C.  Externalities, Environmental Policy, and Public Goods

• Market failure - markets fail to produce efficient level of output

1.  Externalities

• Benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service

- Negative externality - transaction leads to an external cost being generated

Ex. - Pollution

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- Positive externality - transaction leads to an external benefit being generated

Ex. - Art, college enrollment

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a.  Effect of externalities

(1) Negative externalities

• Private cost - cost borne by the producer of a good or service

• Social cost - cost borne by society as a whole, includes both private and external costs

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(2) Positive externalities

• Private benefit - benefit received by the consumer of a good or service

• Social benefit - benefit received by society as a whole, includes both private and external benefits

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b.  Impact of property rights

• Rights individuals or businesses have to the exclusive use of their property

• Externalities occur when property rights do not exist or cannot be legally enforced

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c.  Private solutions

• Economically efficient level of pollution reduction

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• Coase Theorem - private bargaining will lead to an efficient solution

- Doesn't matter who has the property rights

- Could be a problem if transactions costs are high

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d.  Government policies

(1)  Negative externalities

• Use taxes to deal with impact of negative externalities

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(2)  Positive externalities

• Use subsidies to deal with impact of positive externalities

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• Pigouvian taxes and subsidies - use of taxes and subsidies to achieve efficient result when dealing with externalities

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e.  Other alternatives

(1)  Command and control

• Government sets quantitative limits

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(2)  Tradable emissions allowances

• Set overall limit on missions, give polluters rights to pollute, allow rights to be traded in market

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2.  Public goods

a.  Categorizing goods

(1)  Rivalry - one person consuming a good means no one else can consume it

(2)  Excludability - anyone who doesn't pay for a good can't consume it

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b.  Demand for a public good

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c.  Optimal quantity of a public good

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d.  Common resources

• Rivalry, but nonexcludability

Ex. - Pasture

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• Tragedy of the commons - common resources tend to be overused

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