MicroEconomics theory and application 12th by browning an zupan chapter 20

Prepared by Dr. Della Lee Sue, Marist College

MICROECONOMICS: Theory & Applications
Chapter 20: Public Goods and Externalities
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
12th Edition, Copyright 2015

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.


Learning Objectives




Explain what economists mean by the term public goods
and the free rider-rider problem.
Describe the efficiency in the provision and distribution of a
public good.
Define external benefits and external costs and show how
their presence results in nonoptimal output levels for goods
characterized by such aspects.
(continued)

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2


Learning Objectives





(continued)

Show how clearly defined and enforced property rights can
resolve externality problems and thereby ensure an efficient
outcome.
Demonstrate how air pollution can more efficiently be
controlled through the establishment of an overall industry
pollution target and the assignment of tradable emissions
permits to the industry's firms.

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

3


Explain what economists mean by the term public goods and the free
rider-rider problem.

20.1 WHAT ARE PUBLIC GOODS?

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Public Goods and Externalities



Public goods – those goods that benefit all consumers



Externalities – the harmful or beneficial side effects of
market activities that are not fully borne or realized by
market participants

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What Are Public Goods?


Characteristics:
 Nonrival in consumption – a condition in which a good with a
given level of production, if consumed by one person, can also be
consumed by others
 Nonexclusion – a condition in which confining a good’s benefits,
once produced, to selected persons is impossible or prohibitively
costly



Free-Rider Problem
 A consumer who has an incentive to underestimate the value of a

good in order to secure its benefits at a lower, or zero, cost
 As the group size increases, it is more likely that everyone will
behave like a free rider, and the public good will not be provided.

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

6


Describe the efficiency in the provision and distribution of a public good.

20.2 EFFICIENCY IN THE PROVISION
OF A PUBLIC GOOD

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7


Efficiency in the Provision of a Public
Good




Social marginal benefit curve


the demand curve for a public good



derived by vertically summing the consumers’ marginal benefit
curves

Efficient output of a public good


Occurs where the social marginal benefit curve intersects the
marginal cost curve:
MBs = MC

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Figure 20.1 - The Efficient Output of a
Public Good

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Efficiency in Production and
Distribution






Conditions for economic efficiency:
–

an efficient distribution of products among consumers

–

efficiency in production

–

efficiency in output

–

Output be produced by using the least costly combination of inputs

No rationing problem
Inefficient to exclude anyone.

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Patents


A patent gives the holder of a patent the exclusive right to
make and sell the product or process for 17 years



Temporary legal monopoly power



Benefit: stimulates inventors to devote resources to the
production of new knowledge



Cost: after the new knowledge is produced, it is inefficiently
employed

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Define external benefits and external costs and show how their presence
results in nonoptimal output levels for goods characterized by such
aspects.

20.3 EXTERNALITIES

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Externalities
Externalities: Side effects borne by people who are not
directly involved in the market exchanges
External

benefits – positive side effects of ordinary
economic activities
External costs – negative side effects of ordinary economic
activities

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Externalities and Efficiency


Distinction between externalities and public goods: External
effects are unintended side effects of activities undertaken
for other purposes.



Both are likely to lead to an inefficient allocation of
resources.

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Figure 20.2 - External Costs and Taxes

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Figure 20.3 - External Benefits and
Subsidies

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Show how clearly defined and enforced property rights can resolve
externality problems and thereby ensure an efficient outcome.

20.4 EXTERNALITIES AND PROPERTY
RIGHTS

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Externalities and Property Rights


Coase Theorem: As long as property rights are clearly
defined and enforced, bargaining between two parties can
ensure an efficient outcome.



The distributional effects depend on the definition of
property rights.



Whenever the effects are nonrival over a large group and
exclusion is not feasible, the free-rider problem hinders the
process of achieving agreement among all concerned.

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

18


Demonstrate how air pollution can more efficiently be controlled through
the establishment of an overall industry pollution target and the
assignment of tradable emissions permits to the industry's firms.

20.5 CONTROLLING POLLUTION,
REVISITED

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Market-based Pollution Control
Mechanisms
Alternatives to “command-and-control” approach to reducing
pollution:


Per-emission-unit taxes



Tradable emission permits

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Figure 20.4 - A Tax on Pollution

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The Market for Los Angeles Smog
Tradable emission permits:


set an overall industry pollution level



allocate permits to emit a certain amount of pollution units to each
firm



allow the firms to exchange their permits



price at which permits are traded depends upon the bargaining
abilities of the two firms

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

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Market-based Pollution Control
Mechanisms: Effects
Market-based alternatives promise significant efficiencies in
production over command-and-control mechanisms for dealing
with pollution:



Promote efficiency in production



Ensure that any abatement amount is produced at lowest possible
cost

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