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Instructions:  View instructions on the section padlet.

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Instructions:  View instructions on the section padlet.

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Team:  Students will do one chapter per section.  View your assigned padlet at this link.

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Team:  Students will do one chapter per section.  View your assigned padlet at this link.

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A side effect on bystanders whose interests aren't fully taken into account.

Negative externality: an activity whose side effects harm bystanders. Goods that produce negative externalities are overproduced.

Positive externality: an activity whose side effects benefit bystanders Goods that produce positive externalities are underproduced.

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Marginal private costs: the extra cost paid by a seller from one extra unit

External cost: a cost imposed on bystanders

Marginal external costs: the extra external cost imposed on bystanders from one extra unit

Marginal social cost: all marginal costs, no matter who pays them = marginal private cost + marginal external cost

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Marginal private benefits: the extra benefits enjoyed by the buyer from one extra unit

External benefit: a benefit accruing to bystanders

Marginal external benefit: the extra external benefit accruing to bystanders from one extra unit

Marginal social benefit: all marginal benefits, no matter who gets them = marginal private benefit + marginal external benefit

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The outcome that is most efficient for society as a whole, including the interests of buyers, sellers, and bystanders

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Produce more of an item as long as its marginal social benefit is at least as large as the marginal social cost

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Three-step Recipe for Analyzing Externalities 

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Three-step Recipe for Analyzing Externalities 

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1: Predict the equilibrium outcome to forecast what you think will happen

2: Assess what externalities are involved

3: Find the socially optimal outcome that is in society's best interest, and then compare this to the equilibrium forecast from the first step

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Solutions to the Externality Problem, Which Rely on Internalizing the Externality 

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Solutions to the Externality Problem, Which Rely on Internalizing the Externality 

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When someone cannot be easily excluded from using something

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A good for which one person's use doesn't subtract from another's

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When someone can enjoy the benefits of a good without bearing the costs. Free riders are bystanders enjoying positive externalities.

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A good for which your use of it comes at someone else's expense

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A nonrival good that is nonexcludable and hence subject to the free-rider problem

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A good that is excludable, but nonrival in consumption

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Goods that are rival and also nonexcludable

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The tendency to over consume a common resource. Ownership rights solve the tragedy of the commons

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In order to avoid the negative externalities produced by gas-fueled cars, Italy is offering a subsidy for citizens that choose to buy electric cars

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ROME, March 8 (Reuters) - Italy plans to subsidise up to 6,000 euros ($6,570) of the purchase price of new electric vehicles as part of its plan to support the country's automotive industry, a government source said on Tuesday.

Rome has set aside 8.7 billion euros until 2030, including around 700 million euros for this year, to support its carmaking industry.

The subsidy of up to 6,000 euros is subject to the purchase of new vehicles costing up to 35,000 euros and includes a 2,000 euro contribution linked to the scrappage of a polluting combustion-engine car.

The purchase of hybrid electric vehicles costing up to 45,000 euros will be subsidised with up to 2,500 euros, while the plan also includes incentives of 1,250 euros for state-of-the art combustion-engine (Euro6) cars when older vehicles are scrapped, the source said.

($1 = 0.9136 euros)

Reporting by Giuseppe Fonte, Writing by Giulio Piovaccari, Editing by Paul Simao

Our Standards: The Thomson Reuters Trust Principles.

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Italy to give new electric car buyers subsidy of up to 6,000 euros

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ROME, March 8 (Reuters) - Italy plans to subsidise up to 6,000 euros ($6,570) of the purchase price of new electric vehicles as part of its plan to support the country's automotive industry, a government source said on Tuesday. Rome has set aside 8.7 billion euros until 2030, including around 700 million euros for this year, to support its carmaking industry.

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Negative externalities impose costs on others. Some examples are: if I stand up at a concert in front of you, you won't be able to see to enjoy it; If I smoke near you, my secondhand smoke could cause you to get cancer; If I drive a big SUV vs a small car, you are more likely to get seriously hurt if we collide. People don't think about the negative externalities that their choices may cause very often.

Positive externalities also affect others by your decisions, but the side effects are positive instead of negative. Some examples would be: When you plant a tree it helps to create healthier air quality for others; If you buy a big screen tv, the other people in the house get to enjoy it too; If you exercise and become healthier, your health insurer will need to pay less for your medical costs. People again still don't think about the effects of their decisions, even when it's good, on others. With this they tend to do less things that will be socially beneficial.

