Unit 2: Theory of Externalities: Pareto optimality and market failure in the presence of externalities; property rights and the Coase theorem

Save this PDF as:
 WORD  PNG  TXT  JPG

Size: px
Start display at page:

Download "Unit 2: Theory of Externalities: Pareto optimality and market failure in the presence of externalities; property rights and the Coase theorem"

Transcription

1 Unit 2: Theory of Externalities: Pareto optimality and market failure in the presence of externalities; property rights and the Coase theorem Public Goods and Externalities (from chapter five, Kolstad, Intermediate Environmental Economics) The reason the market fails to allocate environmental commodities efficiently (unlike conventional goods which it can allocate efficiently) is because they are associated with externalities and public goods. These characteristics lead to market failure. Characterising a good: excludability and rivalry Economics has defined two fundamental characteristics of goods: excludability and rivalry. Excludability Definition: A good is excludable if it is feasible and practical to selectively allow consumers to consume the good. Conversely, a bad is excludable if it is feasible and practical to selectively allow consumers to avoid consumption of the bad. For example, a hamburger is excludable, whereas a city park without a fence or entrance control is non-excludable. Rivalry 1. If a good/bad is non-excludable, it is not possible to attach a price to the consumption of the good/bad, as we will not be able to prevent that consumption if the price is not paid. Without excludability, a price system will not work. 2. Excludability depends on the following: cost vs benefits of exclusion if the cost of exclusion is far more than the benefits gained, then a good is not excludable. technology of exclusion and how it changes over time; this determines how costly it is to exclude a good laws/legal system; hamburgers are excludable only because of laws ensuring private property, and legal redress if these laws are violated location; a consumer can be excluded from a local city park if he lives in a different city; more generally, goods/bads may be locally non-excludable but globally excludable. therefore, whether a good is excludable or not changes with historical circumstances. For example, with television signals, it used to be too expensive to exclude consumers. With the development of low-cost signal scramblers and unscramblers exclusion became feasible. Definition: A good/bad is rival if one person's consumption of a unit of the good/bad diminishes the amount available for others to consume. In other words, if a good is rival there is an opportunity cost to others associated with one's consumption of the good. For example, an icecream is rival (if you consume the icecream, it cannot be consumed by another person); and a street-light is non-rival (if you find it useful in that it provides illumination at night, this is no way affects the use it has for others).

2 1. In contrast to exclusion, the characteristic of rivalry does not change with technology or costs. It is thus a more fundamental characteristic of a good/bad than excludability. 2. The presence of non-rivalry makes it undesirable to ration individual use through prices or other means. This is because there is no cost associated with incremental use, and if price equals marginal cost of consumption, the price should be zero. 3. But if the price is zero, it makes it difficult to balance costs against revenues. 4. Important distinction: the marginal cost of production of a non-rival good is NOT zero. It is the marginal cost of consumption (adding another user) that is zero. For example, the cost of extending road network is NOT zero, but the cost of letting another car on this road is zero (provided it is not congested). Classification of goods Goods can be divided into four categories on the basis of the degrees of excludability and rivalry they possess. Excludable Non-excludable Rival Private goods hamburger (good), household garbage (bad) Open access resources fishery (good), household garbage when there are no laws on trash disposal (bad) Non-rival Club goods local swimming pool with entry control (good), water pollution in a small lake (bad) Pure public goods National defense (good), air pollution (bad) The supply of public goods/bads The characteristics of non-excludability and non-rivalry of a public good pertain to the consumption side, and affect the possibility of market failure and efficiency of provision. But from the production side, public goods need not be any different from private goods. These are the ways of looking at the supply of public goods: 1. Total supply equals the sum of what is supplied by individual producers If there are a set of i = 1, 2,..., I different producers each producing x i of the public good, then total supply X is given by: X = Σ i x i 2. 'Weakest-link' goods the total supply is the minimum of what is supplied by individual producers (example disease eradication, where producers are individual countries investing in disease eradication) X = min i {x i } 3. 'Best-shot' goods it is the maximum of what is produced (example development of a new cost-effective carbon-free energy source) X = max i {x i }

3 Efficient provision of public goods and bads If MRS i be the marginal rate of substitution between the public good for consumer i and MRT be the marginal rate of transformation in production between the public good and the numeraire good; the condition for efficiency (that is, Pareto optimality) is: Σ i MRS i (G * ) = MRT (G * ) The summing up of the individual MRS (marginal benefit) is done due to the non-rival nature of the good: the provision of an extra unit of G benefits all the consumers, and this must be summed up to get the group's marginal willingness-to-pay, which is then equated to the social cost of producing G. Diagramatically, the demand curve for a public good is given by the vertical summation of individual demand curves (all consumers consume the same amount of the good; so the total marginal willingness-topay is a sum of individual demand curves). Efficiency is given by the intersection with the supply curve (the marginal cost of production). (a) individual demands of Anna and Brewster (b) aggregate demand, rival good (horizontal summation); (c) aggregate demand, nonrival good (vertical summation); (d) efficient provision. Q R, quantity produced of rival good; Q N, quantity produced of nonrival good.

4 Open Access Resources to which there are no owners or the owners are public entities which exert no control over use are termed as open access (anyone may access them), common property (everyone owns the property and has access), or common pool (everyone is drawing from a common pool). Examples: 1. highway/road where access is not regulated 2. urban air pollution 3. stock of wildlife used for hunting 4. oil Model of fishery as open access We assume that the fishery is a well-defined body of water containing fish. The fewer fish, the more the effort to catch them. All fishers are identical in all respects, and there is a large pool of potential fishers who will enter into fishing if it is profitable. This can be represented in the following way: Externalities The cost of catching fish is concave upwards, because as the catch gets larger, it requires more and more effort to get one more unit of output (fish). Without regulation, output will occur at Y OA where total revenue equals total cost, and the net value of the fishery is zero. At any point before, the profit is positive, and hence new fishers will enter until Y OA where profits are zero. Each time a new fisher enters he only calculates his own costs and does not see that his entry has driven up costs for all the incumbent fishers as well. The efficient amount of fishing is at Y * where the marginal cost equals marginal revenue. Social value is DE. This value is the economic profit associated with the fishery and is also called its rent. Definition: An externality exists when the consumption or production choices of one person or firm enters the utility or production function of another entity without that entity's permission or compensation. 1. Consumption externality: A paper mill that discharges pollution into a river that is used for swimming purposes. 2. Production externality: steel and laundry

