Externalities and Public Goods

Transcription

1 Externalities and Public Goods

2 Four Categories of Goods Goods differ on the basis of whether their consumption is rival and excludable. Rival The situation that occurs when one person s consuming a unit of a good means no one else can consume it. If you eat a hamburger, no one can eat the same unit of that hamburger. Excludable The situation in which anyone who does not pay for a good cannot consume it. If you don t pay for a hamburger, you could be excluded from consuming it.

3 Four Categories of Goods 1. Private Good a good that is both rival and excludable. Food, clothing, personal electronics, cars, etc. The market is good at providing private goods 2. Public Good a good that is both nonrival and nonexcludable. National defense, court system, lighthouses, streetlights, flood-control levees etc. The market typically under-provides these goods or not at all since they are nonexcludable. It is difficult for a firm to make a profit off of providing them. People can consume these types of goods without paying for them, which is known as free riding. Free rider problem - Benefiting from a good without paying for it. The mandate in the ACA is supposed to help remedy the problem of uncompensated expenses for health care. The government provides public goods and partially resolves the free rider through taxation.

4 Four Categories of Goods 3. Quasi-Public Good / Club Good a good that is excludable, but not rival. Cable TV, uncongested toll roads, uncongested beach that required a fee, cinemas, etc. 4. Common Property Resource a good that is rival, but nonexcludable. International fish stocks, public pasture land, free water use, hunting and trapping, etc.

5 Four Categories of Goods Excludable Nonexcludable Rival Nonrival Private Goods: Pizza Tennis Rackets Shoes Quasi-Public Goods: Cinemas Uncongested Toll Road Internet Common Resources: International Fish Stocks Public Pasture Lands Public Goods: National Defense Court System Lighthouse

6 Demand for a Public Good The demand for a public good is similar to the demand for a private good. It is the aggregation of all individual demand curves (or marginal benefit curves). The optimal quantity of a public good is where the marginal social benefits equal the marginal social costs. This is also where consumer and producer surplus is maximized.

7 Demand for a Public Good However, there is little to no incentive for an individual to reveal their true preferences regarding a public good since once it is supplied they cannot be excluded from consuming it. In addition, public goods are often supplied to many people and it is difficult and time consuming to determine each individual s marginal private benefit curve.

8 Demand for a Public Good The government typically resorts to cost-benefit analysis when supplying a public good or some sort of political process. Congress and the President do not use a formal cost benefit analysis to determine the optimal level of military spending. Other times, public goods are left up to a referendum.

9 Common Resources and the Tragedy of the Commons Common property resources are not owned by anyone and therefore, everyone has access to it (i.e. it is nonexcludable). Tragedy of the Commons the tendency for a common property resource to be overused, potentially to the point where it is exhausted.

10 Common Resources and the Tragedy of the Commons The Tragedy of the Commons is a 1968 essay by Garret Hardin. Hardin hypothetically claimed that herders who wanted to maximize their herd yields would expand their herd size to a point that would lead to overgrazing of public pastures lands and ultimately rendering them useless. This has been criticized since public pasture lands have been properly maintained, but the tragedy of the commons does exist.

11 Common Resources and the Tragedy of the Commons Haiti was once heavily forested. Today, about 80% of the country s forests have been cut down, primarily to be burned to create charcoal for cooking and heating. Heavy rains lead to devastating floods since the mountains have no tree roots to hold the soil. Overfishing salmon, sturgeon, whales, etc. Over appropriation of water. Pollution and environmental sinks.

12 Solutions to the Tragedy of the Commons 1. Privatization along with clearly defined and enforceable property rights. Individuals do not have an incentive to over-exploit their own resources. 2. Government intervention through regulations, taxation, quotas, and permits.

13 Externalities Externality a spillover benefit or cost onto someone who is not directly involved in the production or consumption process. They impose external benefits and costs onto others Negative Externalities Spillover costs Air pollution from production, water contamination, animal production, a cell phone ringing in class, people smoking by public doorways, loud (and terrible) music at 2 a.m., too much drinking by bar goers, eating unhealthy, crime, being distracted while driving. Positive Externalities Spillover benefits Education, immunization, looking your best, asking a question in class, beekeepers, home improvements or gardens, research and development, home ownership, fireworks, loud music that you like, inspiring others with ideas and actions.

