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Presentation
Chapter Five
Externalities
Submitted To
:
Mrs. Shagufta
shaheen Submitted By :
Arafat Alam
Lecturer, Section : A,
Roll : 114,
Department of
Banking and
Insurance,
University of Dhaka.
What is an Externality?
An EXTERNALITY occurs when:
4
Theory - Externality Features
Externalities carry a variety of rarely
considered features:
1) EXTERNALITIES CAN BE PRODUCED BY
CONSUMERS AS WELL AS FIRMS
2) EXTERNALITIES ARE RECIPROCAL IN
NATURE
3) EXTERNALITIES CAN BE POSITIVE OR
NEGATIVE
4) PUBLIC GOODS CAN BE Viewed AS A
SPECIAL KIND OF EXTERNALITIES
5
Math - Graphical Analysis of Externalities:
When an entity consumes a good with a negative
externality, he only equates marginal benefit
(MB) and his Private Marginal Cost (PMC) and
consumes at Q1.
SMC=PMC+MD
$
PMC Society, however,
experiences Marginal
MD
Damage (MD), and
therefore Social
MB Marginal Cost (SMC) is
Q* Q1 Q higher than PMC.
Efficient consumption therefore occurs where
SMC=MB, at point Q*. 6
Theory - Private Responses to
Externalities
7
1) Assigning Property Rights
One way to privately deal with externalities
is for one party to be given OWNERSHIP
or PROPERTY RIGHTS of the market the
externality exists in.
8
$ SMC
PMC
MD
MB
Q* Q1
9
Private Responses to Externalities
11
2) Private Response: Merger
One way to internalize an externality
is to combine involved parties. For
example, if one firms actions caused an
externality to another, the two firms
could merge (through buyout or a 3rd
party)
13
Public Responses to Externalities
If private responses to externalities dont
work or dont occur, there are a variety
of ways the government can intervene,
including:
1) Taxes
2) Subsidies
14
1) Public Response: Taxes
15
$ SMC PMC+Subsidy
PMC
MD
Subsidy Cost
Subsidy
MB
Q*
16
2) Public Response: Subsidies
MD
Subsidy Cost
Subsidy
MB
Q*
18
Public Responses to
Externalities
1. Emissions fee: A tax levied on each unit of
pollution
2. Cap and- trade: An alternative policy to an
emissions fee is for government to require two
person are submitted one government issued
permit for each unit of pollution they emit
3. Command and control regulation: Policies
that require a given amount of pollution
reduction with limited or no flexibility with
respect to how it may be achieved
Theory - Income Distribution Effects
Although government is responsible to
ensure efficiency in the case of
externalities, it is also responsible to
take into account the distribution effects
of its policies
1) Who benefits?
2) Who bears the cost 20
Theory - Positive Externalities
Although negative externalities are
most often discussed, positive
externalities can also lead to inefficiency
21
$
MC
SMB=PMB+EMB
EMB PMB
Security
Q1 Q*
22
Thank
you