5 With no externality (line I), both firms produce are independent of each other. With an externality (lines II and III), increased steel production diminishes laundry output. The technology for producing laundry is given by: L = f L (x 1,..., x n, e) where L is the output of laundry, x i are the different inputs, and e is the smoke emissions from the steel factory, which is set by the steel mill. This is the production externality as the profits of the laundry are involuntarily affected by what the steel mill does. The steel mill produces both steel (S) and emissions e, using inputs z 1,..., z m : S = f S (z 1,..., z m, e) e = f e (z 1,..., z m ) The diagram to the right shows the different ouput combinations of laundry and steel outputs given a fixed amount of inputs. With no intervention, the steel mill will produce its maximum output S 0 and the laundry can only produce L 0. At prices p S and p L for steel and laundry output respectively, the total value of the output (S 0, L 0 ) is Y 0 = p S S 0 + p L L 0. This line intersects the vertical axis at L = Y 0 / p L. If we eliminate the externality by merging both firms, steel production will adjust so that the value of the output is maximized. This occurs where the price line is tangent to the production frontier at (S 1, L 1 ). As the output Y 1 in this case is greater than Y 0 (as seen on the vertical axis), this is clearly a Pareto improvement. 3. Pecuniary externality This refers to a change in the price of the good that a consumer consumes, purely as a result of the action of others (say, rise in demand). The consumer's income is fixed and her utility falls. While a pecuniary externality has distribution consequences, it does not cause any efficiency.

6 The price change means moving from one point on the Pareto frontier to another. There is a close connection between the ideas of a public good and an externality. Public goods/ bads are an extreme version of externalities in a way: because they are non-rival it means that everyone consumes the same quantity of the public bad. But the amount of consumption is chosen by someone else, the generator of the public bad. This is an externality. The Coase theorem and the assignment of rights (from chapter 13, section I, Kolstad Intermediate Environmental Economics) The establishment of enforceable property rights makes goods excludable (the example of garbage and laws against littering given earlier) is what allows the market system to operate. Without such well-defined property rights the market cannot allocate goods and bads efficiently. In his 1960 paper The Problem of Social Cost, Ronald Coase formulated his result which is now called the Coase Theorem as follows: Assume a world in which some producers or consumers are subject to externalities generated by other producers or consumers. Further, assume - 1. everyone has perfect information 2. consumers and producers are price-takers 3. there is a costless court system for enforcing agreements 4. producers maximize profits and consumers maximize utility 5. there are no wealth or income effects 6. there are no transaction costs In such a case, the initial assignment of property rights regarding exernalities does not matter for efficiency. If any of these conditions do not hold, the inital assignment does matter. Model of car factory and refinery to prove the Coase theorem The car factory is the victim, since it needs clean air to put on a perfect coat of paint on its cars. The refinery is the polluter. Abatement A can go from zero to one (complete abatement). Profits for the refinery and car factory depend on the level of abatement A and are given by Π R (A) and Π C (A), respectively, where the costs of pollution control are borne by the refinery. We will consider three cases and show that the initial assignment of rights does not matter for the efficient level of abatement to be reached:

7 1. Efficiency: As shown in the diagram below, the efficient level of abatement is A * where the marginal cost of pollution control (borne by the refinery) equals the marginal damage of pollution (to the car factory). The total profits are Π R (A * ) + Π C (A * ). The two other cases are that it is more profitable to shut the refinery down so there is zero pollution, or that it is more profitable to shut the car factory down so there is full pollution and the refinery does not have to pay for pollution control. Case Total profits 1 Both facilities operate Π R (A * ) + Π C (A * ) 2 Car factory shuts down Π R (0) 3 Refinery shuts down Π C (1) All three are possible cases of the efficient solution. Whichever profit level is the maximum is the action that should be taken from an efficiency perspective. 2. Victim (car factory) has the rights If the car factory has the legal rights to abatement A = 1 (zero pollution), the refinery will have to compensate the car factory for any pollution it causes. Therefore, the car factory is guaranteed a profit of Π C (1), since it has to be compensated for any loss of profits due to pollution. The refinery is the decision maker here and must decide whether to pay the car factory to reduce abatement below 1, or to buy out the car factory and shut it down, or to shut down itself. If both facilities operate, the abatement will reach A * as the marginal cost to the refinery for abatement starting from A = 1 is greater than the marginal benefit to the car factory from abatement. The refinery will buy the rights to reduce abatement from the car factory, till the point A. * Refinery's decision Refinery's profits Total profits Both facilities operate Π R (A * ) + Π C (A * ) - Π C (1) Π R (A * ) + Π C (A * ) Refinery buys out the car factory and shuts it down Π R (0) - Π C (1) Π R (0) Refinery shuts down 0 Π C (1) The conditions are identical to those in the first situation. The refinery will take the action that results in the highest profit; the choice will be the same as in the case of efficiency. 3. Polluter (refinery) has the rights Similarly we can argue that if the refinery has the legal rights to abatement A = 0 (full pollution), the car factory will have to pay the refinery to take up any pollution control. Therefore, the refinery is guaranteed a profit of Π R (0), since it has to be compensated for any loss of profits due to pollution control. The car factory is the decision maker here.

