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Intermediate Microeconomics


14. Externalities


An externality is the uncompensated impact of one person's actions on the well-being of a bystander. For example, a polluting firm confers a negative externality on society, as its output produces an external cost that it does not take into account when determining how much to produce. An example of a positive externality is education. Increased levels of educational attainment produce positive spillover effects, as people with higher levels of educational attainment are less likely to commit crime, more likely to work, less likely to receive public assistance and are more likely to vote (this list is not exhaustive). In the Screencasts/Pencasts that follow, we will cover implications of negative and positive externalities on market outcomes, demonstrate mathematically how to solve for the social optimum in the presence of externalities, investigate the welfare consequences associated with externalities, and discuss policies designed to combat the inefficiency caused by externalities.


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Negative Externality: Mathematical Example

This Pencast shows how to derive the social cost curve, and it demonstrates how to solve for the socially optimal price and quantity under the presence of a negative externality. [Play Pencast]


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Negative Externality: Graphical Analysis

This Pencast illustrates the effects of a negative externatility in a competitive market. The tool of welfare accounting is applied to identify the deadweight loss caused by the external cost. [Play Pencast]


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Negative Externality in a Market Controlled by One Seller

This Pencast compare competitive and monopoly equilibrium in relation to the social optimum when a negative externality is present. [Play Pencast]


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Positive Externality: Mathematical Analysis

This Pencast shows how to derive the social value curve, and it demonstrates how to solve for the socially optimal price and quantity under the presence of a positive externality. [Play Pencast]


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Positive Externality: Graphical Analysis

This Pencast illustrates the effects of a positive externatility in a competitive market. The deadweight loss caused by buyers that do not internalize the spillover effects is identified. [Play Pencast]


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Corrective Taxes

This Pencast illustrates how a corrective (or Pigouvian) tax can be used to move the market to the social optimum. [Play Pencast]


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Corrective Subsidies

This Pencast illustrates how a corrective (or Pigouvian) subsidy can be used to move the market to the social optimum. [Play Pencast]


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