Price changes are not externalities. The benefits for one offsets the negative for the other. If housing prices rise, it benefits the seller, but negatively affects the buyer.

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It is always important to remember that price changes are not externalities because people tend to make this mistake a lot.

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Positive and Negative Externalities Defined & Explained in One Minute: Education vs. Pollution?

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Six insights for dealing with externalities

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Six insights for dealing with externalities

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Insight one: Don’t intervene if you don’t need to.
If people can use private bargains to solve an externality problem, let them. This is most likely to succeed when transaction costs are small and the benefits to solving the problem are large. In the tragedy of the commons, assigning ownership rights facilitates private bargains between individuals.

Insight two: Complementing market forces is better than hindering them.
If you’re going to intervene, solutions like corrective taxes and subsidies, or cap-and-trade programs complement market forces. This is usually better than regulations or government provision, which hinder market forces. That’s because competition between suppliers helps ensure that output will be produced by those who can do so at a lower social cost, and competition between buyers ensures it will be allocated to those who value that output the most. Alternatively phrased, your analysis of externalities points to a better destination for society. Competition can find the most efficient path to get there.

Insight three: The right tool depends on what you’re uncertain about.
Use corrective taxes (or subsidies) when you are more confident that you know the marginal external costs (or benefits), but use quantity restrictions like cap and trade when you are more confident about the socially optimal quantity.

Insight four: Consider costs and benefits of regulations or public goods.
When market-based solutions aren’t possible, consider either regulations or direct provision of public goods, but only if the benefits exceed the costs.

Insight five: Target outcomes, not specific processes.
If you tell people what to do, they’ll do it. But if you tell them what outcome to achieve, they might find more efficient ways to achieve it. For instance, we’ve analyzed how either a tax on gasoline or a quota on gas usage would reduce emission of greenhouse gases. But if you care about reducing greenhouse gases, an even better solution would be a tax or a cap on greenhouse gas emissions. Why? It could be that businesses have other lower-cost ways to reduce emissions of greenhouse gases than cutting back on gas use.

Insight six: Ensure there’s an incentive to innovate.
Relatedly, you want to ensure there’s always a robust incentive for businesses to innovate and discover new ways to solve externality problems. Policies that tell businesses what you want to achieve give them scope to innovate by figuring out how. By contrast, regulations that tell them what to do, or taxes or caps on specific processes, reduce this incentive.

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My family back home has an organic vineyard and an apple orchard. This has created a lot of positive externalities for our family and the community we live in. Some of the positive effects include less consumption of apples from the store that could have harmful chemicals on them, keeping my family healthier and more active. Also, our neighbor keeps bees during the summer so since we don't spray our grapes with chemicals, we protect them and give them pollen. I hope this is a good example of going deeper into thinking about the external factors in our everyday lives. (:

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Market failures arise because the interests of bystanders are ignored or underweighted.

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Private bargaining involves mergers, side payments, Coase Theorem, and strategic investments.

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Private bargaining involves mergers, side payments, Coase Theorem, and strategic investments.

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The majority of economic arguments for government intervention are based on the belief that the market cannot supply public goods or deal with externalities. Public health and welfare programs, education, roads, R&D, national and domestic security, and a clean environment have all been designated as public goods.
There are two unique characteristics to public goods: "nonexcludability" and "nonrivalrous consumption." Nonpayers cannot be excluded from the benefits of the good or service due to nonexcludability. People can see a fireworks display, for example, from their windows or backyards if a business organizes one. Because the entrepreneur cannot charge a price for consumption, the fireworks display may go unproduced, even if there is a high demand for it. The fireworks scenario exemplifies the "free-rider" issue. Even if the fireworks show is worth ten dollars to each person, no one will pay the entrepreneur ten dollars.
The second feature of public goods is nonrivalrous consumption, as defined by economists. Assume the entrepreneur is successful in keeping noncontributors from watching the show (perhaps one can see the show only from a private field). Entrance to the field will be levied a fee, and any who refuse to pay will be turned away. Exclusion, on the other hand, is inefficient if the field is large enough because nonpayers could see the show without increasing the program's cost or lowering anyone else's enjoyment.