Econ 102: Externalities and Public Goods

What is a a quasi-public good?

Excludable but not rival. -An example is cable television. People who do not pay for cable television do not receive it, but one person watching it doesn't prevent other people from watching it. Another example is a toll road. -They are also known as club goods

How do externalities affect the market?

Externalities interfere with the economic efficiency of a market equilibrium. A competitive market achieves economic efficiency by maximizing the sum of consumer surplus and producer surplus. -But that result holds only if there are no externalities in production or consumption. -Unless there is an externality, the private cost and the social cost are equal. -Unless there is an externality, the private benefit and the social benefit are equal.

How do governments determine what quantity of a public good should be supplied?

Governments sometimes use cost-benefit analysis to determine what quantity of a public good should be supplied. -Before building a dam on a river, the federal government will attempt to weigh the costs against the benefits. The costs include the opportunity cost of other projects the government cannot carry out if it builds the dam.

What are Pigouvian taxes?

Pigou argued that to deal with a negative externality in production, the government should impose a tax equal to the cost of the externality. -The government can use a tax to increase the marginal private cost of producing the negative extranality to equal the marginal social cost. -The tax should increase by the amount in the price area that is equal to deadweight loss. -By imposing a tax on the production of electricity equal to the cost of acid rain, the government will cause electric utilities to internalize the externality. As a consequence, the cost of the acid rain will become a private cost borne by the utilities, and the supply curve for electricity will shift from S1 to S2. -The price consumers pay for electricity will rise from PMarket to PEfficient. Producers will receive a price P, which is equal to PEfficient minus the amount of the tax. -Go to 5.3 for graph.

What happens when their is positive externality and the government wants to get involved?

Pigou reasoned that the government can deal with a positive externality in consumption by giving consumers a subsidy, or payment, equal to the value of the externality. -When marginal social benefits exceed marginal private​ benefits, subsidies can increase output to achieve efficient outcomes. -By paying college students a subsidy equal to the external benefit from a college education, the government will cause students to internalize the externality. -That is, the external benefit from a college education will become a private benefit received by college students, and the demand curve for college educations will shift from D1 to D2. -Producers receive the price PEfficient, while consumers pay the price P, which is equal to PEfficient minus the amount of the subsidy. -Go to 5.3 for graph. -These are usually couls Pigouvian subsdies.

Are Tradable Emission Allowances Licenses to Pollute?

Some environmentalists argue that just as the government does not issue licenses to rob banks or drive drunk, it should not issue licenses to pollute. -But, this criticism ignores one of the central lessons of economics: Because resources are scarce, trade-offs exist. -Resources that are spent on reducing one type of pollution are not available to reduce other types of pollution or for any other use. -Because reducing acid rain using tradable emission allowances cost utilities $870 million per year, rather than $7.4 billion, as originally estimated, society saved more than $6.5 billion per year.

What are transaction costs?

The costs in time and other resources that parties incur in the process of agreeing to and carrying out an exchange of goods or services. -Negotiating an agreement between the people suffering from pollution and the firms causing the pollution often fails because of the transactions costs. -When many people are involved, the transactions costs are often higher than the net benefits from reducing the externality. A private solution to an externality problem is not feasible.

What is a cap-and-trade system?

The federal government gave allowances to utilities equal to the total target amount of sulfur dioxide emissions. -The utilities were then free to buy and sell the allowances on the Chicago Mercantile Exchange. -Utilities that could reduce emissions at low cost did so and sold their allowances to utilities that could only reduce emissions at high cost. -Using tradable emission allowances to reduce acid rain was a success in that it made it possible for utilities to meet Congress's emissions goal at a much lower cost than expected.

What are property rights?

The rights individuals or businesses have to the exclusive use of their property, including the right to buy or sell it. -Governments need to guarantee property rights in order for a market system to function well. -Property can be tangible or physical, such as a store or factory. -Property can also be intangible, such as the right to an idea. -Externalities and market failures result from incomplete property rights or from the difficulty of enforcing property rights in certain situations.

Why are Pigouvian taxes better than other government taxes?

A Pigovian tax eliminates deadweight loss and improves economic efficiency, unlike most other taxes, which are intended simply to raise revenue and can reduce consumer surplus and producer surplus and create a deadweight loss. -One reason that economists support Pigovian taxes as a way to deal with negative externalities is that the government can use the revenues raised by Pigovian taxes to lower other taxes that reduce economic efficiency.

What is market failure?

A situation in which the market fails to produce the efficient level of output.

How does a positive externality in consumption reduce economic efficiency?

Marginal social cost has to equal marginal social benefit for market efficiency. -The demand curve would be D2, which represents the marginal social benefits. -The actual demand curve is D1, however, which includes only the marginal private benefits received by students. -The efficient equilibrium would occur at price PEfficient and quantity QEfficient. -At this equilibrium, economic surplus is maximized. The market equilibrium, at price PMarket and quantity QMarket, will not be efficient because the demand curve is above the supply curve for production of the units between QMarket and QEfficient. -The marginal benefit of producing these units is greater than the marginal cost. -As a result, there is a deadweight loss equal to the area of the yellow triangle. -Go to 5.1 for graph.

