MicroEconomics 5e by besanko braeutigam chapter 17

Chapter 17

Copyright (c)2014 John Wiley & Sons, Inc.

Externalities and Public Goods

1


Chapter Seventeen Overview

1. Motivation
2. Inefficiency of Competition with Externalities
3. Allocation Property Rights to Restore Optimality
•
•
•

The Coase Theorem
Problems with the Coase Approach
Other Methods to Restore Optimality – Standards and Fees

•
•
•

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4. Public Goods
A Taxonomy
Demand for Public Goods

Free Riders and the Supply of Public Goods

Chapter Seventeen

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Externalities

Definition: If one agent's actions imposes costs on another party, the agent exerts
a negative externality, while if the agent's actions have benefits for another party,
the agent exerts a positive externality.

Network externalities, snob effects
Wind chimes

When externalities are present, the competitive market may not attain the Pareto Efficient
outcome.

Chapter Seventeen

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•
•


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Inefficiency of Competition with Externalities

Chapter Seventeen

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Inefficiency of Competition with Externalities

Private

Social

Change

Optimum

Consumers Surplus

•

Private Producers Surplus

E+ F+ R+H+N

•

Externality Cost

-R-H-N-G-K-M

•

Net Social Benefits

A+B+G +K

A+B+E+F-M

A

-B-C-K

B+E+F+R+H+G

-R-H-G

A+B+E+F

B+G-N

M+N+K

M

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•

(consumer surplus + private producer
surplus - cost of externality)

•

Deadweight Loss

M

zero

M

Chapter Seventeen

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Copyright (c)2014 John Wiley & Sons, Inc.

Inefficiency of Competition with Externalities

Chapter Seventeen

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Inefficiency of Competition with Externalities

Private

Social

Change

Optimum

Private Consumers Surplus

•

Producers Surplus

•

Externality Benefit

•

Government Cost from Subsidy

•

Net Social Benefits

(consumer surplus + private producer

B+E +F

G+R

A+H+J

zero

A+B+E+F
+G+H+J+R

B+E+F+G+K+L

F+G+R+J+M

A+H+J+M+N+T

G+K+L

F+J+M

M+N+T

-F-G-J-K-L-M-T

-F-G-J-K-L-M-T

Copyright (c)2014 John Wiley & Sons, Inc.

•

A+B+E+F+G+H M+N
+J+M+N+R

surplus - cost of externality)

Chapter Seventeen

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Competitive Market & Social Optimum

Competitive market: p = MPC
Social optimum:

p = MSC

Competitive market creates a dead-weight loss (socially excessive negative
externalities)

This is because the polluter does not have to pay for pollution

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Socially optimal amount of waste is non-zero.

How can we restore optimality?

Chapter Seventeen

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Competitive Market & Social Optimum

Emissions Standards – A governmental limit on the amount of pollution that may be emitted.

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Emissions Fee – A tax imposed on pollution that is released into the environment.

Chapter Seventeen

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Methods to Restore Optimality
Pp ($/ton)

MCS = MCP + MCW

Emissions Standards (quota)
Emissions Standards (quota)

MCP

Demand for Paper

Qp (tons/day)

0

W (units/day)
Chapter Seventeen

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Copyright (c)2014 John Wiley & Sons, Inc.

MCW


Other Methods to Restore Optimality
MCS = MCP + MCW

Pp ($/ton)

Emissions Standards (quota)
Emissions Standards (quota)

MCP

?

What is the marginal cost of pollution at the social

•

eS

optimum?

T

MCW

•

MCP

Demand for paper
MCG
Qp (tons/day)

0

QS= Quota

W (units/day)
Chapter Seventeen

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Copyright (c)2014 John Wiley & Sons, Inc.

•


Restoring Optimality

Through Property Rights Allocation
Definition: A property right is a legal rule that describes what economic

agents can do with an object or idea.

Common Property – A resource, such as a public park or a highway that
anyone can access.

Chapter Seventeen

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Copyright (c)2014 John Wiley & Sons, Inc.

Deed to parcel of land; patent on a method


Restoring Optimality – Paper Mill & Fishermen

Through Property Rights Allocation

Suppose that paper mill may reduce its emissions of gunk by installing filters and fishermen can reduce emissions by installing a
Suppose that paper mill may reduce its emissions of gunk by installing filters and fishermen can reduce emissions by installing a
water treatment plant.
water treatment plant.

Payoff Assumptions

filter

300,500

Chapter Seventeen

Copyright (c)2014 John Wiley & Sons, Inc.

