ExternalitiesExternality–AnactivityononeentitythataffectsthewelfareofanotherentityinawaythatisoutsidethemarketmechanismNotanExternality–suburban-urbanmigrationexampleTheNatureofExternalitiesPrivately-monly-ownedresourcesExternalitiescanbeproducedbyconsumersaswellasfirmsExternalitiesarereciprocalinnatureExternalitiescanbepositivePublicgoodscanbeviewedasaspecialkindofexternalityTheNatureofExternalities-GraphicalAnalysisQperyear$MB0MDMPCMSC=MPC+MDQ1Q*ActualoutputSociallyefficientoutputabcdfeghWhatPollutantsDoHarm?EmpiricalEvidence:WhatistheEffectofPollutiononHealth?WhatActivitiesProducePollutants?WhatistheValueoftheDamageDone?EmpiricalEvidence:TheEffectofAirPollutiononHousingValuesBargainingandtheCoaseTheoremQperyear$MB0MDMPCMSC=MPC+MDQ1Q*cdghTheCoaseTheoremCoaseTheorem–Providedthattransactioncastsarenegligible,anefficientsolutiontoanexternalityproblemisachievedaslongassomeoneisassignedpropertyrights,independentofwhoisassignedthoserightsAssumptionsnecessaryforCoaseTheoremtoworkThecoststothepartiesofbargainingarelowTheownersofresourcescanidentifythesourceofdamagestotheirpropertyandlegallypreventdamagesOtherPrivateSolutionsMergersSocialconventionsPublicResponsestoExternalities-TaxesQperyear$MB0MDMPCMSC=MPC+MDQ1Q*cd(MPC+cd)Pigouvian taxrevenuesijPublicResponsestoExternalities-SubsidiesQperyear$MB0MDMPCMSC=MPC+MDQ1Q*cd(MPC+cd)ijgkhfePigouvian subsidyPublicResponsestoExternalities-EmissionsFee0PollutionreductionMSBMCe*f*$
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