Chapter in a Nutshell

So far, this book has described consumption and production of goods where all of the costs and benefits are borne directly by those who do the consuming and producing. However, many types of consumption and production activities spill over to affect third parties. These unintended spillover effects are called economic externalities by economists. Externalities may be negative or positive for third parties. For example, a negative externality might be having Beavis and Butthead in the dorm room next to yours coming home late at night and playing AC/DC and Metallica when you have an economics exam at 8:00 a.m. the next day. An example of a positive externality is your dorm neighbors playing the same music (assuming you like AC/DC and Metallica) when you are in a mood to have fun, not sleep. If you like these bands and your rowdy neighbors play them regularly, then you can be a free rider, enjoying the benefits of hearing the music without paying for them.

Negative externalities impose costs on third parties for which they aren't compensated. Positive externalities are benefits that third parties enjoy without having to pay. In either case, the market has failed. Because no one pays for the costs resulting from negative externalities, too much of these types of activities occurs in a market. On the other hand, because people who create positive externalities aren't paid for the benefits they create for others, the market will generate too few of these activities.

Government can correct these market failures. A variety of approaches can be used to address the problem of negative externalities. For example, the government can impose a pollution compensation tax on an activity that creates negative externalities in order to bring the private cost in line with the social cost of the activity. Creating new property forms is another alternative. Here, instead of government directly regulating an activity to make sure that resources are allocated efficiently, resources may be privatized so that individuals will have an incentive to exercise property rights to the resources efficiently. Or, the government may impose obligatory controls regarding certain activities. For example, most municipalities don't allow leaves to be burned or dogs to roam freely.

In cases of positive externalities, the role for government is to encourage more of an activity to be undertaken. Government can do this by subsidizing the activity from tax revenues or by simply providing the activity itself, as in the case of public goods such as national defense, lighthouses, clean air, and clean water. However, government failure can occur if government fails to buy the quantity of public goods that generates maximum efficiency. Government failure can arise because, even with an honest effort, political representatives are unable to accurately measure our preferences regarding the purchase of public goods. Another potential problem is that government's choices of public goods may reflect the preferences of special-interest lobbies rather than the public's interest. Economists who hold this view of public choice believe that the production and allocation of public goods are dictated primarily by the need for government officials to keep their jobs.

After studying this chapter, you should be able to:
· Explain the difference between negative and positive externalities.
· Discuss why poorly defined property rights cause externalities.
· Use graphs to show how market failure can be corrected for both types of externalities.
· Compare and contrast the different approaches for correcting negative externalities.
· Define and give examples of public goods.
· Distinguish between a pure public good and a near-public good.
· Describe the opposing views of public choice.

On the Net

• Why might Exxon (http://www.exxon.com/) devote part of its corporate Web site to highlight its pro-environmental policies?

• The U.S. Environmental Protection Agency (EPA) (http://www.epa.gov/) represents the federal government's concerns with pollution and the environment.

• The American Association of Retired Persons (AARP) (http://www.aarp.org/) and the National Parent Teacher Association (PTA) (http://www.pta.org/) are examples of special-interest groups.

Economic Consultants

Clean Air for Everyone (CAFE), an environmental action group located in Wheeling, West Virginia, was created to address the damage done by acid rain to the local environment. A number of local lakes and forests have suffered the effects of acid rain, which at times is as acidic as lemon juice.

CAFE's organizers have approached Economic Consultants for more information about what the government does to control acid rain, and what citizens can do to help stop this pollution. Prepare a report for CAFE that addresses the following issues:

1. What policy options may government pursue to lessen or stop acid rain?
2. What policies has the federal government implemented to address acid rain? Do any of these policies affect West Virginia?
3. What policies has West Virginia implemented to fight acid rain?

• U.S. Environmental Protection Agency (EPA)
(http://www.epa.gov/)
The EPA provides detailed information about pollution policies and prevention programs. In particular, the EPA maintains a section devoted to acid rain. Also, the regional office that includes West Virginia has materials on air pollution.

• Sierra Club
(http://www.sierraclub.org/cleanair/)
The Sierra Club, a nonprofit environmental organization, maintains a section that addresses air pollution.

• West Virginia Department of Environmental Protection (DEP)
(http://charon.osmre.gov/)
The DEP provides information on West Virginia legislation and policies concerning air pollution.

Added Perspective: More on the Net

• Learn more about Ronald Coase (http://www.nobel.se/laureates/economy-1991.html).

• The EPA's Economy and Environment Division (http://www.epa.gov/oppe/eaed/eedhmpg.htm) conducts research on the economic costs and benefits of environmental regulations and pollution control programs.

Interactive Quiz

Test your understanding of the chapter's concepts with the interactive quiz. The quiz contains twenty multiple-choice questions, like those found on a typical exam. Questions include detailed feedback for each answer, so that you may know instantly why you have answered correctly or incorrectly. In addition, you may email yourself and/or your instructor the results of the quiz, with a listing of correct and incorrect answers. Finally, check your results versus other students around the world -- previous scores to quizzes are displayed online.

How to Take the Quiz
Start the quiz, type in your name (required), your email address (optional), and the email address of your instructor (optional). Answer the questions (as many or as few as you like, but you need to answer at least one question). Then hit the submit button and see your results. At the results page, click on the link in the "description" column to see feedback on your answers. Scroll down the page to see quiz results from students around the world.

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