McConnellBrue 15e

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Externalities Spillover Costs and Benefits
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Market Failures
Caused by either externalities (spillover) or
information problems v Externalities failures
(cost or benefit accruing to an individual or
groupa third partywhich is external to the
market transaction) Failure of the market to
bring about the allocation of resources that best
satisfies the wants of society. Results in
either overallocation or underallocation of
resources dedicated to the production of a
particular good or service.
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When there are NO externalities involved No
benefits or costs beyond those to consumer Qe
is efficient allocation equilibrium, so MBMC.
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OPTIMAL AMOUNT OF A PUBLIC GOOD
P
SMSC
9 7 5 3 1
The public goods marginal Cost as shown by the
Supply Curve
DMSB
0 1 2 3 4 5
Q
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OPTIMAL AMOUNT OF A PUBLIC GOOD
P
9 7 5 3 1
SMSC
Yields the optimum amount of the public good
MB MC
DMSB
0 1 2 3 4 5
Q
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Cost-benefit Analysis
Marginal Cost Marginal Benefit Rule
Externalities
Spillover Costs
Overallocation
Spillover Benefits
Underallocation
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Spillover Costs And Benefits
P
SMSC
Spillover costs
SMPC
DMB
Overallocation
Q
Q0
Qe
0
8
Overallocation of resources v when external
costs are present and suppliers are shifting some
of their costs onto the community, making their
marginal costs lower. v The supply does not
capture all the costs with the MPC curve
understating total production costs. v This
means resources are overallocated to the
production of this product. v By shifting costs
to the consumer, the firm enjoys MSC curve and Qo
(optimum output ).
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Spillover Costs And Benefits
P
SMSC
Spillover costs
SMPC
DMB
Overallocation
Q
Q0
Qe
0
10
Spillover Costs And Benefits
P
SMC
Spillover Benefits
DMSB
DMPB
Underallocation
Q
Qe
Q0
0
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Underallocation of resources v when external
benefits are present and the MPB curve reflects
only the private benefits understating the total
benefits, at Qe. v The output at Qo is optimum
and reflects the MSB curve and the S curve. v
External positive benefits will accrue to society
from the consumption of this product.
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Spillover Costs And Benefits
P
SMC
Spillover Benefits
DMSB
DMPB
Underallocation
Q
Qe
Q0
0
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Correcting Spillover Costs
Individual Bargaining
Coase Theorem
Liability Rules and Lawsuits
Government Intervention
Direct Controls
Specific Taxes
Subsidies and Government Provision
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Correcting Spillover Costs
SMSC
Spillover costs
P
SMPC
TAX
Overallocation Corrected
DMB
Q
Q0
Qe
0
15
Correcting for Spillover Benefits
Subsidy to Buyer to lower the price more
units will be sold. Seller to lower the
marginal cost of producing. More units will be
produced and sold.
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Correcting for Spillover Benefits
P
Correcting by Subsidy to Consumers
SMC
Subsidy to consumer increases demand
DMSB
DMPB
Underallocation Corrected
Q
Qe
Q0
0
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Correcting for Spillover Benefits
P
Correcting by Subsidy to Producers
SMPC
SMSC
Subsidy to producers increases supply
DMB
Underallocation Corrected
Q
Qe
Q0
0
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Market for Externality Rights
D 2002
S Supply of pollution rights
v Determine rights (supply is fixed) v Demand
is downsloping demand will increase over time as
human and business populations increase.
200 100
Price per pollution right
D 2012
500 750 1000
Quantity of pollution rights
Equilibrium price for rights will be
intersection of demand and supply.
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Market for Externality Rights
D 2002
S Supply of pollution rights
Firms are either encouraged to reduce or
eliminate it based on their costs and the price
of the right to pollute.
200 100
Price per pollution right
D 2012
500 750 1000
Quantity of pollution rights
Pollution Rights can be bought and sold
conservation groups can buy up rights to
control spillover costs.
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Societys Optimal Amount Of Externality Reduction
MC
Socially optimum amount of pollution abatement
Societys marginal benefit and marginal cost of
pollution abatement
MB
QO
0
Amount of pollution abatement