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Topics to be DiscussednExternalitiesnWays of Correcting Market FailurenExternalities and Property RightsnCommon Property Resources1Chapter 1Topics to be DiscussednPublic GoodsnPrivate Preferences for Public Goods2Chapter 1ExternalitiesnNegativelAction by one party imposes a cost on another partynPositivelAction by one party benefits another party3Chapter 1External CostnScenariolSteel plant dumping waste in a riverlThe entire steel market effluent can be reduced by lowering output(fixed proportions production function)4Chapter 1External CostnScenariolMarginal External Cost(MEC)is the cost imposed on fishermen downstream for each level of production.lMarginal Social Cost(MSC)is MC plus MEC.5Chapter 1MCS=MCIDP1Aggregate social cost ofnegativeexternalityP1q1Q1MSCMSCIWhen there are negativeexternalities,the marginalsocial cost MSC is higherthan the marginal cost.External CostsFirm outputPriceIndustry outputPriceMECMECIThe differences isthe marginal externalcost MEC.q*P*Q*The industry competitiveoutput is Q1 while the efficientlevel is Q*.The profit maximizing firmproduces at q1 while the efficient output level is q*.6Chapter 1External CostnNegative Externalities encourage inefficient firms to remain in the industry and create excessive production in the long run.7Chapter 1ExternalitiesnPositive Externalities and InefficiencylExternalities can also result in too little production,as can be shown in an example of home repair and landscaping.8Chapter 1MCP1External BenefitsRepair LevelValueDIs research and development discouraged 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 repair.9Chapter 1Ways 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 technology10Chapter 1The Efficient Level of EmissionsLevel of Emissions246Dollarsper 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 cost.E0At E1 the marginalsocial cost is greaterthan the marginal benefit.E1Why is this more efficientthan zero emissions?11Chapter 1Ways of Correcting Market FailurenOptions for Reducing Emissions to E*lEmission StandarduSet a legal limit on emissions at E*(12)uEnforced by monetary and criminal penaltiesuIncreases the cost of production and the threshold price to enter the industry12Chapter 1Standards and FeesLevel of EmissionsDollarsper unitof EmissionsMSCMCA312E*StandardFee13Chapter 1nOptions for Reducing Emissions to E*lEmissions FeeuCharge levied on each unit of emissionWays of Correcting Market Failure14Chapter 1TotalAbatement CostCost is less than thefee if emissions were not reduced.Total Feeof AbatementStandards and FeesLevel of EmissionsDollarsper unitof EmissionsMSCMCA312E*Fee15Chapter 1nStandards Versus FeeslAssumptionsuPolicymakers have asymmetric informationuAdministrative costs require the same fee or standard for all firmsWays of Correcting Market Failure16Chapter 1Firm 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 a standard ofabatement of 7 for both firmsis illustrated.Not efficient becauseMCA2 MCA1.If a fee of$3 was imposedFirm 1 emissions would fallby 6 to 8.Firm 2 emissionswould fall by 8 to 6.MCA1=MCA2:efficient solution.17Chapter 1nAdvantages of FeeslWhen equal standards must be used,fees achieve the same emission abatement at lower cost.lFees create an incentive to install equipment that would reduce emissions further.Ways of Correcting Market Failure18Chapter 1ABC is the increasein social cost less thedecrease in abatementcost.MarginalSocialCostMarginal Costof AbatementThe Case for StandardsLevel of EmissionsFee perUnit ofEmissions0246810121416246810121416EBased on incompleteinformation standard is 9(12.5%decrease).ADE m*.31Chapter 1Refundable DepositsAmount of Glass$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 recycledglass(Sr).M1PWithout refunds the price of glass is P and Sr is M1.SrSPM*With refunds Sr increasesto Sr and S increases to S.32Chapter 1Externalities and Property RightsnProperty RightslLegal rules describing what people or firms may do with their propertylFor exampleuIf residents downstream owned the river(clean water)they control upstream emissions.33Chapter 1nBargaining 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 Rights34Chapter 1Profits Under AlternativeEmissions Choices(Daily)No filter,not treatment plant500100600Filter,no treatment plant300500800No filter,treatment plant500200700Filter,treatment plant300300600FactorysFishermensTotalProfitProfitProfit35Chapter 1nAssumptionslFactory pays for the filterlFishermen pay for the treatment plantnEfficient SolutionlBuy the filter and do not build the plantExternalities and Property Rights36Chapter 1Bargaining 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 Water37Chapter 1nConclusion:Coase TheoremlWhen parties can bargain without cost and to their mutual advantage,the resulting outcome will be efficient,regardless of how the property rights are specified.Externalities and Property Rights38Chapter 1nCostly Bargaining-The Role of Strategic BehaviorlBargaining requires clearly defined rules and property rights.Externalities and Property Rights39Chapter 1nA 