to eliminate 100 units of pollution, then the cost would be 100（100） + 100（20） = $12,000.Now, consider pollution permits. IP still produces 200 tons of polluti

9、on, and their cost of clean-up per ton is still $100. Similarly, LPRPM also produces 200 tons of pollution, and the cost of clean-up per ton is $20. The government wants to limit pollution to 200 tons. An equal reduction would cost $12,000, as seen above. What if IP wants to increase pollution by 10

10、0 tons and LPRPM wants to decrease pollution by 100? Is that O.K.? It makes the firms collectively better off and social welfare is enhanced. Suppose the government issues 100 pollution permits. It doesnt matter how the permits are allocated initially, IP will buy all 100 permits because they are wo

11、rth more to IP than to LPRPM. This internalizes pollution by making it costly to pollute. IP will pay a price for the permits that is between $100 and $20. And, pollution permits will be better than Pigovian taxes if the government knows how much pollution it will allow but it doesnt know the best t

12、ax to set （because they dont know what the demand curve looks like）.Coase Theorem: if private parties can bargain without cost over the allocation of resources, then they can solve the problem of externalities on their own.Consider Richard and Jane and Spot. Spot is Richards dog, but he barks and ke

13、eps Jane up at nights. A negative externality in consumption is created on Jane, the bystander. If BRichardCJane, then let Richard keep the dog. If BRichard CJane, then Richard should get rid of the dog.First, assume B = $100 and C = $150. Jane could offer Richard $120 to get rid of the dog. Then, R

14、ichard would be willing to get rid of the dog and both parties would be better off. If Jane owned the dog, then she would simply get rid of it. So, the outcome doesnt depend on property rights.Second, assume B = $200 and C = $150. Then, Jane couldnt give Richard enough money for him to be willing to

15、 get rid of the dog. That is, Richard should keep the dog, which is the efficient outcome. If Jane owned the dog, then Richard would give her an amount between 200 and 150 to keep the dog, which is the efficient outcome. Again, property rights dont matter with respect to achieving the optimal outcom

16、e for society.When the Coase Theorem doesnt work:1. When transaction costs are high. Suppose Richard and Jane speak different languages and a translator costs $1,000. Then, they shouldnt bargain because its too costly. Certainly lawyers and contracts are costly.2. Imperfect information （bluffing）. L

17、et B = $100 and C = $150. But suppose that Richard claims his benefit is $140. Also, suppose Jane claims the cost is only $110. As they haggle over price and keep bluffing, the barking persists and the efficient outcome is not attained.3. （becomes more difficult） when more parties get involved. Supp

18、ose there are 30 neighbors and 10 other barking dogs. Also, suppose each neighbor either has a different value for B or a different cost of C. Public Goods and Common Resources.Excludable: people can be prevented from using the good.Rival: One persons use of a good diminishes anothers use/enjoyment

19、of it.RivalNon-RivalPrivate Goods: Ice CreamNatural Monopolies: UtilitiesExcludableClothsPhone ServiceCongested Toll RoadsUncongested Toll RoadsCommon Resources: fishPublic Goods: National DefenseNon-ExcludableEnvironmentKnowledgeCongested Non-toll RoadUncongested Non-toll RoadsPublic GoodsConsider

20、fireworks on the 4th of July, which is a public good. The benefit per person is B = $10. The cost is C = $1,000. There are 500 people. Should there be a fireworks display? What is socially optimal? Would the private market result in a fireworks display? No. The government could put it on, and increa

21、se taxes by t = $2.00. The fireworks display creates a positive externality in consumption. Q* QE Fireworks Display National defense is another public good: Cost is $272 billion or $1,035 per person （1995）. Knowledge is another public good. So, the National Institutes of Health and National Science

22、Foundation subsidize knowledge research.The government decides what to provide with cost-benefit analysis.Consider a traffic light, which costs $10,000. If built, engineers estimate that the chance of being fatally injured in a traffic accident will fall from 1.6 percent to 1.1 percent. Should we pu

23、t this traffic light up? If we place infinite value on human lives, should we put a light on every corner? What is the value of a human life?Common Resources The tragedy of the commons （medieval times）: a town had common land on which each member of the town grazed their sheep. But, too many seep ma

24、de the common land barren and the town lost its livelihood. Common resources create negative externalities in production. T D QE Q* Livestock （sheep） So, the government could solve this externality by: Taxing land Dividing the land among the pheasants, as was done in England （private ownership works

25、 best）.This explains the failure of communism it is related to the tragedy of the commons.Other common resources:1. clean air and water2. common oil pools3. fish, whales, buffalo, and elephants （ivory tusks）.Why are buffalo and elephants on the verge of becoming extinct but cows are not?Consider the

26、 market for cows: Price, $ S （Private Cost and Social Cost） Q* = QE Cows No externality here because there is private ownership. QE Q* Buffalo/Elephants Market output is too high and buffalo/elephants are becoming extinct.What are African governments doing about this? In Kenya, Tanzania, Uganda it is illegal to kill elephants In Botswana, Malawi, Nambia, and Zimbabewe, elephants have been privatized by making ownership of elephants according to the owner of the land.Problem Set 6:1. Depict the supply and de