Chapter 9: Externalities and Public Goods

Examining Negative Externality Dead Weight Loss

"In the cases where there are negative externalities, markets (if left alone) will produce too much, resulting in too much pollution." "As a way of checking your work, the deadweight loss is usually int he form of a triangle with the arrow pointing in the direction that society would prefer." When there are negative externalities present, free markets produce and consume too much.

Government Solutions to Externalities

1. Command-and-control policies: Government directly regulates the allocation of resources. 2. Market-based policies: Government provides incentives for private organizations to internalize the externality.

Examples of Positive Externalities

1. Education often increase civic engagement, thereby contributing to a more democratic society. 2. An educated workforce is vital for innovation and adoption of new technologies. 3. An educated citizenry will be less likely to commit crime.

When does the invisible hand fail?

1. Externalities 2. Public Goods 3. Common Pool Resources Where, in each case, markets do not maximize social surplus.

*Public Goods*

Both non-rival and non-excludable (National Defense, early warning systems, earth protection programs).

Common Pool Resource Good

Class of goods that are rival and non-excludable (Fish, Water, Natural Forests, Food at a picnic).

Pigouvian Subsidies (Corrective Subsidies)

Designed to induce agents who produce positive externalities to increase quantity toward the socially optimal level. In the case of positive externalities, a subsidy is used to correct the externality. Pigouvian Subsidies internalize the positive externalities that result in an efficient market outcome.

Examining Positive Externalities and Dead Weight Loss

Education, we will keeping looking for higher level outputs of education. Thus the deadweight loss triangle will point towards more units because that is what society wants. When there are positive externalities present, free markets produce and consume too little.

Command-and-control regulation

Either directly restricts the level of production or mandates the use of certain technologies. There are better ways to regulate polluters that bring about better efficiency. This is because it provides fewer incentives for producers to search for more cost-effective ways to reduce pollution itself.

Property Right

Gives someone ownership of a property or resources.

*Private Goods*

Highly excludable and highly rival in consumption (Cloths, food, furniture).

Market-Based Regulatory Approach

Internalized externalities by harnessing the power of market forces. This incentivizes development of new ways to reduce negative externalities than the command and control approach.

Non-Rival Good

Is a good whose consumption by one person does not prevent consumption by others.

*Club Good*

Is non-rival but excludable (Cable TV, Wi-Fi).

Pecuniary Externality

Occurs when a market transaction affects other people only through market prices. Pecuniary Externalities DO NOT create market inefficiencies like negative and positive externalities do.

Externality

Occurs when economic activity has either a spillover cost or spillover benefit on a bystander. Externalities are not efficient because they produce an external cost or benefit that is not reflected in the market price.

Non-Excludable Good

Once it is produced, it is not possible to exclude people from using the good.

Examples of Negative Externalities

Pollution

Methods of Internalization

Private Bargaining and Moral Code.

Tragedy Of The Commons

Results when common pool resources are dramatically overused. Similar solution to externalities, use a pigouvian tax on every fish that is taken out of Lake Michigan for example. Or use a the Coase Theorem to self-regulate the use of a resource.

The Coase Theorem

States that private bargaining will result in an efficient allocation of resources. End result being that Government intervention is not always necessary to solve externality problems. The initial property right allocation is an important determinant of the distribution of surplus.

Private Provision of Public Goods

Takes place when private citizens make contributions to the production or maintenance of a public good.

Pigouvian Tax (Corrective Tax)

Tax designed to induce agents who produce negative externalities to reduce quantity toward the socially optimal level. This will result in efficient market outcome because the tax will align private and societal incentives.

Transaction Costs

The cost of making an economic exchange.

Internalization of an Externality

When an agent, takes into account the full costs and benefits of their actions because of some public or private incentive. "When the external effects of their actions are internalized, the general result is that the market equilibrium moves toward higher social well being."

Free-Rider Problem

When an individual who has no incentive to pay for a good does not pay for that good because nonpayment does not prevent consumption.