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Lecture Economics: Chapter 18 - Dean Karlan, Jonathan Morduch

Chapter 18 - Externalities. After studying this chapter you will be able to understand: How external costs and benefits affect tradeoffs? What effects externalities have on market price, quantity, and surplus? What private solutions to externalities exist? How taxes, subsidies, quantity regulations, and tradable allowances can be used to counteract an externality? | Chapter 18 Externalities © 2014 by McGraw-Hill Education 1 What will you learn in this chapter? • How external costs and benefits affect tradeoffs. • What effects externalities have on market price, quantity, and surplus. • What private solutions to externalities exist. • How taxes, subsidies, quantity regulations, and tradable allowances can be used to counteract an externality. © 2014 by McGraw-Hill Education 2 What are externalities? • When individuals make calculated decisions, they weigh the costs and benefits of the action. – Private benefit that accrues directly to the decision maker. – Private cost that falls directly on an economic decision maker. • Sometimes other people are affected by our decisions or have a stake in the outcomes. – External cost describes a cost imposed without compensation on someone other than the person who caused it. – External benefit describes a benefit that accrues without compensation to someone other than the person who caused it. © 2014 by McGraw-Hill Education 3 1 External costs and benefits • The total cost of a decision, the social cost, includes both private costs and external costs. • The total benefit of a decision, the social benefit, includes both private benefits and external benefits. • External costs and external benefits are collectively referred to as externalities. – Negative externality: external costs. – Positive externality: external benefits. • A network externality is the effect that an additional user of a good or participant in an activity has on the value of that good or activity for others. – Can be positive or negative. © 2014 by McGraw-Hill Education 4 Negative externality from the demand side How can drivers be forced to consider external costs, and thus operate on the social demand curve? • The most straightforward option is to implement a gasoline tax. Market with private costs only Price ($/gal.) Tax Sprivate Market with social costs 1. If drivers bear full social costs, the .