EXTERNALITIES 1

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0 10 20 30 Q (gallons)

P $

The market for gasoline

Analysis of a Negative Externality

D

S

Social cost

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A C T I V E L E A R N I N G 1

Analysis of a positive externality

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The market for flu shots

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0 10 20 30

P

Q

$External benefit

= $10/shot

Draw the social value curve.

Find the socially optimal Q.

What policy would internalize this externality?

Collectively, the 1000 residents of Green Valley value swimming in Blue Lake at $100,000.

A nearby factory pollutes the lake water, and would have to pay $50,000 for non-polluting equipment.

A. Describe a Coase-like private solution.

B. Can you think of any reasons why this solution might not work in the real world?

A C T I V E L E A R N I N G 2

Applying Coase

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In each case, identify which worker would earn more and explain why.

A. The best physical therapist on the planet or the best writer on the planet

B. A trucker that hauls produce or a trucker that hauls hazardous waste from nuclear power plants

C. A graduate of an Ivy League college or an equally intelligent & capable graduate of a state university

D. Someone who graduated from a state university with a 3.7 GPA, or someone who graduated from the same university with a 2.4 GPA

A C T I V E L E A R N I N G 2

Explaining wage differentials

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