230 CH. 18

Summarize the 2 main results that occur from negative externalities and why we cannot get rid of pollution completely

1. A competitive market produces excessive negative externalities - because the price of pollution to the firms is zero (which is less than the MC that the last unit of pollution imposes on society), an unregulated market produces more pollution than social optimal 2. The optimal amount of pollution is greater than zero. Even though pollution is harmful and we'd like to have none, we cannot wipe it out without eliminating virtually all production and consumption

How is DWL analyzed here?

A DWL occurs when the social cost EXCEEDS the value that consumers place on these last 21 tons of paper. In other words, it results because the competitive market equates price with MCp instead of with MCs

Define public good

A commodity or service whose consumption by one person does not preclude others from also consuming it. It produces a positive externality and excluding one from consuming a public good is inefficient.

A tax on discharges into the air or waterways is called...

An effluent charge

A tax output or on air pollution produced is called...

An emissions fee

Why are firms uninclined to change their behaviour?

Because there is no financial punishment or incentive to do so The only way to produce less pollution for example is to stop producing some quantity of good

Under what conditions should a government impose a tax on output vs a direct tax on pollution produced?

Either option works when the ratio between output and pollution is fixed, however when the relationship varies by varying inputs or adding pollution-control devices than the government should tax pollution If the government knows the MCg, it can set the output tax equal to MCg to internalize the externality

What should the government do if the social optimum is greater than the unregulated monopoly output? Why?

If the government has enough information to determine the social optimum, they should subsidize the monopoly to get the monopoly to produce as much output as desired. The government must aim to eliminate BOTH the problems arising from EXTERNALITIES and the exercise of MARKET POWER.

Under what conditions would this be maximized if there are no externalities? How does this change if there's are externalities?

In a competitive equilibrium with no externalities, the total surplus and welfare would be maximized When there are externalities welfare is maximized where price equals social marginal cost because with an externality, you are now subjecting total surplus to the social marginal cost curve.

How do market failure's occur?

Market failure results from competitive forces that equalize the price and private marginal cost rather than social marginal cost, which includes both the private costs of production and the externality of damage

What are some issues of implementing an Emissions Standard?

Often the government does not know enough information to be able to do this optimally To set quantity restrictions they must know how both the MCs curve and demand curve for the good and pollution vary with output. Even if the government know enough to set the optimal regulation, it must be able to adequately and effective enforce this regulation to achieve the social optimum.

What does it mean when a good is rivalrous? Example?

Only one person can consume the good as its used up in consumption. (Water bottle)

No exclusion, rivalrous good

Open-access common property, e.g fishery, highway, internet

What does it mean when a good has property of exclusion?

Others can be prevented from consuming the good. Only the person who bought the water bottle may drink from it.

What happens when producers cannot restrict access to a public good?

Positive externalities and too little production may occur

A good that entails exclusion and rivalry

Private good, e.g candy bar, aluminium foil, water bottle

Non rivalrous, exclusion good

Public good with exclusion, e.g club good: concerts, membership clubs

No exclusion, non rivalrous good

Public good without exclusion e.g national defence, clean air

What is a open-access common property?

Resources to which everyone has free access and equal rights to exploit. They are not subject to exclusion and thus anyone can freely use (and abuse), creating externalities for the general public.

How do you analyze the efficiency of a voting result?

Take the total cost of the good and divide by the number of voters. Each individual will vote only if that person values the good by an amount that is at least their individual proportions. Therefore, the good is implemented only if the total added value is that amount. If the value to society is greater, it is not implemented and if it is lesser it is also not implemented.

What happens when a public good ignores the positive externality created?

The competitive market for the public good provides too little of this which creates inefficiency.

What is a private cost?

The cost of production only, not including externalities (labor, capital, materials)

Summarize a scenario in which a firm is granted a property right to pollute

The firm that is being affected by the negative externality may pay the firm that is producing it a "bribe" to reduce its output so that both firms benefit. The exact amount depends on their bargaining firms.

Who are the main beneficiaries from producing at the competitive output level rather than at the social optimal level?

