public finance5

CHAPTER 5
Externalities
McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.
Externalities
• Externality – An activity on one entity that affects the welfare of another entity in a way that is outside the market mechanism • Not an Externality – suburban-urban migration example
• Empirical Evidence: What is the Effect of Pollution on Health? • What Activities Produce Pollutants? • What is the Value of the Damage Done? • Empirical Evidence: The Effect of Air Pollution on Housing Values
– The costs to the parties of bargaining are low – The owners of resources can identify the source of damages to their property and legally prevent damages
Public Responses to Externalities- Emissions Fee
$ MC
f*
MSB 0 e* Pollution reduction
Emissions Fees ContinuedUniform Pollution Reductions
MCH
Bart’s Tax Payment MCB f= $50 f= $50
MC’ $ MC*
f*
MSB 0 ef e’ e* Pollution reduction Too much pollution reduction
Too little pollution reduction
Emissions Fee v Cap-andTrade
• • • • Responsiveness to Inflation Responsiveness to Cost Changes Responsiveness to Uncertainty Distributional Effects
Homer’s Taxrt’s pollution reduction
25
50
75
90 Homer’s pollution reduction
Public Responses to Externalities- Cap-and-Trade
MCH b
MCB f= $50 a 10 50 75 90 Bart’s pollution reduction 25 50 75 90 Homer’s pollution reduction f= $50
– Emissions fee – Cap-and-Trade
• Policy Perspective: Addressing Climate Change
Command-and-Control Regulation
• Incentive-based regulations • Command-and-control regulations
Progress with Incentive-Based Approaches
• Policy Perspective: Cap-and-Trade for Sulfur Dioxide
Implications for Income Distribution
• Who Benefits? • Who Bears the Cost?
Cap-and-Trade vs. Emissions Fee
MC’ $ MC*
f*
MSB 0 ef e’ e* Too little pollution reduction Pollution reduction Too much pollution reduction
Cap-and-Trade v Emissions Fee
i j
d c
MD
MB 0 Q* Q1 Q per year
Public Responses to Externalities - Subsidies
MSC = MPC + MD $ Pigouvian subsidy d c k f g h (MPC + cd) MPC
i j
MD
MB 0 e Q* Q1 Q per year
Positive Externalities
$ MC
MSB = MPB + MEB MPB MEB R1 R* Research per year
A Cautionary Note
• Requests for subsidies
– Resource extracted from taxpayers – Market does not always fail
Bargaining and the Coase Theorem
MSC = MPC + MD $ MPC
h d c g MD
MB 0 Q* Q1 Q per year
The Coase Theorem
• Coase Theorem – Provided that transaction costs are negligible, an efficient solution to an externality problem is achieved as long as someone is assigned property rights, independent of who is assigned those rights • Assumptions necessary for Coase Theorem to work
• Policy Perspective: Owner-Occupied Housing
The Nature of Externalities-Graphical Analysis
MSC = MPC + MD $ MPC
h d c g MD
0 Socially efficient output
b a Q*
f e Q1 Actual output
MB Q per year
What Pollutants Do Harm?
– Technology standard – Performance standard
• Is command-and-control ever better?
– Hot spots
The U.S. Response
• Clean Air Act
– 1970 amendments – Command-and-control in the 70s – How well did it work?
The Nature of Externalities
• Privately-owned versus commonly-owned resources • Externalities can be produced by consumers as well as firms • Externalities are reciprocal in nature • Externalities can be positive • Public goods can be viewed as a special kind of externality
Other Private Solutions
• Mergers • Social conventions
Public Responses to Externalities - Taxes
MSC = MPC + MD $ Pigouvian tax revenues (MPC + cd) MPC