14 Externalities Externalities are a type of market failure since the price mechanism does not take into accounts the full marginal social costs and marginal social benefits of production and consumption. Externalities are a divergence between the private and social cost or benefits. Private costs or benefits are borne by the decision maker; either the buyer or seller External costs or benefits are the values lost to (or gained by) outside parties who are not represented by the market supply and demand

15 Social Costs or Benefits Social costs or benefits are the sum of all the costs or all the benefits to all members of society; includes both private and external costs. To summarize: Social costs = private costs + external costs Social benefits = private benefits + external benefits

16 Example: Positive Externality Education is a positive externality. The private benefits of education are: Earning more money, having more opportunities, increasing your utility from becoming more worldly, fixing a problem in your life, help you to achieve your dreams, etc. However, are these the only benefits of education? The external benefits of educations are: Education leads to higher incomes and more taxes being paid in which others benefits from, less (property) crime, better voting decisions which affect many, economic growth and increased opportunities for others. Notice that individuals who pay for their education do not get compensated for these spillover effects.

17 Example: Negative Externality Pollution from production (steel firm, paper mill, industrial farming) is a negative externality. The private costs are: What the firm pays for their factors of productions. The external costs are: Bad odors, increases in respiratory and cardiovascular diseases, water contamination, increase in resilience of bacteria to antibiotics, dirtier homes, cars, and clothes. Notice that the firm does not pay for these external costs, unless government or legal action takes places.

18 Externalities and Market Failure Externalities are a type of market failure since the price mechanism does not take into accounts the full marginal social costs and marginal social benefits of production and consumption. Therefore, the market price is not the efficient price and we have deadweight loss. With negative externalities, the market over-allocates resources towards that activity. With positives externalities, the market, under-allocates resources towards that activity.

19 What causes Externalities and Market Failures? Externalities and their coinciding market failures are the result from incomplete property rights or from the difficulty of enforcing property rights in certain situations. For example, when you buy a college education, other people may benefit from it. You have no property rights that enable you to prevent others from benefiting or to charge them for the benefits they receive.

20 Correcting for Externalities. 1. Tax away negative externalities or subsidize away positive externalities. This is also known as a Pigouvian Tax or Pigovian Subsidy. For example, if the marginal external cost of a negative externality (e.g. smoking) is $1, then a $1 per-unit tax would lead to the right outcome. The individual (or firm) would be internalizing their external costs. A key problem with the Pigouvian tax (and subsidy) is that it is difficult to estimate and like all taxes, it may promote gray and black activity

21 Correcting for Externalities. 2. Quotas For example, set a maximum quota for pollution or set a minimum amount of rest for airline pilots. 3. Tradable permits are quotas for pollution that can be traded on the market. Advantages over quotas are that tradable permits tend to promote efficient exchange, give the incentive to promote pollution abatement technology, and environmental groups can even buy the right to pollute permits.

22 Correcting for Externalities. 4. Regulation and mandates. Technology mandates such as catalytic convertors for automobiles and scrubbers for smokestacks. Mandate that children must be provided an education up to a certain level or age. Mandatory vaccinations for children enrolling in public schools. 5. Criminalization. Prostitution, addictive drugs, commercial fraud, and many types of environmental and public health laws. 6. Government provision. As with lighthouses, education, and national defense (i.e. goods that provide positive externalities). 7. Do nothing. The cost of correcting the externality may exceed the benefit.

23 Coase Theorem Coase Theorem in absence of transaction costs, individuals may be able to solve the problem of externalities without government involvement through negotiation. A major problem with the Coase Theorem is the assumption of zero transaction costs; that it costs absolutely nothing to strike a deal--no time, no effort, no lawyers, and not even a paper and pen on which to write it up the deal. Even if transactions are low, then the Coase Theorem could be applied, but transactions costs are not typically low for significant externalities, such as pollution.

24 To Summarize: There are four types of goods based on whether their consumption is rival and excludable. Externalities spillover benefits or costs. Public Goods and Externalities are a type of market failure. The market underprovides public goods since they are nonexcludable. As for externalities, there is a divergence between the market price and efficient price due to external benefits and costs. DWL results when prices are not efficient. The market over-allocate resources with negative externalities and under-allocates resources with positive externalities.