8 As before, there are three cases: if both facilities operate, the abatement will reach A * as the marginal benefit from abatement to the car-factory starting from A = 0 is greater than the marginal cost to the refinery from abatement. The car factory will pay the refinery to abate till the point A *. Car-factory's decision Car-factory's profits Total profits Both facilities operate Π R (A * ) + Π C (A * ) - Π R (0) Π R (A * ) + Π C (A * ) Car-factory shuts down 0 Π R (0) Car-factory buys out refinery and shuts it down Π C (1) - Π R (0) Π C (1) The conditions are identical to those in the previous two situations. The choice will be the same as in the case of efficiency. This proves the Coase theorem, that if there are no barriers to reaching an agreement we get efficiency, regardless of the initial assignment of property rights. Problems with the Coase theorem: 1. In the real-world there are significant transaction costs which limits the practical application of the Coase theorem. However, it then explains why property rights should be allocated in a particular way. 2. Even with no transaction costs, bargaining may break down because of an inability to decide to on the precise division of gains. 3. Also, in a case of public bads where there are many affected parties, the problem of freeriding arises. 4. Wealth effects: the initial allocation of rights affects the wealth and income of the parties involved (being allocated the right increases your wealth). Change in wealth and income affect choices, and hence the final bargain. Existence of transaction costs: If transaction costs exist, the status quo tends to prevail and bargaining is unlikely to happen. So the rights must be assigned to those who value them the most or have the greatest willingness to pay. One cannot rely on trade to re-allocate the rights. The initial allocation of rights thus does affect the final outcome. Bargaining Problems 1. Free-riding This problem arises because of the non-rival nature of pollution: it is a public bad. Suppose we have a plant that causes damages of $5 to 20 people (total damages = $100). The cost of cleaning up the plant is $91, suppose. It is thus socially desirable to undertake pollution control. If the right to pollution is vested with the plant, the individuals must come together and contribute $4.55 each to pay the plant to clean up. However, some individuals may choose to free-ride and

9 claim that the pollution does not affect them (this information is private). If two people or more decide to free-ride, it is not feasible for the remaining to contribute, and the efficient outcome cannot be reached. Conversely, if the right to clean is vested with the individuals, the plant must ask the citizens for their damages. The individuals then have an incentive to overstate their damages, and this leads to pollution control which is greater than optimum. 2. Bargaining with groups When there are more than two people bargaining, it may be the case that there is no bargain that is agreeable to all three people simultaneously. This can be illustrated in the case of two polluters (a steel mill S and railroad R) and one victim, a laundry L. We assume that all economic profits come from the laundry, and whenever a polluter gets together with the laundry it is always best to shut the laundry down. Suppose the laundry is vested with the rights to clean air. It can form a coalition with both the steel mill and the rail road and shut them down. However, it can be the case, that this coalition is dominated by a coalition with just the laundry and the steel mill. One can continue endlessly this way: each coalition and split of profits is dominated by another. Therefore, no bargain will be struck when the laundry is vested with rights to clean air. Policy implications of the Coase theorem 1. Transaction costs matter to the efficient distribution of rights to a clean environmental: rights must either be distributed efficient or trading costs must be reduced. 2. Making the victims of pollution pay should not be a barrier to implementing the solution of pollution reduction. Often, this becomes a stalemate, particularly when polluters have political power and it is impossible to force them to pay themselves to reduce pollution.

Market failure: The price system often fails to achieve reasonable consumption and production decisions.

Market failure: The price system often fails to achieve reasonable consumption and production decisions. 6. Market Failure: Public bads and externalities Market failure: The price system often fails to achieve reasonable consumption and production decisions. On the production side scale economies and natural

More information

C H A P T E R 18 Externalities and. Public Goods CHAPTER OUTLINE

C H A P T E R 18 Externalities and. Public Goods CHAPTER OUTLINE C H A P T E R 18 Externalities and Public Goods CHAPTER OUTLINE 18.1 Externalities 18.2 Ways of Correcting Market Failure 18.3 Stock Externalities 18.4 Externalities and Property Rights 18.5 Common Property

More information

Public Goods & Externalities

Public Goods & Externalities Market Failure Public Goods & Externalities Spring 09 UC Berkeley Traeger 2 Efficiency 26 Climate change as a market failure Environmental economics is for a large part about market failures: goods (or

More information

PUBLIC GOODS AND EXTERNALITIES

PUBLIC GOODS AND EXTERNALITIES PUBLIC GOODS AND EXTERNALITIES I. PRIVATE GOODS a. PRIVATE GOODS are produced through the competitive market system. They encompass the full range of goods available to the consumer in stores and shops

More information

AP Microeconomics Chapter 5 Outline

AP Microeconomics Chapter 5 Outline I. Learning Objectives In this chapter students should learn: A. How to differentiate demand side market failures and supply side market failures. B. The origin of consumer surplus and producer surplus,

More information

Chapter 5. Externalities, Environmental Policy, and Public Goods

Chapter 5. Externalities, Environmental Policy, and Public Goods Chapter 5. Externalities, Environmental Policy, and Public Goods Instructor: JINKOOK LEE Department of Economics / Texas A&M University ECON 202 504 Principles of Microeconomics Externalities Externality:

More information

Public Goods : (b) Efficient Provision of Public Goods. Efficiency and Private Goods

Public Goods : (b) Efficient Provision of Public Goods. Efficiency and Private Goods Public Goods : (b) Efficient Provision of Public Goods Efficiency and Private Goods Suppose that there are only two goods consumed in an economy, and that they are both pure private goods. Suppose as well

More information

Market Failures. Lecture 13: Market Failure and Government Action. Insufficient Competition. Insufficient Competition. Insufficient Competition

Market Failures. Lecture 13: Market Failure and Government Action. Insufficient Competition. Insufficient Competition. Insufficient Competition Slide 17-1 Lecture 13: Market Failure and Government Action Market Failures Markets can fail to be efficient: Readings: Chapters 13 (pp.313-315), 16, 17 Public goods And Markets can be unfair: Inequality

More information

The economics of the public sector:

The economics of the public sector: The economics of the public sector: Externalities and market inefficiency Public goods and common resource Dr. Anna Kowalska-Pyzalska Department of Operations Research Presentation is based on: http://www.swlearning.com/economics/mankiw/mankiw3e/powerpoint_micro.html

More information

Chapter 7 Externalities

Chapter 7 Externalities Chapter 7 Externalities Reading Essential reading Hindriks, J and G.D. Myles Intermediate Public Economics. (Cambridge: MIT Press, 2006) Chapter 7. Further reading Bator, F.M. (1958) The anatomy of market

More information

Environmental Policy, and Public Goods

Environmental Policy, and Public Goods CHAPTER 5 Externalities, Environmental Policy, and Public Goods Chapter Summary and Learning Objectives 5.1 Externalities and Economic Efficiency (pages 138 141) Identify examples of positive and negative

More information

Econ 460 Study Questions Fall 2013

Econ 460 Study Questions Fall 2013 Econ 460 Study Questions Fall 2013 MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) A monopoly might produce less than the socially optimal amount

More information

Supply and Demand, and Market Failure. Economics looks at the world from a perspective of choices we make given our limited resources.

