Page 208 - The Principle of Economics

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PART FOUR THE ECONOMICS OF THE PUBLIC SECTOR
Price of Alcohol
0
QOPTIMUM
QMARKET
Quantity of Alcohol
Price of Education
0
QMARKET
QOPTIMUM
Quantity of Education
(a) Negative Consumption Externality
(b) Positive Consumption Externality
Supply (private cost)
Demand (private value)
Social value
Supply (private cost)
Social value
Demand (private value)
CONSUMPTION EXTERNALITIES. Panel (a) shows a market with a negative consumption externality, such as the market for alcoholic beverages. The curve representing social value is lower than the demand curve, and the socially optimal quantity, QOPTIMUM, is less than the equilibrium quantity, QMARKET. Panel (b) shows a market with a positive consumption externality, such as the market for education. The curve representing social value is above the demand curve, and the socially optimal quantity, QOPTIMUM, is greater than the equilibrium quantity, QMARKET.
Figure 10-4
or consumption lead markets to produce a smaller quantity than is socially desirable. To remedy the problem, the government can internalize the externality by taxing goods that have negative externalities and subsidizing goods that have positive externalities.
QUICK QUIZ: Give an example of a negative externality and a positive externality. N Explain why market outcomes are inefficient in the presence of externalities.
PRIVATE SOLUTIONS TO EXTERNALITIES
We have discussed why externalities lead markets to allocate resources ineffi- ciently, but have mentioned only briefly how this inefficiency can be remedied. In practice, both private actors and public policymakers respond to externalities in various ways. All of the remedies share the goal of moving the allocation of re- sources closer to the social optimum. In this section we examine private solutions.
THE TYPES OF PRIVATE SOLUTIONS
Although externalities tend to cause markets to be inefficient, government action is not always needed to solve the problem. In some circumstances, people can de- velop private solutions.