The paper buyers who get to pay the competitive price rather than the lower socially optimal price

What is a social cost?

The private cost PLUS the cost of the harms from externalities

What is the social cost of open-access common properties?

The social cost is the private cost plus the externality cost from reduced future populations of fish.

In what circumstances could a tax on a monopoly with an externality increase welfare?

The tax lowers welfare if the untaxed monopoly was producing less than the social optimum. If the untaxed monopoly was originally producing more than the social optimum, a tax may cause welfare to increase.

What are the conditions for which a market for public goods can exist?

They can exist only if non purchasers can be excluded from consuming them. Therefore, markets for non exclusive public goods do not exist. If the government does not provide a non exclusive public good, no one provides it.

What are more common methods that a government may intervene?

Through indirect pollution controls such as quantity restrictions or taxes on output or inputs

What is a club good?

non-rival and excludable.

Summarize the two approaches to solving open-access commons problems. Provide examples of each.

1. Direct gov regulations through either taxation or restriction of access Applying a tax equal to the harm that each individual imposes on others, a government forces each person to internalize the externality. E.g charging an entrance fee to the national park 2. Assigning property rights. Converting common access property to private property removes the incentive to overuse it.

How would you find the effects on output, price, and welfare of taxing the monopoly an amount equal to the marginal harm of the externality?

1. Show how the equilibrium shifts if the firm is taxed. The intersection of the MR and MCs curves determines the taxed-monopoly equilibrium e*t. Show the before and after effects of the output and price. The tax will cause equilibrium quantity to fall and the equilibrium price to rise 2. Determine how this shift affects the DWL of the monopoly. The tax will exacerbate the monopoly's tendency to produce too little output. Before the tax, the monopoly produced too little, and now even less.

Summarize the methods used to reduce free riding

1. Social pressure 2. Mergers. Merging internalizes the positive externality. The sum of the benefit to the individual stores equals the benefit to the single merged firm, as an optimal decision is made to hire guards. 3. Privatization. This eliminates free riding by creating exclusion. 4. Compulsion. An outside entity such as the government could dictate a solution. Such as creating a contract with internalized costs, making certain practice (compulsary)

What is a firm's private producer surplus ?

A firm's private producer surplus is the producer surplus of paper mills based on their private marginal cost curve, below the market price and above MCP up to the competitive equilibrium quantity

Explain (summarize) the reason as to why a non cooperative market cannot treated like a competitive market when trying to internalizing the externality by simply placing a tax? (Include the two effects of a monopoly that causes this.

Although the competitive market with an externality always produces more output than the social optimum, a monopoly may produce more than, the same as, or less than the social optimum, therefore welfare may be greater under monopoly than with competition. Two offsetting effects of a monopoly causes this: 1. The monopoly tends to produce too little output because the sets price above marginal cost 2. but the monopoly tends to produce too much output because its decisions depend on its private marginal cost instead of the social marginal cost.

"A government limit on the amount pollution that may be released is called...

An emissions standard

What is a positive externality? Provide an example

An externality that can help its neighbours, the government is helping others by making a park more attractive

What is a negative externality? Provide an example?

An externality that harms others such as me creating a negative externality by fighting with my boyfriend and keeping people up

Explain the impact on marginal customer value to consumers from price of e*s and e*c

At smaller quantities the value (price) that consumers place on the last unit of the goo sold is higher than the full MCs. There the gain to consumers of paper exceeds the cost of producing an extra unit of output (and an extra unit of gunk). At largest quantities, the price is below the MCs, so the gain to consumers is less than the cost of producing an extra unit.

Summarize the issues that arise from open-access common properties?

Because people do not have to pay for open-access property (individuals do not bear the full social cost) they are overused. Examples include internet, fisheries, land and overgrazing. It causes congestion, competition and greediness without clearly defined property rights. Poorer conditions today raise the cost of conditions in the future (consider an example of fishing).

Why is welfare higher at the social optimum than at the competitive equilibrium?

Because the gain from reducing pollution from the competitive to the social optimal level more than offsets the loss to consumers and producers of the paper. The cost of the pollution to people who live near the factories is the area under the MCs curve below zero and the quantity produced.