Supply and Demand, and Market Failure. Economics looks at the world from a perspective of choices we make given our limited resources. and Demand, and Market Failure Economics looks at the world from a perspective of choices we make given our limited resources. Economics - the study of how society manages its scarce resources Or the study

More information

Public Goods and Common Resources

Public Goods and Common Resources CHAPTER 16 Public Goods and Common Resources After studying this chapter you will be able to Distinguish among private goods, public goods, and common resources Explain how the free-rider problem arises

More information

2. Efficiency and Perfect Competition

2. Efficiency and Perfect Competition General Equilibrium Theory 1 Overview 1. General Equilibrium Analysis I Partial Equilibrium Bias 2. Efficiency and Perfect Competition 3. General Equilibrium Analysis II The Efficiency if Competition The

More information

Practice Questions Week 6 Day 1

Practice Questions Week 6 Day 1 Practice Questions Week 6 Day 1 Multiple Choice Identify the choice that best completes the statement or answers the question. 1. Economists assume that the goal of the firm is to a. maximize total revenue

More information

Lecture 4. Chapter 4

Lecture 4. Chapter 4 Lecture 4 Chapter 4 Public Goods What we are going to do Definitions Examples Rivalry If someone consumes a good, then no one else can Excludability If you don t pay, you don t get the good. Private Goods:

More information

Market Failure. presented by: Dr. Ellen Sewell esewell@uncc.edu

Market Failure. presented by: Dr. Ellen Sewell esewell@uncc.edu Market Failure presented by: Dr. Ellen Sewell esewell@uncc.edu In general, a system of competitive markets will produce a socially optimal allocation of resources. What does this mean? When does a market

More information

Chapter 18. Externalities and Public Goods. Externalities. Negative Externalities

Chapter 18. Externalities and Public Goods. Externalities. Negative Externalities Chapter 18 Externalities and Public Goods Chapter 18 1 Externalities Externalities are the effects of production and consumption activities not directly reflected in the market They can be negative or

More information

Chapter 3:Externalities and Government Policy

Chapter 3:Externalities and Government Policy Reading: page 98~130 (Public Finance in Canada, David N. Hyman 10th edition) :Externalities and Government Policy Objectives: Define an externality and understand how such externality can prevent efficiency

More information

What are the conditions that lead to a perfectly competitive market?

What are the conditions that lead to a perfectly competitive market? Review: Lecture 1. Idea of constrained optimization. Definitions of economics. Role of marginal analysis. Economics as a way to explain. Also used to predict. Chapter 1 and 2. What is a market? What are

More information

Introduction. Introduction. Chapter 5: Externalities Problems and Solutions. Outline

Introduction. Introduction. Chapter 5: Externalities Problems and Solutions. Outline Outline Chapter 5: Externalities Problems and Solutions Externality theory Private solutions Public solutions Focus on prices or focus on quantities? A couple problems Introduction Externalities arise

More information

Department of Economics Academic year Fall-Winter term

Department of Economics Academic year Fall-Winter term University of Athens Department of Economics Academic year 2016-2017 Fall-Winter term Course: Public Finance Instructor: Georgia Kaplanoglou Assignment No 2. Answers A. Multiple choice questions (Correct

More information

Chapter 17 Externalities and Public Goods

Chapter 17 Externalities and Public Goods Chapter 17 Externalities and Public Goods Solutions to Review Questions 1. What is the difference between a positive externality and a negative externality? Describe an example of each. With a negative

More information

A public good is often defined to be a good that is both nonrivalrous and nonexcludable in consumption.

A public good is often defined to be a good that is both nonrivalrous and nonexcludable in consumption. Theory of Public Goods A public good is often defined to be a good that is both nonrivalrous and nonexcludable in consumption. The nonrivalrous property holds when use of a unit of the good by one consumer

More information

Topics Today (2/6/14)

Topics Today (2/6/14) Topics Today (2/6/14) Approaches to correct for externalities Government can make things worse last time and today The Coase Theorem today Other approaches future lectures The economics of pollution control

More information

There is no difference when everyone is identical. All systems are equal

There is no difference when everyone is identical. All systems are equal PART I: Short Answer 5 marks each 1) What is the difference between an ambient and emissions standard; and what are the enforcement issues with each? Ambient set an air/water quality level. It is the true

More information

nonrivalry => individual demand curves are summed vertically to get the aggregate demand curve for the public good.

nonrivalry => individual demand curves are summed vertically to get the aggregate demand curve for the public good. Public Goods Public Goods have two distinct characteristics: non-rivalry: several individuals can consume the same good without diminishing its value non-excludability: an individual cannot be prevented

More information

Chapter 3 Externalities and Government Policy

Chapter 3 Externalities and Government Policy Chapter 3 Externalities and Government Policy What are externalities? Externalities = Classifications 1. Negative Externalities (external costs) to third parties, other than the buyers or the sellers of

More information

ENVIRONMENTAL ECONOMICS. Efficiency and Markets. Efficiency and Markets. First Theorem of Welfare Economics. MARKET FAILURE AEC 829 October 4, 2004

ENVIRONMENTAL ECONOMICS. Efficiency and Markets. Efficiency and Markets. First Theorem of Welfare Economics. MARKET FAILURE AEC 829 October 4, 2004 ENVIRONMENTAL ECONOMICS MARKET FAILURE AEC 829 October 4, 2004 Efficiency and Markets First Theorem of Welfare Economics In a competitive economy, a market equilibrium is Pareto efficient Efficiency in

