(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 692

CHAPTER 18 • Externalities and Public Goods 667

18.2 Ways of Correcting Market Failure
How can the inefficiency resulting from an externality be remedied? If the firm
that generates the externality has a fixed-proportions production technology, the
externality can be reduced only by encouraging the firm to produce less. As we
saw in Chapter 8, this goal can be achieved through an output tax. Fortunately,
most firms can substitute among inputs in the production process by altering
their choices of technology. For example, a manufacturer can add a scrubber to
its smokestack to reduce emissions.
Consider a firm that sells its output in a competitive market. The firm emits
pollutants that damage air quality in a neighborhood. The firm can reduce its
emissions, but only at a cost. Figure 18.4 illustrates this trade-off. The horizontal axis represents the level of factory emissions and the vertical axis the cost
per unit of emissions. To simplify, we assume that the firm’s output decision
and its emissions decision are independent and that the firm has already chosen its profit-maximizing output level. The firm is therefore ready to choose its
preferred level of emissions. The curve labeled MEC represents the marginal
external cost of emissions. This social cost curve represents the increased harm
associated with the emissions. We will use the terms marginal external cost and
marginal social cost interchangeably in the discussion that follows. (Recall that
we have assumed that the firm’s output is fixed, so that the private costs of
production—as opposed to pollution abatement—are unchanged.) The MEC
curve slopes upward because the marginal cost of the externality gets higher as
the externality becomes more extensive. (Evidence from studies of the effects
of air and water pollution suggests that small levels of pollutants generate
little harm. However, the harm increases substantially as the level of pollutants increases.)
Because our emphasis will be on reducing emissions from existing levels, we
will find it useful to read the MEC graph from right to left. From this perspective, we see that the MEC associated with a small reduction in emissions from a
level of 26 units, which reflects the incremental benefit of reduced emissions, is

Dollars
per unit

of emissions

Recall from §7.3 that a firm
can substitute among inputs
by changing technologies in
response to an effluent fee.

MEC

6

F IGURE 18.4

THE EFFICIENT LEVEL OF
EMISSIONS

4

The efficient level of factory emissions
is the level that equates the marginal
external cost of emissions MEC to the
benefit associated with lower abatement costs MCA. The efficient level of
12 units is E*.

2

MCA
0

2

4

6

E0

8

10

12

E*

14

16

18

20

22

24

26

E1 Level of emissions