IV. Externalities
A. Externalities are costs
or benefits not accounted for in the price of a product
that accrue to those outside or
external to the market
place.
B. Please review Part IV of
6)
Government's Economic Functions for an analysis of government action to
decrease
externality costs and increase externality benefits
C.
Econ Concepts in 60 Seconds Video on
Negative Externalities (Spillover Costs)
D. Coase's
Theorem
1. Analysis
by Ronald Coase revealed that government should not get involved
with disputes over externality costs
when property ownership
is well-defined and the number of people involved is
small.
2. He demonstrated
that individual maximizing behavior would correct these problems.
3. The government should only
be involved when the number of participants is so large
as to make bargaining costs
prohibitive.
4. For
example, the government should not get involved in a noise pollution problem
near an amusement park because
of the small number of people
involved but should get involved with acid rain generated
in the Midwest and falling into
New England because of the large number of people
involved.
5. Read
The World According to Coase,
Illustration of the Coase Theorem
for more information and
Orange Blossom Special: Externalities and the
Coase Theorem
how ronald coase demolished current libertarian ideas about property
6.
Coase theorem - from Wikipedia has additional information.
E. Solving the pollution
problem
Orange Blossom Special: Externalities and the Coase Theorem
1.
The market solution
a. First, taking into account diminishing returns, calculate
the economically tolerable level of pollution acceptable
to society. This can be done by comparing the marginal costs to society of
pollution
(supply), which increases
with more anti-pollution
spending, with the marginal gain
to society of a clean environment (demand), which
decreases with additional spending.
b. The resulting quantity of acceptable pollution would be
fixed and sold as "rights" to pollute.
c. Industrialization causes an increase in the demand to
pollute and with a fixed supply, the costs of rights to
pollute
would increase.
d. Those who want goods that pollute would simply have to pay!