Why does internalizing the externality work?

By internalizing the externality the private marginal cost (MCp +t) will be the same as MCs. Therefore the competitive AFTER-TAX equilibrium will be the same as the SOCIAL OPTIMUM e*s.

How can the government use permits to pollute to help alleviate the effects of pollution?

By issuing permits to pollute that can be exchanged in a market, the government is creating a new market for this "bad." The Cap-and Trade system is used and issues a right for each firm to create a certain amount of pollution in which each firm may use or sell to others. Trading maximizes value of output for a given amount of pollution damage, thus increasing efficiency. If the government has adequate information, it could assign the optimal amount of pollution to each firm and no trading would be necessary. But by using a market, the government doesn't have to do this nearly impossible task and will only have to be concerned with the total amount of pollution to allow. In a way they are controlling the "supply" of pollution to be exchanged. Pollution reduction under this method costs less than it would cost if permits were not tradable. The ones to benefit most from this are the poorest of households.

Summarize the scenario in which the government or court grants a firm the property right to be free of pollution

By making a motion to do so, the firm is preventing the firm creating the negative externality from doing so at all. With no (pollution), the firm can experience hiring profits. However the firm creating the negative externality would have to shut down without coming to some sort of agreement, thus they offer the firm a fee for a right to dump. The firm is willing to allow this ONLY IF THEY MAKE AT LEAST AS MUCH AS THEY WOULD WITH NO POLLUTION. Therefore, the largest amount the firm is willing to take is one that leaves them with a positive profit. The "bad" firm paying for the right to pollute will also be constrained to only pay as much as premium as they would have positive profit as well. The exact payment depends on the firm's bargaining skills. However, this outcome does result in a mutually benefit scenario in which joint profits are maximized so they should be able to reach an agreement if transaction costs are low enough.

If the government could only choose to regulate one market, which market should it choose?

Competitive market. Because the failure to regulate a noncompetitive market is less harmful.

Is it usually better for the government to regulate pollution directly or indirectly? Why or why not?

Direct regulation of pollution is better because it encourages firms to adopt efficient new technologies to control pollution

Define free riding, what problem arises from this?

Free riding is to benefit from the actions of others without paying. Firms may be reluctant to act in their best interests due to fear of free riding (prisoner's dilemma)

When and how might a government produce at e*c when faced when an externality?

If a government has sufficient knowledge about pollution damage, the demand curve, costs and the production technology, it can force a competitive market to produce the social optimum but introducing a tax or by restricting output

What are some problems with the Coase Theroem?

It is not a practical pollution but more of a demonstration that a lack of clearly defined property rights is the root of the externality problem. If the transaction costs are high it might not pay for the two sides to meet. Pollution can affect hundreds of thousands, not just firm-firm If firms engage in strategic bargaining behaviour, no agreement may be reached If either side lack info about costs or benefits of reducing pollution, a non efficient outcome may occur.

What is MCs in the paper mill example? What does it comprise of?

MCs is the social marginal cost. In this example for a given amount of good's production, the full cost to society of one more ton of paper to society, the MCs is the cost of manufacturing one more ton of paper to the paper firms PLUS the additional externality damage to all people in the community from producing this last ton of paper.

What happens with an exclusive public good due to lack of rivalry?

Markets tend to produce too little so they price above MC and too few units are sold. The MC of providing a public good is essentially zero.

Explain what it means to internalize the externality

Means to bear the cost of the harm that one inflicts on others (or to capture the benefit that one provides to others)

What are some problems with the methods that the government uses to gather information regarding the value of a public good?

Most people do not know how much they truly value a public good. Even so, people have incentive to lie through exaggeration. In voting, they ignore the intensity of preferences. Majority voting fails to value the public good fully and hence does not guarantee that it is efficiently provided.

What was the main idea of the Pulp and Paper Mill Pollution and Regulation case application?

Regulating pollution is a delicate matter. Often the pollution emitted is not in a fixed ratio with output. There are technologies and actions to lower pollution per output but politics and regulations must be taken into consideration. Plants in different areas are subject to different regulations due to different interests.

