10. Externalities and Public Goods

Two scenes of market failure — externalities, where harm to others goes unpriced, and public goods, which everyone uses but no one buys.

• Externalities and the Pigouvian Tax — The factory's cost and the neighborhood's cost come apart here. The factory counts only its own cost. It never counts the harm from its smoke. Social cost adds the two together, as in the formula below. So the factory produces too much, thinking it is cheap. The lost welfare is the red triangle. Flip the Pigouvian tax on, and the cost curve aims at the social optimum. For example, a 🏭 factory makes one toy for 100 won. Its chimney smoke dirties the neighbor's laundry. That damage is worth 30 won. The true cost is 130 won, but the factory counts only 100. So it makes too many toys.
• Public Goods and Free-Riding — Everyone uses the same public good, but who pays to provide it? Public-good demands add up vertically, not horizontally. Everyone consumes the same unit at the same time. So willingness to pay is stacked vertically. Where that sum meets the cost is the optimum. But each person reasons differently. Hoping others will pay, each pays nothing. Too little is collected, so supply falls short. For example, 30 🧑 classmates chip in to buy a ⚽ ball for the classroom. The ball costs 30,000 won. If half think 'the others will pay' and pay nothing, the money falls short. Nobody gets a ball to play with.