1、Chapter 18Externalities and Public GoodsTopics to be DiscussednExternalitiesnWays of Correcting Market FailurenExternalities and Property RightsnCommon Property ResourcesTopics to be DiscussednPublic GoodsnPrivate Preferences for Public GoodsExternalitiesnNegativelAction by one party imposes a cost
2、on another partynPositivelAction by one party benefits another partyExternal CostnScenariolSteel plant dumping waste in a riverlThe entire steel market effluent can be reduced by lowering output(fixed proportions production function)External CostnScenariolMarginal External Cost(MEC)is the cost impos
3、ed on fishermen downstream for each level of production.lMarginal Social Cost(MSC)is MC plus MEC.MCS=MCIDP1Aggregate social cost ofnegativeexternalityP1q1Q1MSCMSCIWhen there are negativeexternalities,the marginalsocial cost MSC is higherthan the marginal cost.External CostsFirm outputPriceIndustry o
4、utputPriceMECMECIThe differences isthe marginal externalcost MEC.q*P*Q*The industry petitiveoutput is Q1 while the efficientlevel is Q*.The profit maximizing firmproduces at q1 while the efficient output level is q*.External CostnNegative Externalities encourage inefficient firms to remain in the in
5、dustry and create excessive production in the long run.ExternalitiesnPositive Externalities and InefficiencylExternalities can also result in too little production,as can be shown in an example of home repair and landscaping.MCP1External BenefitsRepair LevelValueDIs research and development discoura
6、ged by positiveexternalities?q1MSBMEBWhen there are positiveexternalities(the benefitsof repairs to neighbors),marginal social benefitsMSB are higher thanmarginal benefits D.q*P*A self-interested home ownerinvests q1 in repairs.Theefficient level of repairsq*is higher.The higher priceP1 discourages
7、repair.Ways of Correcting Market FailurenAssumption:The market failure is pollutionlFixed-proportion production technologyuMust reduce output to reduce emissionsuUse an output tax to reduce outputlInput substitution possible by altering technologyThe Efficient Level of EmissionsLevel of Emissions246
8、Dollarsper unitof Emissions02468101214161820222426MSCMCAE*The efficient level ofemissions is 12(E*)where MCA=MSC.Assume:1)Competitive market2)Output and emissions decisions are independent3)Profit maximizing output chosenAt Eo the marginalcost of abating emissionsis greater than themarginal social c
9、ost.E0At E1 the marginalsocial cost is greaterthan the marginal benefit.E1Why is this more efficientthan zero emissions?Ways of Correcting Market FailurenOptions for Reducing Emissions to E*lEmission StandarduSet a legal limit on emissions at E*(12)uEnforced by monetary and criminal penaltiesuIncrea
10、ses the cost of production and the threshold price to enter the industryStandards and FeesLevel of EmissionsDollarsper unitof EmissionsMSCMCA312E*StandardFeenOptions for Reducing Emissions to E*lEmissions FeeuCharge levied on each unit of emissionWays of Correcting Market FailureTotalAbatement CostC
11、ost is less than thefee if emissions were not reduced.Total Feeof AbatementStandards and FeesLevel of EmissionsDollarsper unitof EmissionsMSCMCA312E*FeenStandards Versus FeeslAssumptionsuPolicymakers have asymmetric informationuAdministrative costs require the same fee or standard for all firmsWays
12、of Correcting Market FailureFirm 2s ReducedAbatementCostsFirm 1s IncreasedAbatement CostsMCA1MCA2The Case for FeesLevel of Emissions246Fee perUnit ofEmissions01234567891011121313514The cost minimizing solutionwould be an abatement of 6for firm 1 and 8 for firm 2 andMCA1=MCA2=$3.3.752.50The impact of
13、 a standard ofabatement of 7 for both firmsis illustrated.Not efficient becauseMCA2 MCA1.If a fee of$3 was imposedFirm 1 emissions would fallby 6 to 8.Firm 2 emissionswould fall by 8 to 6.MCA1=MCA2:efficient solution.nAdvantages of FeeslWhen equal standards must be used,fees achieve the same emissio