More information

Perman et al.: Ch. 4. Welfare economics and the environment

Perman et al.: Ch. 4. Welfare economics and the environment Perman et al.: Ch. 4 Welfare economics and the environment Objectives of lecture Derive the conditions for allocative efficiency of resources Show that a perfect market provides efficient allocation of

More information

Intermediate Microeconomics. Chapter 13 Monopoly

Intermediate Microeconomics. Chapter 13 Monopoly Intermediate Microeconomics Chapter 13 Monopoly Non-competitive market Price maker = economic decision maker that recognizes that its quantity choice has an influence on the price at which it buys or sells

More information

Chapter 10. Perfect Competition

Chapter 10. Perfect Competition Chapter 10 Perfect Competition Chapter Outline Goal of Profit Maximization Four Conditions for Perfect Competition Short run Condition For Profit Maximization Short run Competitive Industry Supply, Competitive

More information

Chapter 5. Market Equilibrium 5.1 EQUILIBRIUM, EXCESS DEMAND, EXCESS SUPPLY

Chapter 5. Market Equilibrium 5.1 EQUILIBRIUM, EXCESS DEMAND, EXCESS SUPPLY Chapter 5 Price SS p f This chapter will be built on the foundation laid down in Chapters 2 and 4 where we studied the consumer and firm behaviour when they are price takers. In Chapter 2, we have seen

More information

13 Externalities. Microeconomics I - Lecture #13, May 12, 2009

13 Externalities. Microeconomics I - Lecture #13, May 12, 2009 Microeconomics I - Lecture #13, May 12, 2009 13 Externalities Up until now we have implicitly assumed that each agent could make consumption or production decisions without worrying about what other agents

More information

(that is to say it takes place in a way other than through changing prices).

(that is to say it takes place in a way other than through changing prices). McPeak Lecture 12 PPA 723 Externalities. An externality occurs when an economic agent s consumption or production activities confer a benefit or impose a cost on other actors, and this benefit is conferred

More information

Chapter 17 Externalities

Chapter 17 Externalities Goldwasser AP Microeconomics BEFORE YOU READ THE CHAPTER Chapter 17 Externalities Summary This chapter describes positive, negative, and network externalities and the effects of these externalities in

More information

Midterm Exam #1 - Answers

Midterm Exam #1 - Answers Page 1 of 9 Midterm Exam #1 Answers Instructions: Answer all questions directly on these sheets. Points for each part of each question are indicated, and there are 1 points total. Budget your time. 1.

More information

Microeconomics Topic 9: Explain externalities and public goods and how they affect efficiency of market outcomes.

Microeconomics Topic 9: Explain externalities and public goods and how they affect efficiency of market outcomes. Microeconomics Topic 9: Explain externalities and public goods and how they affect efficiency of market outcomes. Reference: Gregory Mankiw s Principles of Microeconomics, 2 nd edition, Chapters 10 and

More information

Externalities. Pollution Smoking Ugly houses Drunk driving Loud noises Strong perfume Barking dogs Fire hazards Education Bad Drivers Disease

Externalities. Pollution Smoking Ugly houses Drunk driving Loud noises Strong perfume Barking dogs Fire hazards Education Bad Drivers Disease Externalities Pollution Smoking Ugly houses Drunk driving Loud noises Strong perfume Barking dogs Fire hazards Education Bad Drivers Disease Experiment 6 We're trading lawn ornaments today. Every lawn

More information

Microeconomics Required Graphs and Terms

Microeconomics Required Graphs and Terms Microeconomics Required Graphs and Terms Understanding and explaining the economic concepts required by the AP and IB exams rests on a solid knowledge of fundamental economic graphs and terms. In order

More information

CHAPTER 11 MARKETS WITHOUT POWER Microeconomics in Context (Goodwin, et al.), 1 st Edition (Study Guide 2008)

CHAPTER 11 MARKETS WITHOUT POWER Microeconomics in Context (Goodwin, et al.), 1 st Edition (Study Guide 2008) CHAPTER 11 MARKETS WITHOUT POWER Microeconomics in Context (Goodwin, et al.), 1 st Edition (Study Guide 2008) Chapter Summary This chapter presents the traditional, idealized model of perfect competition.

More information

12 MONOPOLY. Chapter. Key Concepts

12 MONOPOLY. Chapter. Key Concepts Chapter 12 MONOPOLY Key Concepts Market Power Monopolies have market power, the ability to affect the market price by changing the total quantity offered for sale. A monopoly is a firm that produces a

More information

MC 2 AC 2 P 1 P 2 D. q Q 1 Q 2 Q

MC 2 AC 2 P 1 P 2 D. q Q 1 Q 2 Q Perfect Competition Problem 1 (APT 93, P1) A perfectly competitive manufacturing industry is in long-run equilibrium. Energy is an important variable input in the production process and therefore the price

More information

Name Eco200: Practice Test 2 Covering Chapters 10 through 15

Name Eco200: Practice Test 2 Covering Chapters 10 through 15 Name Eco200: Practice Test 2 Covering Chapters 10 through 15 1. Four roommates are planning to spend the weekend in their dorm room watching old movies, and they are debating how many to watch. Here is

More information

Externalities: Problems and Solutions. 131 Undergraduate Public Economics Emmanuel Saez UC Berkeley

Externalities: Problems and Solutions. 131 Undergraduate Public Economics Emmanuel Saez UC Berkeley Externalities: Problems and Solutions 131 Undergraduate Public Economics Emmanuel Saez UC Berkeley 1 OUTLINE Chapter 5 5.1 Externality Theory 5.2 Private-Sector Solutions to Negative Externalities 5.3

More information

Fall 2007 Economics 431 Mid-Term Exam Prof. Hamilton

Fall 2007 Economics 431 Mid-Term Exam Prof. Hamilton Fall 2007 Economics 431 Mid-Term Exam Prof. Hamilton Name: KEY Question 1A. (15 points) Externalities and Monopoly Markets Demonstrate on a diagram that the deadweight loss from a negative production externality

More information

DEMAND AND SUPPLY IN FACTOR MARKETS

DEMAND AND SUPPLY IN FACTOR MARKETS Chapter 14 DEMAND AND SUPPLY IN FACTOR MARKETS Key Concepts Prices and Incomes in Competitive Factor Markets Factors of production (labor, capital, land, and entrepreneurship) are used to produce output.

