[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Consider what happens if, in the production of steel, there is an
externality—producers are polluting the air and water without penalty.
The social marginal cost—the marginal cost borne by all individuals in
the economy—will now exceed the private marginal cost—the marginal
cost borne by the producer alone. Note that in a competitive industry,
the supply curve corresponds to the horizontal sum of all producers’ private
marginal cost curves. Panel B contrasts the two situations. It shows
the social marginal cost curve for producing steel lying above the private
marginal cost curve. Thus, with social marginal costs equated to social
marginal benefits, the economically efficient level of production of steel
will be lower, at Q s , than it would be, at Q p , if private costs were the
only ones.
The level of production of steel, which generates negative externalities,
will therefore be too high in a free market. We can also ask, What
about the level of expenditure on pollution abatement? Such expenditures
confer a positive externality—the benefits of the equipment, the
cleaner air, accrue mainly to others. Figure 18.2 shows a firm’s demand
curve for pollution-abatement equipment in the absence of government
regulation. It is quite low, reflecting the fact that the firm itself derives
little benefit. That is, the firm’s marginal private benefit from expenditures
on pollution-abatement equipment is small. The firm sets its marginal
private benefit equal to the marginal cost of pollution abatement,
which results in a level of expenditure on pollution abatement at E. The
figure also depicts the marginal social benefit of pollution abatement,
PRICE OF POLLUTION-ABATEMENT
EQUIPMENT
which is far greater than the marginal private benefit. Efficiency requires that the
marginal social benefit equal the marginal cost, point E′. Thus, economic efficiency
requires greater expenditures on pollution abatement than there would be in the
free market.
One of government’s major economic roles is to correct the inefficiencies resulting
from externalities. Among the many types of negative externalities, perhaps the
most conspicuous are those that harm the environment.
E
Figure 18.2
Supply curve
(marginal cost
of equipment)
Society’s demand
curve (social
marginal benefit
of equipment)
Firm’s demand curve
(private marginal benefit
of equipment)
QUANTITY OF POLLUTION-ABATEMENT EQUIPMENT
HOW POSITIVE EXTERNALITIES CAUSE
UNDERSUPPLY
The private marginal benefit includes just the benefits
received by the firm; but since pollution-abatement
equipment provides a positive externality, it will
have a social marginal benefit that is higher. If the
firm takes only its private benefit into account, it will
operate at point E, using less equipment than at the
point where marginal benefits are equal to marginal
costs for society as a whole (E’).
E'
Policy Responses to Problems in
the Environment
As the negative externalities associated with pollution and other environmental
issues are increasingly recognized, the various approaches of governments seeking
to curtail their bad effects have received considerable attention from economists
and others. This section evaluates several of the major options.
PROPERTY RIGHTS RESPONSES
Large-scale environmental degradation is a conspicuous form of negative externalities.
Having identified these market failures, what can the government do to improve
POLICY RESPONSES TO PROBLEMS IN THE ENVIRONMENT ∂ 407