14、n abatement at lower cost.lFees create an incentive to install equipment that would reduce emissions further.Ways of Correcting Market FailureABC is the increasein social cost less thedecrease in abatementcost.MarginalSocialCostMarginal Costof AbatementThe Case for StandardsLevel of EmissionsFee per
15、Unit ofEmissions0246810121416246810121416EBased on inpleteinformation standard is 9(12.5%decrease).ADE m*.Refundable DepositsAmount of Glass$DPrice falls to P and the amount of recycled glass increases to M*.SvSrSThe supply of glass is the sum of the supplyof virgin glass(Sr)and the supply of recycl
16、edglass(Sr).M1PWithout refunds the price of glass is P and Sr is M1.SrSPM*With refunds Sr increasesto Sr and S increases to S.Externalities and Property RightsnProperty RightslLegal rules describing what people or firms may do with their propertylFor exampleuIf residents downstream owned the river(c
17、lean water)they control upstream emissions.nBargaining and Economic EfficiencylEconomic efficiency can be achieved without government intervention when the externality affects relatively few parties and when property rights are well specified.Externalities and Property RightsProfits Under Alternativ
18、eEmissions Choices(Daily)No filter,not treatment plant500100600Filter,no treatment plant300500800No filter,treatment plant500200700Filter,treatment plant300300600FactorysFishermensTotalProfitProfitProfitnAssumptionslFactory pays for the filterlFishermen pay for the treatment plantnEfficient Solution
19、lBuy the filter and do not build the plantExternalities and Property RightsBargaining with Alternative Property RightsNo CooperationProfit of factory$500$300Profit of fishermen$200$500CooperationProfit of factory$550$300Profit of fishermen$250$500Right to Dump Right to Clean WaternConclusion:Coase T
20、heoremlWhen parties can bargain without cost and to their mutual advantage,the resulting oute will be efficient,regardless of how the property rights are specified.Externalities and Property RightsnCostly Bargaining-The Role of Strategic BehaviorlBargaining requires clearly defined rules and propert
21、y rights.Externalities and Property RightsnA Legal Solution-Suing for DamageslFishermen have the right to clean waterlFactory has two optionsuNo filter,pay damageslProfit=$100($500-$400)uFilter,no damageslProfit=$300($500-$200)Externalities and Property RightsnA Legal Solution-Suing for DamageslFact
22、ory has the right to emit effluentlFishermen have three optionsuPut in treatment plantlProfit=$200uFilter and pay damageslProfit=$300($500-$200)uNo plant,no filterlProfit=$100Externalities and Property RightsnConclusionlA suit for damages results in an efficient oute.nQuestionlHow would imperfect in
23、formation impact the oute?Externalities and Property RightsThe Coase Theorem at WorknNegotiating an Efficient Solutionl1987-New York garbage spill(200 tons)littered the New Jersey beachesuThe potential cost of litigation resulted in a solution that was mutually beneficial to both parties.Common Prop
24、erty ResourcesnCommon Property ResourcelEveryone has free access.lLikely to be overutilizedlExamplesuAir and wateruFish and animal populationsuMineralsCommon Property ResourcesFish per MonthBenefits,Costs($perfish)DemandHowever,private costsunderestimate true cost.The efficient level of fish/month i
25、s F*whereMSC=MB(D)Marginal Social CostF*Private CostFCWithout control the numberof fish/month is FC where PC=MB.Common Property ResourcesnSolutionlPrivate ownershipnQuestionlWhen would private ownership be impractical?Crawfish Fishing in LousiananFinding the Efficient Crawfish CatchlF=crawfish catch
26、 in millions of pounds/yrlC=cost in dollars/poundCrawfish Fishing in LousiananDemandlC=0.401=0.0064FnMSClC=-5.645+0.6509FnPClC=-0.357+0.0573FCrawfish Fishing in LousiananEfficient Catchl9.2 million poundslD=MSCCrawfish Catch(millions of pounds)CCost(dollars/pound)DemandMarginal Social CostPrivate Co
27、stCrawfish as a CommonProperty Resource11.92.109.20.325Public GoodsnQuestionlWhen should government replace firms as the producer of goods and services?Public GoodsnPublic Good CharacteristicslNonrivaluFor any given level of production the marginal cost of providing it to an additional consumer is z