More information

Econ 201, Microeconomics Principles, Final Exam Version 1

Econ 201, Microeconomics Principles, Final Exam Version 1 Econ 201, Microeconomics Principles, Final Exam Version 1 Instructions: Please complete your answer sheet by filling in your name, student ID number, and identifying the version of your test (1 or 2).

More information

Microeconomics. Claudia Vogel EUV. Winter Term 2009/2010. Externalities and Public Goods

Microeconomics. Claudia Vogel EUV. Winter Term 2009/2010. Externalities and Public Goods Microeconomics Claudia Vogel EUV Winter Term 2009/2010 Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 1 / 21 Lecture Outline Part IV Information, Market Failure and the Role of Government 14

More information

Micro Externalities WCC P E Q Q

Micro Externalities WCC P E Q Q Micro Externalities WCC If it ain t broke, don t fix it consider our standard supply and demand diagram below note the size of the shaded economic surplus generated if we allow the market to reach its

More information

Chapter 13 Perfect Competition

Chapter 13 Perfect Competition Chapter 13 Perfect Competition 13.1 A Firm's Profit-Maximizing Choices 1) What is the difference between perfect competition and monopolistic competition? A) Perfect competition has a large number of small

More information

Chapter 6: Pure Exchange

Chapter 6: Pure Exchange Chapter 6: Pure Exchange Pure Exchange Pareto-Efficient Allocation Competitive Price System Equitable Endowments Fair Social Welfare Allocation Outline and Conceptual Inquiries There are Gains from Trade

More information

THE ECONOMY AT FULL EMPLOYMENT: THE CLASSICAL MODEL*

THE ECONOMY AT FULL EMPLOYMENT: THE CLASSICAL MODEL* Chapter 8 THE ECONOMY AT FULL EMPLOYMENT: THE CLASSICAL MODEL* The Classical Model: A Preview Topic: Real Variables 1) Real variables A) are those that determine the cost of living. B) are those that determine

More information

Firms in Perfectly Competitive Markets

Firms in Perfectly Competitive Markets Chapter 11 Firms in Perfectly Competitive Markets Chapter Outline 11.1 LEARNING OBJECTIVE 11.1 Perfectly Competitive Markets Learning Objective 1 Define a perfectly competitive market, and explain why

More information

Practice Questions Week 8 Day 1

Practice Questions Week 8 Day 1 Practice Questions Week 8 Day 1 Multiple Choice Identify the choice that best completes the statement or answers the question. 1. The characteristics of a market that influence the behavior of market participants

More information

Microeconomics Instructor Miller Practice Problems Externalities and Public Goods

Microeconomics Instructor Miller Practice Problems Externalities and Public Goods Microeconomics Instructor Miller Practice Problems Externalities and Public Goods 1. An externality is A) a benefit realized by the purchaser of a good or service. B) a cost paid for by the producer of

More information

MATH MODULE 11. Maximizing Total Net Benefit. 1. Discussion M11-1

MATH MODULE 11. Maximizing Total Net Benefit. 1. Discussion M11-1 MATH MODULE 11 Maximizing Total Net Benefit 1. Discussion In one sense, this Module is the culminating module of this Basic Mathematics Review. In another sense, it is the starting point for all of the

More information

chapter >> Consumer and Producer Surplus Section 3: Consumer Surplus, Producer Surplus, and the Gains from Trade

chapter >> Consumer and Producer Surplus Section 3: Consumer Surplus, Producer Surplus, and the Gains from Trade chapter 6 >> Consumer and Producer Surplus Section 3: Consumer Surplus, Producer Surplus, and the Gains from Trade One of the nine core principles of economics we introduced in Chapter 1 is that markets

More information

1 of 18 10/19/ :51 PM

1 of 18 10/19/ :51 PM 1 of 18 10/19/2013 12:51 PM Which of the following is true about a competitive market supply curve? It is horizontal. It is downward-sloping to the right. It is the sum of the marginal cost curves of all

More information

CHAPTER 15 Public Goods, Externalities, Information Asymmetries, and Market Failure

CHAPTER 15 Public Goods, Externalities, Information Asymmetries, and Market Failure Part Four: Microeconomics of Government and International Economics CHAPTER 15 Public Goods, Externalities, Information Asymmetries, and Market Failure 2010 McGraw-Hill Ryerson Ltd. Slides prepared by

More information

Version 1-Yellow. 1. My version of the quiz is a. Version 1 Yellow b. Version 2 Purple c. Version 3 Green d. Version 4 Pink e.

Version 1-Yellow. 1. My version of the quiz is a. Version 1 Yellow b. Version 2 Purple c. Version 3 Green d. Version 4 Pink e. Midterm Exam 2 Version 1-Yellow Instructions: Answer each of the questions. Print your name and student number clearly on the answer sheet. Fill in the bubbles corresponding to your student number, leaving

More information

Market Failures 4/6/2015. WHAT ARE ANTITRUST LAWS? Laws designed to prevent monopolies and promote competition. WHAT DOES THE GOVERNMENT DO?

