Today

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Today

• Review table on monopolistic competition
• ExternalitiesCh. 30

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Table 1a
Perfect Comp Monopolistic Competition Monopoly
Firms are price takers Firms are price makers Firms are price makers
Choose q where PMC Choose q where MRMC Choose q where MRMC
In SR, P ?AVC in order to produce. In SR, P ?AVC in order to produce. In SR, P ?AVC in order to produce.
In LR, P ?ATC in order to produce. In LR, P ?ATC in order to produce In LR, P ?ATC in order to produce.
Firms face perfectly elastic demand for their product. Firms face downward-sloping market demand. Firms face downward-sloping market demand.
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Table 1b
Perfect Comp Monopolistic Competition Monopoly
No profits or losses in LR No profits or losses in LR May have profits in LR
No barriers to entry or exit Barriers to Entry Barriers to Entry
Firms produce at lowest possible LRAC Produce on downward-sloping portion of LRAC May or may not produce at lowest possible LRAC
In LR equilibrium, P MC In LR equilibrium, P gt MC In LR equilibrium, P gt MC
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Table 1c
Perfect Comp Monopolistic Competition Monopoly
No need for advertising, goods are homogeneous Advertising may increase demand for product Advertising may increase demand for product
Brand name is unimportant to consumers Brand name is often very important Only one brand to choose from
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Externality

• When an individual course of action affects
  others beyond the amount considered by that
  individual.

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Negative externality

• The individual course of action imposes costs on
  others.

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Example Bobs smoking

• Costs to Bob
• Cost of cigarettes
• Cost to own health
• Cost of keeping home and clothes clean
• Costs to others from Bobs smoking
• Health costs from second-hand smoke
• Cost of cleaning home, clothes
• Increased price of health insurance due to
  inclusion of smokers in group rates.

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Social Costs

• The social cost of the activity is the private
  cost plus the external cost.
• The social cost of one person smoking includes
  the costs to the smoker plus the costs to others.

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Social Benefits

• The social benefits are equal to the private
  benefits plus any external benefits.
• Assume no external benefits from Bob smoking.
• Note if there are external benefits, that is a
  positive externality, see below.
• Then the social benefits of Bob smoking are just
  the private benefits that Bob gets.

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Costs versus Benefits
How much will Bob smoke? How much is optimal?
/Cigarette
Marginal Benefit (Bob)
Marginal Social Cost (to Bob to others)
Marg. Ext. Cost
Marginal Private Cost (to Bob)
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Bobs choice versus societys
How can society get Bob ( others) to smoke less?
/Cigarette
Marginal Benefit
Social costs exceed benefits.
Marginal Social Cost
Marginal Private Cost
Cigarettes/day
Bobs choice
Optimal for society
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A Tax to Correct Negative Externalities

• Society wants Bob to internalize the external
  costs of his smoking.
• One way to do that is to tax cigarettes.
• The amount of the tax per cigarette should equal
  the costs to others from Bobs smoking.

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A Tax on Cigarettes
Use a tax to force Bob to pay the full costs of
his smoking.
/Cigarette
Marginal Benefit
Marginal Social Cost Marg. Private Cost tax
Tax per cig.
Marginal Private Cost
Cigarettes/day
Optimal
Bobs choice if taxed
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Pollution as a Negative Externality

• Industrial production often creates pollution of
  air or water as a by-product.
• Public policy options for dealing with pollution
• Ban pollution
• Tax pollution
• Establish maximum rates of pollution per firm
• Issue a limited number of permits to pollute,
  allow them to be traded. (Used for CO2 in US)

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The Tragedy of the Commons

• Why is the copier always out of paper or in a
  paper jam?

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The Commons

• Historically, refers to common grazing land for a
  town.
• In economics, refers to any situation in which a
  resource is used by many people, none of whom
  owns the resource.

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What happened in The Commons?

• The private cost of grazing your sheep in the
  commons was zero.
• The social cost wasnt, because once your sheep
  ate the grass, it wasnt there for the next
  farmer.
• The commons were routinely over-grazed, because
  nobody had an incentive to make sure the grass
  had time to grow back.

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Current Tragedies

• Fishing in the ocean
• There are no property rights to fishing grounds
  in international waters. Fisherman have no
  incentive to let the population recover.
• The shared copier
• The cost of fixing the paper jam is higher than
  the benefits one person expects to get out it.
• Tendency to move on to another machine, or wait
  until someone else fixes the problem.

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Other Tragedies

• Air Quality
• We drive our cars without regard to the marginal
  cost to society of the air pollution.
• Gasoline taxes help.
• Use of Outer Space
• Without some sort of controls, likely to see so
  much debris and so many satellites that the use
  of space is impaired.
• Public restrooms

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Positive externality

• The individual course of action imposes benefits
  on others.
• The social benefit of an activity is greater than
  the private benefit.

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Examples of Positive Ext.

• Education Makes people better citizens. These
  benefits are in addition to the private benefits.
• Attractive architecture, landscaping, etc. at
  your house increases the value of the neighbors
  houses.
• Vaccinations When one person is vaccinated, it
  helps the rest of us because we are less likely
  to catch the disease.

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The Role of the Government Externalities

• Governments can use taxes to discourage
  activities with negative externalities.
• They can use subsidies to encourage activities
  with positive externalities.

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Government Regulation

• Planning commissions or architectural review
  boards are used to create positive externalities
  rather than negative ones.
• Commercial activities tend to be zoned separately
  from residential neighborhoods.
• Property owners may be required to preserve
  historic buildings or to complement existing
  buildings.

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Coming Up

• Review for third midterm exam

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Group Work-Externalities

• List 3 examples of negative externalities (not
  already mentioned in class). How does society
  address each?
• List 3 examples of positive externalities (not
  already mentioned in class). How does society
  address each?
• Write out your answers.