Module 74: Introduction to Externalities

Module 75: Externalities and Public Policy

Module 76: Public Goods

Module 77: Public Policy to Promote Competition

Module 78: Income Inequality and Income Distribution

Economics by Example: “Why Not Split the Check?”

For many people in the northeastern United States, there is no better way to relax than to fish in one of the region’s thousands of lakes. But in the 1960s, avid fishers noticed something alarming: lakes that had formerly teemed with fish were now almost empty. What had happened?

The answer was acid rain, caused mainly by coal-burning power plants. When coal is burned, it releases sulfur dioxide and nitric oxide into the atmosphere; these gases react with water, producing sulfuric acid and nitric acid. The result in the Northeast, downwind from the nation’s industrial heartland, was rain sometimes as acidic as lemon juice. Acid rain didn’t just kill fish; it also damaged trees and crops, and in time even began to dissolve limestone buildings.

You’ll be glad to hear that the acid rain problem today is much less serious than it was in the 1960s. Power plants have reduced their emissions by switching to low-sulfur coal and installing scrubbers in their smokestacks. But they didn’t do this out of the goodness of their hearts; they did it in response to government policy. Without such government intervention, power companies would have had no incentive to take the environmental effects of their actions into account.

The Gulf of Mexico oil spill of 2010 is among the reminders that environmental problems persist. Neglected pollution is one of several reasons why markets sometimes fail to deliver efficient quantities of goods and services. We’ve already seen that inefficiency can arise from market power, which allows monopolists and colluding oligopolists to charge prices above marginal cost, thereby preventing mutually beneficial transactions from occurring. In this section we will consider other reasons for market failure. In Modules 74 and 75, we will see that inefficiency can arise from externalities, which create a conflict between the best interests of an individual or a firm and the best interests of society as a whole. In Module 76, we will focus on how the characteristics of goods often determine whether markets can deliver them efficiently. In Modules 77 and 78, we will look at the role of government in addressing market failures. The investigation of sources of inefficiency will deepen our understanding of the types of policy that can make society better off.