Market Failures 4/6/2015. WHAT ARE ANTITRUST LAWS? Laws designed to prevent monopolies and promote competition. WHAT DOES THE GOVERNMENT DO? Market Failures A market failure occurs when the supply of a good or service is insufficient to meet demand. Examples: Resource Immobility - Job Openings in Alaska Inefficient Resource Allocation Exorbitant

More information

26 : Perfect Competition

26 : Perfect Competition 26 : Perfect Competition 1 Recap from last Session Features of Perfect Competition Demand and Revenue of a firm Short run Equilibrium Market supply and firm s supply analysis Session Outline Market supply

More information

Marginal cost. Average cost. Marginal revenue 10 20 40

Marginal cost. Average cost. Marginal revenue 10 20 40 Economics 101 Fall 2011 Homework #6 Due: 12/13/2010 in lecture Directions: The homework will be collected in a box before the lecture. Please place your name, TA name and section number on top of the homework

More information

Economic Freedom. Market Failure. Market Failure. Market Failures. Externalities. Externalities. Chapter 14 Externalities

Economic Freedom. Market Failure. Market Failure. Market Failures. Externalities. Externalities. Chapter 14 Externalities Market Failure Chapter 14 Externalities Economic Freedom Economic freedom refers to the degree to which private individuals are able to carry out voluntary exchange without government involvement. The

More information

ANSWERS TO END-OF-CHAPTER QUESTIONS

ANSWERS TO END-OF-CHAPTER QUESTIONS ANSWERS TO END-OF-CHAPTER QUESTIONS 24-1 No firm is completely sheltered from rivals; all firms compete for the consumer dollars. Pure monopoly, therefore, does not exist. Do you agree? Explain. How might

More information

Managerial Economics Prof. Trupti Mishra S.J.M. School of Management Indian Institute of Technology, Bombay. Lecture - 13 Consumer Behaviour (Contd )

Managerial Economics Prof. Trupti Mishra S.J.M. School of Management Indian Institute of Technology, Bombay. Lecture - 13 Consumer Behaviour (Contd ) (Refer Slide Time: 00:28) Managerial Economics Prof. Trupti Mishra S.J.M. School of Management Indian Institute of Technology, Bombay Lecture - 13 Consumer Behaviour (Contd ) We will continue our discussion

More information

Oligopoly: How do firms behave when there are only a few competitors? These firms produce all or most of their industry s output.

Oligopoly: How do firms behave when there are only a few competitors? These firms produce all or most of their industry s output. Topic 8 Chapter 13 Oligopoly and Monopolistic Competition Econ 203 Topic 8 page 1 Oligopoly: How do firms behave when there are only a few competitors? These firms produce all or most of their industry

More information

Chapter 17. The Economics of Pollution Control

Chapter 17. The Economics of Pollution Control Chapter 17 The Economics of Pollution Control Economic Rationale for Regulating Pollution Pollution as an Externality -pollution problems are classic cases of a negative externality -the MSC of production

More information

Unit 1. Basic economic concepts

Unit 1. Basic economic concepts Unit 1. Basic economic concepts Learning objectives to understand the principle of marginal analysis; to understand that the existence of limited resources along with unlimited wants results in the need

More information

chapter >> Making Decisions Section 2: Making How Much Decisions: The Role of Marginal Analysis

chapter >> Making Decisions Section 2: Making How Much Decisions: The Role of Marginal Analysis chapter 7 >> Making Decisions Section : Making How Much Decisions: The Role of Marginal Analysis As the story of the two wars at the beginning of this chapter demonstrated, there are two types of decisions:

More information

The Efficiency of Markets. What is the best quantity to be produced from society s standpoint, in the sense of maximizing the net benefit to society?

The Efficiency of Markets. What is the best quantity to be produced from society s standpoint, in the sense of maximizing the net benefit to society? The Efficiency of Markets What is the best quantity to be produced from society s standpoint, in the sense of maximizing the net benefit to society? We need to look at the benefits to consumers and producers.

More information

MARKETS WITHOUT POWER Microeconomics in Context (Goodwin, et al.), 3 rd Edition

MARKETS WITHOUT POWER Microeconomics in Context (Goodwin, et al.), 3 rd Edition Chapter 16 MARKETS WITHOUT POWER Microeconomics in Context (Goodwin, et al.), 3 rd Edition Chapter Summary This chapter presents the traditional, idealized model of perfect competition. In it, you will

More information

This equation tells us something about the optimal path of the shadow price.

This equation tells us something about the optimal path of the shadow price. PROBLEM 1 A transboundary environmental problem can be a problem where the damage from emissions (or more likely the stock of pollutants) in one country depends on the total level of emissions (from all

More information

Economics I. General equilibrium and microeconomic policy of the state

Economics I. General equilibrium and microeconomic policy of the state Economics I General equilibrium and microeconomic policy of the state Course Objectives: The aim of the first lecture is to define the general equilibrium conditions of the economic system. Clarification

More information

Monopoly. Problem 1 (APT 93, P3) Sample answer:

Monopoly. Problem 1 (APT 93, P3) Sample answer: Monopoly Problem 1 (APT 93, P3) A single airline provides service from City A to City B. a) Explain how the airline will determine the number of passengers it will carry and the price it will charge. b)

More information

DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 1. Dartmouth College, Department of Economics: Economics 1, Fall 02.

DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 1. Dartmouth College, Department of Economics: Economics 1, Fall 02. Dartmouth College, Department of Economics: Economics 1, Fall 02 Topic 5: Welfare Economics 1, Fall 2002 Andreas Bentz Based Primarily on Frank Chapters 16-18 Review: Equilibrium Topic 3, Consumer Theory:

More information

Chapter 16 General Equilibrium and Economic Efficiency

Chapter 16 General Equilibrium and Economic Efficiency Chapter 16 General Equilibrium and Economic Efficiency Questions for Review 1. Why can feedback effects make a general equilibrium analysis substantially different from a partial equilibrium analysis?