It is impossible to exclude others from consuming the good, whether they have paid for it or not.

Nonexcludable

One person's consumption does not interfere with another person's consumption.

Nonrival

The benefit received by the consumer of a good or service.

Private Benefit

The cost borne by the producer of a good or service.

Private Cost

What is a common resource?

Rival but not excludable. -Forest land in many poor countries is a common resource. If one person cuts down a tree, no one else can use that tree. But if no one has a property right to the forest, no one can be excluded from using it.

The total benefit from consuming a good or service, and it is equal to the private benefit plus any external benefit, such as the benefit to others resulting from your college education.

Social Benefit

What are command-and-control approach?

A policy that involves the government imposing quantitative limits on the amount of pollution firms are allowed to emit or requiring firms to install specific pollution control devices.

What is a public good?

Both nonrival and nonexcludable. -Public goods are often, although not always, supplied by a government rather than by private firms. The classic example of a public good is national defense. -No private firm would be willing to supply national defense because everyone can consume national defense whether they pay for it or not. The behavior of consumers in this situation is called free riding because individuals benefit from a good without paying for it.

What is a private good?

Both rival and excludable. -Food, clothing, haircuts, and many other goods and services fall into this category.

Anyone who does not pay for a good cannot consume it. If you don't pay for a Big Mac, McDonald's can exclude you from consuming it.

Excludability

On a graph, where is marginal benefit and where is marginal cost?

Marginal benefit takes on demand while marginal cost takes on supply. -Between Q1 and efficent qualtity, and below marginal cost curve is the total cost. -Between Q1 and efficent qualtity above the supply curve but below the marginal benefit curve (triangle), is the net benefit. -Those two combine is the total benefit.

Occurs when one person's consumption of a unit of a good means no one else can consume it. -If you consume a Big Mac, for example, no one else can consume it.

Rivalry

The total cost of producing a good or service, and it is equal to the private cost plus any external cost, such as the cost of pollution.

Social Cost

What are extranalities?

Something that effects an outside force in a market. -They are not directly related to the market.

What is the Coase Theorem?

The argument of economist Ronald Coase that if transactions costs are low, private bargaining will result in an efficient solution to the problem of externalities. -In addition to low transactions costs, private solutions to the problem of externalities will occur only if all parties to the agreement have full information about the costs and benefits associated with the externality, and all parties must be willing to accept a reasonable agreement.

What is tradegy of the commons?

The tendency for a common resource to be overused often leading to negative externalities. -When a family chops down a tree in a public forest, it takes into account the benefits of gaining firewood or wood for building, but it does not take into account the costs of deforestation.

What is the optimal quantity of a public good?

To achieve economic efficiency, a good or service should be produced up to the point where the sum of consumer surplus and producer surplus is maximized, or, alternatively, where the marginal social cost equals the marginal social benefit.

How do you find the total demand of a public good?

You add all the consumers prices at zero.

When does deadweight loss occur?

-An equilibrium is economically efficient if economic surplus is at a maximum. -When economic surplus is at a maximum, the net benefit to society from the production of the good or service is at a maximum. -With an equilibrium quantity of QEfficient, economic surplus is at a maximum, and the equilibrium is efficient. -But, with an equilibrium quantity of QMarket, economic surplus is reduced by the deadweight loss and the equilibrium is not efficient.

Why is it bad to completely elimate negative extranalities?

-It would be incredibly expensive. -The net benefit to society from reducing pollution is equal to the difference between the benefit of reducing pollution and the cost. -For us to maximize the net benefit to society, sulfur dioxide emissions—or any other type of pollution—should be reduced up to the point where the marginal benefit from another ton of reduction is equal to the marginal cost.

In situations in which enforcing property rights is not feasible, what two types of solutions to the tragedy of the commons are possible?

-Norms and traditions-If the geographic area concerned is limited and the number of people involved is small, access to the commons can be restricted through community norms and traditions. -Laws-If the geographic area or the number of people involved is large, legal restrictions on access to the commons are required. These restrictions can take several different forms, including taxes, quotas, and tradable permits.

How do you graph this?

-Replace marginal social benefit with demand, and we have a winner. -S1 is the market supply curve and represents only the private costs that utilities have to bear. -If utilities also had to bear the cost of pollution, the supply curve would be S2, which represents the true marginal social. -The equilibrium with price PEfficient and quantity QEfficient is efficient. -The equilibrium with price PMarket and quantity QMarket is not efficient.

Is there a way out of the tragedy of the commons?

-The source of the tragedy of the commons is the same as the source of negative externalities: lack of clearly defined and enforced property rights. -Suppose that instead of being held as a collective resource, a piece of pastureland is owned by one person. That person will take into account the effect of adding another cow on the grass available to cows already using the pasture.

What are some examples of externalities?

-There is a positive externality in the production of college educations because people who do not pay for them will nonetheless benefit from them. -There is a negative externality in the generation of electricity. -Negative extranalities leads to an overproduction of a good in a market equilibrium. -When there is a positive externality in consuming a good or service, too little of the good or service will be produced at market equilibrium.