![]() An alternative would be to impose a corrective tax on the good whose production causes the externality: With an appropriate increase in the price, consumers will demand a reduced quantity. In this particular example, the total cost of the tolerated pollution equals the area between the private and full supply functions, K E ×VR.Īs a matter of policy, how is this market influenced to produce the amount Q × rather than Q 0? One option would be for the government to intervene directly with production quotas for each firm. ![]() Economists do not advocate such a zero-pollution policy rather, we advocate a policy that permits a "tolerable" pollution level – one that still results in net benefits to society. If the government decreed that, instead of producing Q ×, no pollution would be tolerated, then society would forgo the possibility of earning the total real surplus equal to the area U E ×K. However, an efficient outcome may not involve a zero level of pollution! If the production of power were reduced below Q ×, the loss in value to buyers, as a result of not being able to purchase the good, would exceed the full cost of its production. Note that some pollution is being created here, and environmentalists frequently advocate that pollution should be reduced to zero. Next, consider the consequences of reducing output further from Q ×. Accordingly, if the last unit of output produced is cut, society gains by the amount A E 0, because the cut in output reduces the excess of true cost over value.Īpplying this logic to each unit of output between Q 0 and Q ×, it is evident that society can increase its well-being by the dollar amount equal to the area E ×A E 0, as a result of reducing production. The full cost, as represented by S f, exceeds the buyer's valuation. ![]() But from a societal standpoint there is a pollution/health cost of A E 0 associated with that unit of production. At Q 0 the willingness of buyers to pay for the marginal unit supplied is E 0. To see why, consider the impact of reducing output by one unit from Q 0. This implies that low levels of pollution do less damage per unit: Perhaps the population has a natural tolerance for low levels, but higher levels cannot be tolerated easily and so the cost per unit is greater.ĭespite the externality, an efficient level of production can still be defined. Note also that this illustration assumes that, as power output increases, the external cost per unit rises, because the difference between the two supply curves increases with output. Of course, we are assuming that this external cost is ascertainable, in order to be able to characterize S f accurately. In Figure 5.5, the supply curve S represents the cost to the supplier, whereas S f (the full cost) reflects, in addition, the cost of bad air to the population. ![]() If an oil driller knows that the price of oil will rise sharply in ten years, he has an incentive to conserve oil instead of selling it today.\) Similarly, as long as resources are privately owned, firms balance their current profits of logging and drilling against their future profits. If the price of aluminum cans fails to spark recycling, that suggests that the cost of recycling-including human effort-is more than the benefit. The people who enjoy national parks are visitors, who can easily be charged for admission. ![]() The externalities of many environmentalist measures, including national parks, recycling, and conservation, are hard to discern. Educated workers are more productive, but this benefit is hardly “external” markets reward education with higher wages. Prevention and treatment of contagious disease has clear externalities, but most health care does not. Other common candidates include health care, education, and the environment, but claims that these are externalities are much less tenable. ![]()
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