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 Rights40Chapter 1nA Legal Solution-Suing for DamageslFactory has the right to emit effluentlFishermen have three optionsuPut in treatment plantlProfit=$200uFilter and pay damageslProfit=$300($500-$200)uNo plant,no filterlProfit=$100Externalities and Property Rights41Chapter 1nConclusionlA suit for damages results in an efficient outcome.nQuestionlHow would imperfect information impact the outcome?Externalities and Property Rights42Chapter 1The Coase Theorem at WorknNegotiating an Efficient Solutionl1987-New York garbage spill(200 tons)littered the New Jersey beachesuThe potential cost of litigation resulted in a solution that was mutually beneficial to both parties.43Chapter 1Common Property ResourcesnCommon Property ResourcelEveryone has free access.lLikely to be overutilizedlExamplesuAir and wateruFish and animal populationsuMinerals44Chapter 1Common Property ResourcesFish per MonthBenefits,Costs($perfish)DemandHowever,private costsunderestimate true cost.The efficient level of fish/month is F*whereMSC=MB(D)Marginal Social CostF*Private CostFCWithout control the numberof fish/month is FC where PC=MB.45Chapter 1Common Property ResourcesnSolutionlPrivate ownershipnQuestionlWhen would private ownership be impractical?46Chapter 1Crawfish Fishing in LousiananFinding the Efficient Crawfish CatchlF=crawfish catch in millions of pounds/yrlC=cost in dollars/pound47Chapter 1Crawfish Fishing in LousiananDemandlC=0.401=0.0064FnMSClC=-5.645+0.6509FnPClC=-0.357+0.0573F48Chapter 1Crawfish Fishing in LousiananEfficient Catchl9.2 million poundslD=MSC49Chapter 1Crawfish Catch(millions of pounds)CCost(dollars/pound)DemandMarginal Social CostPrivate CostCrawfish as a CommonProperty Resource11.92.109.20.32550Chapter 1Public GoodsnQuestionlWhen should government replace firms as the producer of goods and services?51Chapter 1Public GoodsnPublic Good CharacteristicslNonrivaluFor any given level of production the marginal cost of providing it to an additional consumer is zero.lNonexclusiveuPeople cannot be excluded from consuming the good.52Chapter 1Public GoodsnNot all government produced goods are public goodslSome are rival and nonexclusiveuEducationuParks53Chapter 1D1D2DWhen a good is nonrival,the social marginalbenefit of consumption(D),is determined byvertically summing the individual 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$5.50.54Chapter 1Public GoodsnPublic Goods and Market FailurelHow much national defense did you consume last week?55Chapter 1Public 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.56Chapter 1Public GoodsnEstablishing a mosquito abatement companylHow do you measure output?lWho do you charge?lA mosquito meter?57Chapter 1The Demand for Clean AirnClean Air is a public goodlNonexclusive and nonrivalnWhat is the price of clean air?58Chapter 1The Demand for Clean AirnChoosing where to livelStudy in Boston correlates housing prices with the quality of air and other characteristics of the houses and their neighborhoods.59Chapter 1The Demand for Clean AirNitrogen Oxides(pphm)0Dollars1234567810920002500300050015001000Low IncomeMiddle IncomeHigh Income60Chapter 1The Demand for Clean AirnFindingslAmount people are willing to pay for clean air increases substantially as pollution increases.lHigher income 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.61Chapter 1Private Preferences for Public GoodsnGovernment 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.62Chapter 1Determining the Levelof Educational SpendingEducational spendingper pupil$0Willingnessto pay$1200$600$1800$2400W1W2W3AWThe efficient level of educational spending is determined by summing thewillingness to pay for education for eachof three citizens.63Chapter 1Determining the Levelof Educational SpendingEducational spendingper pupil$0Willingnessto pay$1200$600$1800$2400W1W2W3AWWill majority rule yield an efficient outcome?W1 will vote for$600W2 and W3 will vote for$1200The median vote will always win in a majorityrule election.64Chapter 1nQuestionlWill 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 be underinvestment.Private Preferences for Public Goods65Chapter 1nMajority rule is inefficient because it weighs each citizens preference equally-the efficient outcome weighs each citizens vote by his or her strength of preference.Private Preferences for Public Goods66Chapter 1SummarynThere is an externality when a producer 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.67Chapter 1SummarynInefficiencies due to market failure 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.68Chapter 1SummarynGoods that private markets are not likely to produce efficiently are either nonrival or nonexclusive.Public goods 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.69Chapter 1SummarynUnder majority rule voting,the level of spending provided will be that preferred by the median voter-this need not be the efficient outcome.70Chapter 1 End of Chapter 18Externalities and Externalities and Public GoodsPublic Goods71Chapter 1谢谢
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