11.5 Welfare Analysis with Externalities,An externality arises when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect. If the impact on the bystander is adverse, it is called a negative externality. If the impact on the bystander is beneficial, it is called a positive externality. Market outcome is different with externalities.,Price,Quantity,S,D,The Market Equilibrium without Externalities,Market Surplus,Price,Quantity,S,D,The Market Equilibrium with a Negative Externality,Market Surplus,S1,Price,Quantity,S,D,The Market Equilibrium with a Negative Externality,Social Cost,S1,Price,Quantity,S,D,The Market Equilibrium with a Negative Externality,Net Gain,S1,Price,Quantity,S,D,The Market Equilibrium with a Positive Externality,Market Surplus,S2,Price,Quantity,S,D,The Market Equilibrium with a Positive Externality,Social Benefit,S2,Price,Quantity,S,D,The Market Equilibrium with a Positive Externality,S2,Net Gain,11.6 The Impact of a Tax or Subsidy,What would happen to the market if the government impose a tax on trade? Who bear the burden of the tax, sellers or buyers? Specific Tax: Tax of a certain amount of money per unit sold. Subsidy: Payments reducing the buyers price below the sellers price; i,.e., a negative tax.,Tax Levied on Sellers or Buyers,Suppose the government impose a tax of t per unit of one goods and collect it from sellers. Given the market price P, the market supply becomes Suppose the government impose a tax of t per unit of one goods and collect it from buyers. Given the market price P, the market demand becomes,Tax Levied on Sellers or Buyers,The market equilibrium price can be deduced from the following equation when tax is levied on sellers The market equilibrium price can be deduced from the following equation when tax is levied on buyers,Tax Levied on Sellers or Buyers,The relationship between market equilibrium price when tax is levied on sellers and the market equilibrium price when tax is levied on buyers can be deduced as following The market equilibrium quantity when tax is levied on sellers is always equal to the equilibrium quantity when tax is levied on buyers,Tax Levied on Sellers or Buyers,Total surplus produced by the market when tax levied on sellers can be written as Total surplus produced by the market when tax levied on buyers can be written as,Tax Levied on Sellers or Buyers,Total surplus produced by the market when tax levied on sellers can be written as Total surplus produced by the market when tax levied on buyers can be written as,Price,Quantity,S,D,Tax Levied on Sellers,Price,Quantity,S,D,Tax Levied on Sellers,S1,Price,Quantity,S,D,Tax Levied on Sellers,S1,Size of Tax,Price,Quantity,S,D,Tax Levied on Buyers,Price,Quantity,S,D,Tax Levied on Buyers,D1,Price,Quantity,S,D,Tax Levied on Buyers,D1,Size of Tax,Price,Quantity,S,D,Tax Levied on Sellers,S1,Size of Tax,Price,Quantity,S,D,The Effect of a Tax,Deadweight Loss,Incidence of a Tax,Four conditions can be summarized by following four equations:,Price,Quantity,S,D,Impact of Tax depends on Elasticities,t,Price,Quantity,S,D,Impact of Tax depends on Elasticities,t,Price,Quantity,S,D,The Effects of a Subsidy,Deadweight Loss,Price,Quantity,S,D,The Effects of a Subsidy,Buyer Gain,Price,Quantity,S,D,The Effects of a Subsidy,Deadweight Loss,Price,Quantity,S,D,The Effects of a Subsidy,Seller Gain,Price,Quantity,S,D,The Effects of a Subsidy,Payment of Government,Price,Quantity,S,D,The Effects of a Subsidy,Deadweight Loss,Impacts of Tax with Externalities,We will now consider a market where there is an externality. Four classes of economic agents must be taken into account: buyers, sellers, government, environment Tax or subsidy are not bad thing any more when there are externalities,Price,Quantity,S,D,The Market Equilibrium with a Negative Externality,Market Surplus,S1,Price,Quantity,S,D,Tax with a Negative Externality,Market Surplus,S1,Price,Quantity,S,D,Tax with a Negative Externality,S1,Government Gain,Price,Quantity,S,D,Tax with a Negative Externality,S1,Market Surplus,Price,Quantity,S,D,Tax with a Negative Externality,S1,Social Loss,Price,Quantity,S,D,Tax with a Negative Externality,S1,Net Gain,Price,Quantity,S,D,The Market Equilibrium with a Positive Externality,Market Surplus,S2,Price,Quantity,S,D,Subsidy with a Positive Externality,Market Surplus,S2,Price,Quantity,S,D,Subsidy with a Positive Externality,S2,Government Loss,Price,Quantity,S,D,Subsidy with a Positive Externality,S2,Seller Gain,Price,Quantity,S,D,Subsidy with a Positive Externality,S2,Buyer Gain,Price,Quantity,S,D,