Sunday, April 17, 2011

Negative Externalities and how the market price does not account for all the costs of production...Nice example here for class tomorrow...

Tomorrow in AP Microeconomics we will use basic supply and demand analysis to solve positive and negative externalities.  Below is a great example of a negative externality. Many costs are imposed on society through the use of coal for energy, but many of those costs are NOT reflected in the price of the good in the market-place.  The idea is to use public policy (taxes, regulation, etc) to require the market to accurately reflect the full cost of producing and consuming the product. If the "third party" effects of producing and consuming coal can be quantified and added to the cost of the electricity produced, then the price would certainly be higher and the market quantity would be lower.  This lower market quantity would be what is termed the "socially optimal" market quantity (remember, this is different than "socially efficient" market quantity)...
Paul R. Epstein, et. al., “Full cost accounting for the life cycle of coal”

Each stage in the life cycle of coal—extraction, transport, processing, and combustion—generates a waste stream and carries multiple hazards for health and the environment. These costs are external to the coal industry and are thus often considered “externalities.” We estimate that the life cycle effects of coal and the waste stream generated are costing the U.S. public a third to over one-half of a trillion dollars annually. Many of these so-called externalities are, moreover, cumulative. Accounting for the damages conservatively doubles to triples the price of electricity from coal per kWh generated, making wind, solar, and other forms of nonfossil fuel power generation, along with investments in efficiency and electricity conservation methods, economically competitive. We focus on Appalachia, though coal is mined in other regions of the United States and is burned throughout the world. (Source: Matthew Yglesias)
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