More information

Module 2 Lecture 5 Topics

Module 2 Lecture 5 Topics Module 2 Lecture 5 Topics 2.13 Recap of Relevant Concepts 2.13.1 Social Welfare 2.13.2 Demand Curves 2.14 Elasticity of Demand 2.14.1 Perfectly Inelastic 2.14.2 Perfectly Elastic 2.15 Production & Cost

More information

Intermediate Microeconomics (22014)

Intermediate Microeconomics (22014) Intermediate Microeconomics (22014) IV. Market Instructor: Marc Teignier-Baqué First Semester, 2011 Part IV. Market First Welfare Theorem: all competitive equilibrium allocations are Pareto ecient (invisible

More information

Law & Economics Lecture 2: Externalities

Law & Economics Lecture 2: Externalities I. The Pigouvian Approach Law & Economics Lecture 2: Externalities An externality is a cost or benefit that is experienced by someone who is not a party to the transaction that produced it. A negative

More information

Externality Essentials P E Q E

Externality Essentials P E Q E Micro Externality Essentials If it ain t broke, don t fix it consider our standard supply and demand diagram below note the size of the shaded economic surplus generated if we allow the market to O reach

More information

Public Goods, Externalities, and Government Behavior

Public Goods, Externalities, and Government Behavior Taylor, Economics, 3 rd Edition, Chapter 15, Lecture Outline 2 CHAPTER 15 Public Goods, Externalities, and Government Behavior 3. Externalities: From the Environment to Education 3a. An externality is

More information

Monopoly. Key differences between a Monopoly and Perfect Competition Perfect Competition

Monopoly. Key differences between a Monopoly and Perfect Competition Perfect Competition Monopoly Monopoly is a market structure in which one form makes up the entire supply side of the market. That is, it is the polar opposite to erfect Competition we discussed earlier. How do they come about?

More information

Suggested Solutions to Assignment 1 (Optional)

Suggested Solutions to Assignment 1 (Optional) EC 238 Environmental Economics Instructor: harif F. Khan Department of Economics ilfrid Laurier University Intersession 2009 uggested olutions to Assignment 1 (Optional) Part A True/ False/ Uncertain Questions

More information

Chapter 13 Perfect Competition and the Supply Curve

Chapter 13 Perfect Competition and the Supply Curve Goldwasser AP Microeconomics Chapter 13 Perfect Competition and the Supply Curve BEFORE YOU READ THE CHAPTER Summary This chapter develops the model of perfect competition and then uses this model to discuss

More information

Chapter 4 Specific Factors and Income Distribution

Chapter 4 Specific Factors and Income Distribution Chapter 4 Specific Factors and Income Distribution Chapter Organization Introduction The Specific Factors Model International Trade in the Specific Factors Model Income Distribution and the Gains from

More information

Short-Run Production and Costs

Short-Run Production and Costs Short-Run Production and Costs The purpose of this section is to discuss the underlying work of firms in the short-run the production of goods and services. Why is understanding production important to

More information

ECONOMICS 336Y5Y Fall/Winter 2011/12. PUBLIC ECONOMICS Spring Term Test Sample Solutions Feb. 28, 2014

ECONOMICS 336Y5Y Fall/Winter 2011/12. PUBLIC ECONOMICS Spring Term Test Sample Solutions Feb. 28, 2014 UNIVERSITY OF TORONTO MISSISSAUGA DEPARTMENT OF ECONOMICS ECONOMICS 336Y5Y Fall/Winter 2011/12 PUBLIC ECONOMICS Spring Term Test Sample Solutions Feb. 28, 2014 Please fill in your full name and student

More information

ECON 1100 Global Economics (Fall 2013) Market Failure and the Allocation Function of Government

ECON 1100 Global Economics (Fall 2013) Market Failure and the Allocation Function of Government ECON 1100 Global Economics (Fall 2013) Market Failure and the Allocation Function of Government Relevant Readings from the Required Textbooks: Economics Chapter 10, Market Failure Definitions and Concepts:

More information

The fundamental question in economics is 2. Consumer Preferences

The fundamental question in economics is 2. Consumer Preferences A Theory of Consumer Behavior Preliminaries 1. Introduction The fundamental question in economics is 2. Consumer Preferences Given limited resources, how are goods and service allocated? 1 3. Indifference

More information

Student Name: Date: Teacher Name: Heather Creamer. Score:

Student Name: Date: Teacher Name: Heather Creamer. Score: Economics EOC Quiz Answer Key Microeconomic Concepts - (SSEMI1) Flow Of Goods, (SSEMI2) Law Of Demand, (SSEMI3) Economic Behavior, (SSEMI4) Organization And Role Of Business Student Name: Teacher Name:

More information

1 Annex 11: Market failure in broadcasting

1 Annex 11: Market failure in broadcasting 1 Annex 11: Market failure in broadcasting 1.1 This annex builds on work done by Ofcom regarding market failure in a number of previous projects. In particular, we discussed the types of market failure

More information

Lecture 6 Part I. Markets without market power: Perfect competition

Lecture 6 Part I. Markets without market power: Perfect competition Lecture 6 Part I Markets without market power: Perfect competition Market power Market power: Ability to control, or at least affect, the terms and conditions of the exchanges in which one participates

More information

AP Microeconomics Chapter 3 Outline

AP Microeconomics Chapter 3 Outline I. Learning Objectives In this chapter students should learn: A. What demand is and how it can change. B. What supply is and how it can change. C. How supply and demand interact to determine market equilibrium.

More information

Topic 7 General equilibrium and welfare economics

Topic 7 General equilibrium and welfare economics Topic 7 General equilibrium and welfare economics. The production possibilities frontier is generated using a production Edgeworth box diagram with the input goods on the axes. The following diagram illustrates

More information

1. Explain the law of demand. Why does a demand curve slope downward? How is a market demand curve derived from individual demand curves?

1. Explain the law of demand. Why does a demand curve slope downward? How is a market demand curve derived from individual demand curves? Chapter 03 Demand, Supply, and Market Equilibrium Questions 1. Explain the law of demand. Why does a demand curve slope downward? How is a market demand curve derived from individual demand curves? LO1

More information

MARKET DEMAND &SUPPLY DEMAND

MARKET DEMAND &SUPPLY DEMAND MARKET Market is a place where consumers meet sellers and the trading takes place. The consumers buy products at certain price, so money is exchanged for goods and services. We distinguish types of market

More information

Unit Perfect Competition Unit Overview

Unit Perfect Competition Unit Overview Unit 2.3.2 - erfect competition Assumptions of the model Demand curve facing the industry and the firm in perfect competition rofit-maximizing level of output and price in the short-run and long-run The

More information