28、ero.lNonexclusiveuPeople cannot be excluded from consuming the good.Public GoodsnNot all government produced goods are public goodslSome are rival and nonexclusiveuEducationuParksD1D2DWhen a good is nonrival,the social marginalbenefit of consumption(D),is determined byvertically summing the individu
29、al demand curves for the good.Efficient Public Good ProvisionOutput0Benefits(dollars)12345678109$4.00$5.50$7.00Marginal Cost$1.50Efficient output occurswhere MC=MB at 2units of output.MB is$1.50+$4.00 or$5.50.Public GoodsnPublic Goods and Market FailurelHow much national defense did you consume last
30、 week?Public GoodsnFree RiderslThere is no way to provide some goods and services without benefiting everyone.lHouseholds do not have the incentive to pay what the item is worth to them.lFree riders understate the value of a good or service so that they can enjoy its benefit without paying for it.Pu
31、blic GoodsnEstablishing a mosquito abatement panylHow do you measure output?lWho do you charge?lA mosquito meter?The Demand for Clean AirnClean Air is a public goodlNonexclusive and nonrivalnWhat is the price of clean air?The Demand for Clean AirnChoosing where to livelStudy in Boston correlates hou
32、sing prices with the quality of air and other characteristics of the houses and their neighborhoods.The Demand for Clean AirNitrogen Oxides(pphm)0Dollars1234567810920002500300050015001000Low IneMiddle IneHigh IneThe Demand for Clean AirnFindingslAmount people are willing to pay for clean air increas
33、es substantially as pollution increases.lHigher ine earners are willing to pay more(the gap between the demand curves widen)lNational Academy of Sciences found that a 10%reduction in auto emissions yielded a benefit of$2 billion-somewhat greater than the cost.Private Preferences for Public GoodsnGov
34、ernment production of a public good is advantageous because the government can assess taxes or fees to pay for it.nDetermining how much of a public good to provide when free riders exist is difficult.Determining the Levelof Educational SpendingEducational spendingper pupil$0Willingnessto pay$1200$60
35、0$1800$2400W1W2W3AWThe efficient level of educational spending is determined by summing thewillingness to pay for education for eachof three citizens.Determining the Levelof Educational SpendingEducational spendingper pupil$0Willingnessto pay$1200$600$1800$2400W1W2W3AWWill majority rule yield an eff
36、icient oute?W1 will vote for$600W2 and W3 will vote for$1200The median vote will always win in a majorityrule election.nQuestionlWill the median voter selection always be efficient?nAnswerlIf two of the three preferred$1200 there would be overinvestment.lIf two of the three preferred$600 there would
37、 be underinvestment.Private Preferences for Public GoodsnMajority rule is inefficient because it weighs each citizens preference equally-the efficient oute weighs each citizens vote by his or her strength of preference.Private Preferences for Public GoodsSummarynThere is an externality when a produc
38、er or a consumer affects the production or consumption activities of others in a manner that is not directly reflected in the market.nPollution can be corrected by emission standards,emissions fees,marketable emissions permits,or by encouraging recycling.SummarynInefficiencies due to market failure
39、may be eliminated through private bargaining among the affected parties.nCommon property resources are not controlled by a single person and can be used without a price being paid.SummarynGoods that private markets are not likely to produce efficiently are either nonrival or nonexclusive.Public good
40、s are both.nA public good is provided efficiently when the vertical sum of the individual demands for the public good is equal to the marginal cost of producing it.SummarynUnder majority rule voting,the level of spending provided will be that preferred by the median voter-this need not be the efficient oute.End of Chapter 18Externalities and Public Goods