Mill

Fishermen
No
Treatment
treatment
No filter 500,100
500,200
300,300

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Restoring Optimality – Paper Mill & Fishermen

Through Property Rights Allocation

•

Nash outcome: no filter, treatment plant

•

Joint payoff = 700 (not Pareto efficient)

Chapter Seventeen

Copyright (c)2014 John Wiley & Sons, Inc.

Case 1: No explicit rights allocation

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Restoring Optimality – Paper Mill & Fishermen

Through Property Rights Allocation
Case 2: Fishermen have property right to no Pollution (and so, set a fee of, say, $500 for
receiving pollution)

Nash Outcome: Filter, No
treatment

Joint Payoff = 800 (Pareto
Efficient)

Mill

No
Treatment
treatment
No filter 0,600
0,700
Filter

Chapter Seventeen

300,500

300,300

15

Copyright (c)2014 John Wiley & Sons, Inc.

Fishermen


Restoring Optimality – Paper Mill & Fishermen

Through Property Rights Allocation
Case 3: Mill has right to pollute. Suppose the mill "sells" right to fresh water (i.e. obligation to
install filter) for $250:

Fishermen

Treatment
Joint Payoff = 800 (Pareto
Efficient)

Mill

filter

Chapter Seventeen

550,250

550,50

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Copyright (c)2014 John Wiley & Sons, Inc.

Nash Outcome: Filter, No

No
Treatment
treatment
No filter 500,100 500,200


The Coase Theorem

•

If there are no impediments to bargaining, assigning property rights results in the
efficient outcome (at which joint profits are maximized).

•

Efficiency is achieved regardless of who receives the property rights.

•

Who gets the property rights affects the income distribution: the property rights
are valuable. (The party with the property rights is compensated by the other

Copyright (c)2014 John Wiley & Sons, Inc.

party.)

Chapter Seventeen

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The Coase Theorem

•

Transaction Costs may be high;

•

Large numbers of injured parties;

•

Incomplete/Asymmetric Information.
Copyright (c)2014 John Wiley & Sons, Inc.

Challenges

e.g. What are the long run effects of genetic engineering?

Chapter Seventeen

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Public Goods

Definition:
Definition: Rivalry
Rivalryininconsumption
consumptionmeans
meansthat
thatonly
onlyone
oneperson
personcan
canconsume
consumeaagood:
good:the
the
good
goodisisused
usedup
upininconsumption
consumption(it(itcan
canbe
bedepleted).
depleted).

Definition:
Definition: Exclusion
Exclusion inin consumption

consumption means
means that
that others
others can
can be
be prevented
prevented from
from
Copyright (c)2014 John Wiley & Sons, Inc.

consuming
consumingaagood.
good.

Chapter Seventeen

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Public Goods
Definition: Private goods have properties of rivalry and exclusion. Pure Public goods lack both rivalry and
exclusion. Club goods lack rivalry but have property of exclusion. Common property lacks exclusion but does
have the property of rivalry.

Examples

No exclusion

Rivalry

Pure Private Commons:
goods: Apple Fisheries

No Rivalry

Club goods:
concert

Chapter Seventeen

Pure public
good: clean
air

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Exclusion


Demand for Public Goods

Because
Becausepublic
publicgoods
goodslack
lackrivalry,
rivalry,the
theaggregate

aggregatedemand
demandisisthe
the
aggregate
aggregate willingness
willingness toto pay
pay curve:
curve: the
the vertical
vertical sum
sum ofof the
the

Copyright (c)2014 John Wiley & Sons, Inc.

individual
individualdemand
demandcurves.
curves.

Chapter Seventeen

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Efficient Provision of a Public Good
400
Price ($/unit)

300

100

D1
0

30

Quantity of Public Good
100
Chapter Seventeen

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Copyright (c)2014 John Wiley & Sons, Inc.

200


Efficient Provision of a Public Good
400
Price ($/unit)

300

100

D2
D1
0

30

Quantity of Public Good
100

200
Chapter Seventeen

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Copyright (c)2014 John Wiley & Sons, Inc.

200


Efficient Provision of a Public Good
400
Price ($/unit)

300

MC = 240

100

D2

MC = 50

D1
0

30

Quantity of Public Good
100

200
Chapter Seventeen

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Copyright (c)2014 John Wiley & Sons, Inc.

200


Efficient Provision of a Public Good
400
Price ($/unit)

MSB
300

MC = 240

100

D2

MC = 50

D1
0

30

Quantity of Public Good
100

200
Chapter Seventeen

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Copyright (c)2014 John Wiley & Sons, Inc.

200