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Understanding Externalities: The Economics of Pollution and Private Solutions

This module explores the concept of externalities, particularly focusing on the economics of pollution. Environmentalists argue that unregulated electricity producers overpollute, while producers claim regulations hinder cost-effective production. Economists suggest a cost-benefit analysis approach to determine the socially optimal pollution level where Marginal Social Costs (MSC) intersect with Marginal Social Benefits (MSB). Additionally, the module discusses the Coase Theorem, which proposes that private solutions to externalities can be achieved under certain conditions, including well-defined property rights and low transaction costs.

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Understanding Externalities: The Economics of Pollution and Private Solutions

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  1. AP Economics Mr. Bernstein Module 74: Introduction to Externalities January 15, 2014

  2. AP EconomicsMr. Bernstein The Economics of Pollution • Environmentalists argue unregulated electricity producers overpollute because they do not consider harmful effects • Producers argue regulation interferes with ability to produce at lowest cost • Economists view as topic for cost-benefit analysis where the socially optimal level is where Marginal Social Costs (MSC) intersect with Marginal Social Benefits (MSB)

  3. AP EconomicsMr. Bernstein The Economics of Pollution • MSC curve is upward sloping • MSB curve is downward sloping (~ cleanup cost savings?) • Will society reach OOPT? • NO! (Note optimal pollution is not 0)

  4. AP EconomicsMr. Bernstein The External Costs of Pollution • Negative Externality is an uncompensated cost that a firm or individual imposes on others • Pollution from an Ohio River electricity plant lands on Jersey residents who do not benefit from the electricity • The unregulated market does not care about the pollution costs and produces until MSB = 0

  5. AP EconomicsMr. Bernstein MSC $1000 The External Costs of Pollution • Society would gain the entire shaded triangle if pollution is reduced from Qmkt (MSB=0) to Qopt MSC=MSB MSC and MSB of pollution MSB Qmkt Qopt Qty of Pollution Emitted (tons)

  6. AP EconomicsMr. Bernstein Private Solutions to Externalities • Coase Theorem • Ronald Coase (1960) • Requires clearly defined property rights plus minimal transactions costs • A private solution can be worked out (ie $$ settlement) • Hurdles include communication problems, high legal costs, delaying tactics

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