The Economics of Pollution
Is it a legitimate goal to have zero pollution in society?
- Pollution, just like most things in economics, is a "how much" question that requires benefit/cost analysis
Marginal social cost of pollution
additional cost imposed on society created by a unit of pollution
ie. acid rain harms crops and forests
Marginal social benefit of pollution
additional benefit to society from a unit of pollution
ie. pollution avoidance incurs an opportunity cost and is expensive
Socially optimal quantity of pollution
point at which marginal social cost (MSC) equals the marginal social benefit (MSB)
MSB = MSC
Socially Optimal Quantity of Pollution
Upward-sloping MSC curve
Downward-sloping MSB curve
Intersection of MSC and MSB is socially optimal point
Market-determined quantity of pollution is where MSB is x-axis
Not allocatively efficient: Q too high, Price too low
In the absence of government intervention, the quantity of pollution will be QMKT, the level at which the marginal social benefit of pollution is zero.
This is an inefficiently high quantity of pollution: the marginal social cost, $400, greatly exceeds the marginal social benefit $0.
An optimal Pigouvian tax of $200, the value of the marginal social cost of pollution when it equals the marginal social benefit of pollution, can move the market to the socially optimal quantity of pollution, QOPT
Negative Externality vs. Positive Externality
a decision that a firm or individual makes that imposes a cost to "society" as a whole (ie. the decision to pollute)
Impact is similar to that of a supply shift to the left on a supply and demand graph
Market price too low, Market Quantity too high
a decision that an individual or firm makes that yields positive benefits to society (ie. the decision to attend college and become a productive citizen)
Impact is similar to that of a demand shift to the right on a supply and demand graph
Market price too low, market quantity too low
By what means would the government be able to correct a nagative externality?
By what means would the government be able to encourage a positive externality?
Private (or Coase) Solution
- Even in the presence of externalities, an economy can be efficient (assuming low transaction costs) by internalizing the externalities
Let's say that Jeff and Chris are neighbors in Chino Hills and that Jeff enjoys throwing loud parties wile Chris does not
Chris does not enjoy the music but Jeff has a legal right to play loud music, so Chris can play Jeff a payment equal to the external cost he imposes on him
Or, if Jeff does not have a legal right to play loud music, Jeff can pay Chris an amount equal to the cost the music imposes on Chris
- named after economist A.C. Pigou, these taxes were designed to reduce external costs
Negative Externality Example
MSC = MPC + MEC
MSC: Marginal Social Cost
MPC: Marginal Private Cost
MEC: Marginal External Cost
Smoking cigarettes is considered a negative externality
An optimal Pigouvian tax charges where MSC = D, so that less quantity is consumed at a higher price
Positive Externality Example
MSB = MPB + MEB
MSB: Marginal Social Benefit
MPB: Marginal Private Benefit
MEB: Marginal External Benefit
Getting a flu shot not only benefits you but also reduces the number the number of others getting the flu by as much as 1.5
Getting a flu shot is considered a positive externality
An optimal Pigouvian subsidy intersects where MSB = S. Lower prices encourages consumption
Draw a correctly labeled graph of the market for dog barking contests that is perfectly competitive. If neighbors are disturbed by dog barking, draw the marginal social cost curve, labeled MSC. Label the marginal social benefit curve, labeled MSB, and shade in the deadweight loss or DWL, if any.
Draw a correctly labeled graph of the market for dog barking contests that is perfectly competitive. If neighbors now enjoy dog barking, is the market equilibrium greater, less than or equal to the socially optimal quantity? If the government bans dog barking, will the deadweight loss increase, decrease, or remain unchanged?
Market equilibrium is less than optimal
Deadweight loss will increase
Assume that the market for paper bags is perfectly competitive and that they create a negative externality. Draw a graph that includes the MPC and MSC, as well as the market quantity, Qm. Label the allocatively efficient quantity as Qs and shade the area of deadweight loss and label as DWL. If a lump-sum tax is imposed, what happens to DWL?
- Allocatively efficient: MSC = MSB
The DWL stays the same