Chapter 10

Chapter 10 talks about externalities and how they create inefficiencies in the market. When there's a negative externality, the socially optimal quantity in a market is less than the equilibrium quantity. When there's a positive externality, the socially optimal quantity in a market is greater than the equilibrium quantity. The Coase theorem states that people can solve the problems of externalities on their own. People can bargain until they reach an efficient solution that benefits everyone. When this private bargaining doesn't work, the government intervenes. The government can respond to externalities by command-and-control policies or market-based policies. Command-and-control policies usually mean the government makes laws banning or requiring certain actions to remedy an externality. Market-based policies the government can internalize the externality by applying taxes to goods that cause negative externalities or by subsidizing goods that have positive externalities. The corrective taxes on negative externalities raise revenue for the government and also enhance economic activity. Another market-based policy is tradable pollution permits. The markets that trade these permits are guided by the invisible hand to ensure efficiency. From this, the pollution permits will be given to firms that value it most highly, according to their willingness to pay. A firm's willingness to pay is based on its cost of reducing pollution. The more it costs for a firm to cut back on pollution, the more it would be willing to pay for a permit. I thought this chapter was interesting because it expanded my knowledge of externalities and their effects on the market.