chapter 181 externalities and public goods. chapter 182 externalities externalities are the effects...
TRANSCRIPT
Chapter 18 1
Chapter 18
Externalities and Public Goods
Chapter 18 2
Externalities
Externalities are the effects of production and consumption activities not directly reflected in the market
They can be negative or positive
Chapter 18 3
Negative Externalities
Action by one party imposes a cost on another partyPlant dumps waste in a river affecting those
downstreamThe firm has not incentive to account for the
external costs that it imposes on those downstream
Chapter 18 4
Positive Externalities
Action by one party benefits another partyHomeowner plants a beautiful garden where
all the neighbors benefit from itHomeowner did not take their benefits into
account when deciding to plant
Chapter 18 5
Negative Externalities and Inefficiency
Scenario – plant dumping wasteMarginal External Cost (MEC) is the increase
in cost imposed on fishermen downstream for each level of production.
Marginal Social Cost (MSC) is MC plus MEC.
Chapter 18 6
Negative Externalities and Inefficiency
Assume the firm has a fixed proportions production function and cannot alter its input combinationsThe only way to reduce waste is to reduce
output
Price of steel and quantity of steel initially produced is at the intersection of supply and demand
Chapter 18 7
Negative Externalities and Inefficiency
The MC curve for the firm is the marginal costs of production
Firm maximizes profit by producing where MC equals Price in a competitive firm
As firm output increase, external cost on fishermen increases measured by the marginal external cost curve
From a social point of view, the firm produces too much output
Chapter 18 8
External Costs
MC
S = MCI
P1
q1
P1
Q1
MSC
MSCI
Firm output
Price
Industry output
Price
MEC
MECI
q*
P*
Q*
D
Firm will produce q1 at P1. There is MEC of production from the waste released. The MSC is
true cost of production.
The profit maximizing firmproduces at q1 while the
efficient output level is q*.
Chapter 18 9
External Costs
Aggregate social cost of
negativeexternality
By no producing at the efficient level, there is a social cost on
society MC
S = MCI
D
P1 P1
q1 Q1
MSC
MSCI
Firm output
Price
Industry output
Price
MEC
MECI
q*
P*
Q*
Chapter 18 10
External Cost
Negative Externalities encourage inefficient firms to remain in the industry and create excessive production in the long run.
Chapter 18 11
Positive Externalities and Inefficiency
Externalities can also result in too little production, as can be shown in an example of home repair and landscaping.
Repairs generate external benefits to the neighborsShow by the Marginal External Benefit curve
(MEB)Marginal Social Benefit (MSB) curve adds
MEB +D
Chapter 18 12
MCP1
External Benefits
Repair Level
Value
D
q1
MSB
MEB
When there are positiveexternalities (the benefitsof repairs to neighbors),marginal social benefits
MSB are higher thanmarginal benefits D.
q*
P* A self-interested home ownerinvests q1 in repairs. Theefficient level of repairs
q* is higher. The higher priceP1 discourages repair.
Chapter 18 13
Ways of Correcting Market Failure
Assumption: The market failure due to pollutionFirm has chosen its profit-maximizing output
levelMSC is marginal social cost of emissions
Chapter 18 14
Ways of Correcting Market Failure
MCA is marginal cost of abating emissionsAdditional cost to firm of controlling pollutionDownward sloping because when emissions
are high, little cost to controlling them
Chapter 18 15
Ways of Correcting Market Failure
If the firm does not consider abatement, their profit maximizing level is 26 units of emissionsLevel where MCA is zero
The socially efficient level of emissions is 12 where the MSC equals the MCA
Chapter 18 16
The Efficient Level of Emissions
2
4
6
Dollars/ unitof Emissions
Level of Emissions0 2 4 6 8 10 12 14 16 18 20 22 24 26
MSC
MCA
E*
The efficient level ofemissions is where
MCA = MSC.
At Eo the marginalcost of abating emissions
is greater than themarginal social cost.
E0
At E1 the marginalsocial cost is greater
than the marginal benefit.
E1
Chapter 18 17
Ways of Correcting Market Failure
Firms can be encouraged to reduce emissions to the efficient level in three ways
1. Emissions standards
2. Emissions fees
3. Transferable emissions permits
Chapter 18 18
Public Goods
CharacteristicsNonrival
For any given level of production the marginal cost of providing it to an additional consumer is zero.
NonexclusivePeople cannot be excluded from consuming the
good.
Example – use of lighthouse by a ship
Chapter 18 19
Public Goods
Nonexclusive goodsGoods that people cannot be excluded from
consuming, so that it is difficult or impossible to charge for their use
Example: fireworks, national defense
Chapter 18 20
Efficiency and Pubic Goods
Efficient level of private good is where marginal benefit equals marginal cost
For a public good, the value of each person must be consideredCan add demand of all those who value
good
Must equate the sum of these marginal benefits to the marginal cost of production
Chapter 18 21
D1
D2
D
D1 is demand for consumer 1
D2 is demand for consumer 2
D is total demand for all consumers
Efficient Public Good Provision
Output0
Benefits(dollars)
1 2 3 4 5 6 7 8 109
$4.00
$5.50
$7.00
MC
$1.50
Efficient output occurswhere MC = total MB
2 units of output. MB is $1.50 + $4.00 or $5.50.
Chapter 18 22
Public Goods and Market Failure
Free RidersThere 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.