What is NOT an externality?

Something negatively impacting society that occurred INDIRECTLY

How does the government use voting to decide on the value or fate of a public good?

The decision will ultimately depend on the media voter, the person with respect to whom half the populace values the project less and half values the project more. It is efficient to implement the public good if the value of the good to society is at least as great as its cost. However, majority voting does not ensure efficiency.

Define externality

The direct effect of the person's actions or firms on another person's wellbeing or a firms production capability rather than an indreict effect through changes in prices

How will the government decide to set an output restriction or a pollution standard?

The ease with which the government can monitor output and pollution

What ultimately determines how much output a monopoly produces?

The elasticity of demand for the output and on the extent of the marginal damage the pollution causes. If the marginal curve is very elastic, the monopoly markup is small - the monopoly equilibrium is close to the competitive equilibrium e*c, and greater than the social optimum e*s If extra pollution causes little additional harm, MCg is close to zero at the equilibrium, the social marginal cost essentially equals the private marginals cost, and the monopoly process less than the social optimum.

Define property right, provide an example

The exclusive privilege to use an asset. Property rights assign a price to something, if not one holds one for a good or bad, it is unlikely that it has a price. This is particularly an issue with bands because property rights are not usually clearly defined, allowing a polluter's (for example) MCp of production to be less than the MCs. By owning a textbook I have a property right to read it and stop others from reading or taking my copy.

How does the government gather the information needed to be able to ensure a non exclusive public good is provided?

The government must know the cost and the value of the public good to many individuals. To do this, they pay do so through surveys or voting results.

After a tax is implemented, what becomes the Marginal cost for the producer?

The marginal cost for the producer is the after tax marginal cost which = MCs = MCp + t(Q) where t(Q) = the cost of the externality at the socially optimal quantity

How is demand for public goods different from demand for a private good. Why? Explain intuitively and graphically.

The market demand or social marginal benefit curve for private goods is the HORIZONTAL sum of the demand curves of each individual because the social marginal benefit of a private good is the same as the marginal benefit to the individual who consumes the good. The social marginal benefit of a public good if the sum of the marginal benefit to each person who consumer the good. The social demand curve for a public good is always the VERTICAL sum of the demand curves of each individual.

What does the Coase Theorem state?

The optimal levels of pollution and output can result from bargaining between polluters and their victims if property rights are clearly defined. If there are no impediments to bargaining, assigning property rights results in the efficient outcome at which joint profits are maximized Efficiency is achieved regardless of who receives the property rights Who gets the property rights affects the income distribution because they are valuable. The party with the rights may be compensated by the other party.

How will the government decide what tax to place on firms to maximize welfare?

The tax placed will equal the harm from the negative externality. The dollar amount can be found by setting e*s equal to the linear demand curve to find Qs. Tax will be the price of MCg at Qs. The after tax quantity of MCp + t (in this case MCp + 84) equals the social marginal cost at the socially optimal quantity and intersects the demand curve at the socially optimal quantity as a result (because MC = Supply curve).

Which market will have a higher total welfare if the monopoly produces less than the social optimum?

This depends on which distortion between the two markets is larger. Either the monopoly producing too little or the competitive market producing too much. Find out by doing a DWL analysis.

Which market will have a higher total welfare if BOTH monopoly and competitive outputs are greater than the social optimum?

Welfare will be greater under monopoly because the output is less than at the competitive market.

In the context of the Coase Theroem, summarize the scenario in which there are no property rights

Without property rights, the two firms with conflicting interests will not negotiate with each other because their property rights are not clearly defined. There is not incentive for either firm to do so otherwise. If the firms do not negotiate the firm producing the negative externality will produce at a level that maximizes its own profit, ignoring the costs that they are causing to the other firm. In this situation, the firm producing the externality has a dom. Strategy in which no matter what the other firm does, they will choose the option that maximizes their own profit. It is possible for this to be an efficient outcome as long as no one else is directly affected by the pollution. This is analyzed in the sum of the two profits. If profits are not maximized that that signals that the firm producing the externality is negatively impacting the sales of the other firm in some way, meaning too much of it has been produced.