Externalities, Commons and Public Goods

1
Externalities, Commons and Public Goods

• Perloff Chapter 18

2
Externalities

• When a persons well being or a firms production
  capacity is affected directly by anothers
  actions.
• Negative
• Chemical plant dumping waste into a lake.
• Positive
• A firm installing shrubs and sculpture benefits
  its neighbours

3
Marginal cost with and Externality

• Marginal Private Cost
• The additional cost incurred when an additional
  unit of output is produced.
• Marginal Social Cost
• The full cost incurred by all of society in
  producing another unit of output.
• MCsMCpMCg

4
Welfare Effects of Pollution
Social Private Change
CS A ABCD BCD
PSp BCFG FGH H-B-C
Cg CG CDEGH DEH
PSp-Cg BF F-C-D-E -B-C-D-E
CsPSs ABF ABF-E -EDWL
450
Price of paper, p, per ton
s
p
g


MC


MC


MC
A
p
MC
e
s
E
p
282
s
B
D
C
e
p
240
c
c
H
198
p
g
MC
MC
G
F
84
g
MC
30
Demand


Q


105
Q

84
225
0
c
s
Q
, Tons of paper per day
5
Emissions Standard

• Regulate pollution (or output) in order to
  achieve the social optimum.
• In the paper example constrain output to 84 units
  per day. Need to know
• Demand curve
• Marginal social cost curve
• Relationship between paper production and
  pollution.
• Enforcement is costly.

6
Emissions Fee

• Tax the pollution that is produced.
• Tax output (assuming a fixed relationship with
  pollution)
• Either
• vary tax with output (t(Q))
• fixed tax (t)

Price of paper, p, per ton
450
s
p


MC


MC


t
(
Q
)
p

MC


t
e
s
p
MC

84
t
g
MC
Demand

Q

84
225
0
s
Q
, Tons of paper per day
7
Cost benefit Analysis

• Compares the costs and benefits of a movement
  away from the market equilibrium.
• Costs
• Reduced output of paper
• Consumer surplus reduced
• Producer surplus reduced
• Benefits
• Reduced costs of polution

8
CBA of polution
(a) Cost and Benefit
Cost less paper
4,000
Benefit, Cost,
Benefit less gunk
2,000
Maximum
net
benefit
0
84
63
105
Q
, Tons of paper per day
G
, Units of gunk per day
(b) Marginal Cost and Marginal Benefit
MC
105
Marginal benefit,Marginal cost,
84
MB
0
84
105
Q
, Tons of paper per day
G
, Units of gunk per day
9
Externality With Monopoly
450
s
p
g


MC


MC


MC
Price of paper, p, per ton
e
t
330
e
m
310
e
s
p
MC
D
282
C
A
B
e
240
c
g
MC
30
Demand
MR
84
105
225
70
60
0
10
Regulation of a Monopoly with an Externality

• It may be that the monopoly is preferable to
  competition if regulation is not possible.
• Charging a tax equal to the MC of pollution may
  reduce welfare if monopoly output is below social
  optimum.
• Achieving the social optimum may entail
  subsidisation of a monopoly.

11
Property rights

• An exclusive right to use an asset
• Private ownership of asset
• Right to be free of noise pollution
• Courts could be used to enforce the right
• You could sell the right to someone who wants to
  be noisy.
• In many cases the rights are not assigned.

12
Coase Theorem No property Rights
Boat firm Boats rented per day
0 1 2
0
1
2
0
14
15
0
0
0
Chemical firm tonnes dumped per day.
0
10
5
10
10
10
0
2
-3
15
15
15
If property rights are with boat owner Minimum
price per unit of pollution is 5 Maximum price
is 10
If property rights are with chem. firm Minimum
price per unit of pollution is 5 Maximum price
is 7.50
13
Coase theorem Property rights with boat firm
Pollution priced at 7 per tonne
Boat firm Boats rented per day
0 1 2
0
1
2
14
0
15
0
0
0
Chemical firm tonnes dumped per day.
7
17
12
3
3
3
14
16
11
1
1
1
14
Coase theorem property rights with chemical firm
Pollution priced at 6 per tonne
Boat firm Boats rented per day
0 1 2
0
1
2
2
-12
3
12
12
12
Chemical firm tonnes dumped per day.
-6
4
-1
16
16
16
0
2
-3
15
15
15
15
Coase Therorem Summary

• Assigning property rights results in the
  efficient outcome.
• Efficiency is achieved regardless of who has the
  property rights.
• The distribution of welfare in the efficient
  outcome is dependent on the initial allocation of
  property rights.

16
Common Property

• Unlike private property people cannot be
  excluded.
• When deciding how much to use, people ignore the
  impacts on others so the resource is overused.
• Common pool, water, gas, oil.
• Internet
• Roads
• Fisheries

17
Public Goods

• Non-Excludability
• People cannot be prevented from consuming a good.
• Non rivalry
• The good is not used up when one person uses it.

18
Markets for public goods

• Only exist for excludable goods.
• Demand curve is the vertical summation of
  individual willingness-to-pay or demand curves

25
D
Price of guard service, per hour
1
D
18
13
e
e
p
s
10
Supply,
MC
8
7
2
D
3
2
5
7
9
4
0
Guards per hour
19
Free riding
20
Voting for the provision of a public good