ECO 3104

1
ECO 3104

• Lecture 26

2
Externalities and Public Goods

• Introduction
• In some situations market system of voluntary
  exchange may not lead to allocative efficiency
• lack of consumer information
• monopoly
• externalities and public goods

3
Externalities

• Negative
• Action by one party imposes a cost on another
  party
• Positive
• Action by one party benefits another party

4
Externalities

• Negative Externalities
• Example Steel plant dumping waste in a river
• amount of effluent directly related to output
• Marginal External Cost (MEC) is the cost imposed
  on fishermen downstream for each level of
  production.
• Marginal Social Cost (MSC) is MC plus MEC.

5
External Costs
Price
Price
Industry output
Firm output
6
Externalities

• Positive Externalities
• Example home repair bestows benefits on
  neighbors as well as homeowner

7
External Benefits
Value
Repair Level
8
The Efficient Level of Emissions
Dollars per unit of Emissions
6
Assume 1) Competitive market 2) Output and
emissions decisions are independent 3) Profit
maximizing output chosen
4
2
Level of Emissions
0
2
4
6
8
10
12
14
16
18
20
22
24
26
9
Ways of Correcting Market Failure

• Options for Reducing Emissions to E
• Emission Standard
• Emission Fee
• Transferable Emissions Permits

10
Ways of Correcting Market Failure

• Options for Reducing Emissions to E
• Emission Standard
• Set a legal limit on emissions at E (12)
• Enforced by monetary and criminal penalties
• Increases the cost of production and the
  threshold price to enter the industry

11
Standards and Fees
Dollars per unit of Emissions
Level of Emissions
12
Ways of Correcting Market Failure

• Options for Reducing Emissions to E
• Emissions Fee
• Charge levied on each unit of emission

13
Standards and Fees
Dollars per unit of Emissions
Level of Emissions
14
Ways of Correcting Market Failure

• Standards Versus Fees
• When equal standards must be used, fees achieve
  the same emission abatement at lower cost.
• Fees create an incentive to install equipment
  that would reduce emissions further.

15
The Case for Fees
Fee per Unit of Emissions
6
The cost minimizing solution would be an
abatement of 6 for firm 1 and 8 for firm 2
and MCA1 MCA2 3.
5
4
3
2
1
Level of Emissions
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
16
Ways of Correcting Market Failure

• Transferable Emissions Permits
• Permits help develop a competitive market for
  externalities.
• Agency determines the level of emissions and
  number of permits
• Permits are marketable
• High cost firm will purchase permits from low
  cost firms

17
Externalities and Property Rights

• Property Rights
• property rights are the set of actions one can
  take with respect to the use of a resource
• right to use (and exclude others from using)
• right to transfer outright (i.e. sell)
• right to transfer partial use rights in exchange
  for income (i.e. rent or lease) Legal rules
  describing what people or firms may do with their
  property

18
Externalities and Property Rights

• Bargaining and Economic Efficiency
• Economic efficiency can be achieved without
  government intervention when the externality
  affects relatively few parties and when property
  rights are well defined and enforced.
• Example bargaining over a view

19
Externalities and Property Rights

• Conclusion Coase Theorem
• When parties can bargain without cost and to
  their mutual advantage, the resulting outcome
  will be efficient, regardless of how the property
  rights are specified.
• Costly Bargaining and Strategic Behavior
• When bargaining is costly, assignment of rights
  does matter
• Example multiple parties affected by single
  polluter

20
Common Property Resources

• Common Property Resource
• Everyone has free access.
• Likely to be overutilized
• Examples

21
Common Property Resources
Benefits, Costs ( per fish)
Fish per Month
22
Common Property Resources

• Solution
• Private ownership

23
Public Goods

• Public Good Characteristics
• Nonrival
• For any given level of production the marginal
  cost of providing it to an additional consumer is
  zero.
• Nonexclusive
• People cannot be excluded from consuming the good.

24
Public Goods

• Not all government produced goods are public
  goods
• Some are rival and nonexclusive
• Education
• Parks

25
Efficient Public Good Provision
Benefits (dollars)
7.00
5.50
4.00
Output
0
1
2
3
4
5
6
7
8
10
9
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Public Goods

• Free Riders
• There is no way to provide some goods and
  services without benefiting everyone.
• Households do not have the incentive to pay what
  the item is worth to them.
• Free riders understate the value of a good or
  service so that they can enjoy its benefit
  without paying for it.

27
Public Goods

• Conclusions
• Government production of a public good is
  advantageous because the government can assess
  taxes or fees to pay for it.
• Determining how much of a public good to provide
  when free riders exist is difficult.

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End of Lecture 26