KINH TẾ VI MÔ 2015 chapter 7 micro 1 5 public goods

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Microeconomics

Externalities and Public Goods
Chapter 7
By Tran Thi Kieu Minh, MSc

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Externalities
• The uncompensated impact of one person’s actions
on the well-being of a bystander
• Market failure
• Negative externality: Impact on the bystander is
adverse
▫ Exhaust from automobiles
▫ Barking dogs

• Positive externality: Impact on the bystander is
beneficial
▫ Restored historic buildings
▫ Research into new technologies

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Externalities and Market Inefficiency
• Externalities
 Cause markets to allocate resources inefficiently

• Welfare economics: a recap

▫ Demand curve – value to consumers
 Prices they are willing to pay

▫ Supply curve – cost to suppliers
▫ Equilibrium quantity and price
 Efficient
 Maximizes sum of producer & consumer surplus

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The market for aluminum
Price of
Aluminum

Externalities and Market Inefficiency

Supply
(private cost)

• Negative externalities
▫ Pollution
▫ Cost to society (of producing aluminum)

Equilibrium

 Larger than the cost to the aluminum producers

▫ Social cost - supply

Demand
(private value)
0

 Private costs of the producers
 Plus the costs to those bystanders affected adversely
by the negative externality

Quantity of
Aluminum

QMARKET

The demand curve reflects the value to buyers, and the supply curve reflects the costs
of sellers. The equilibrium quantity, QMARKET, maximizes the total value to buyers minus
the total costs of sellers. In the absence of externalities, therefore, the market
equilibrium is efficient.

▫ Social cost curve – above the supply curve
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Pollution and the social optimum
Price of
Aluminum

External
Cost

Externalities and Market Inefficiency

Social cost (private cost
and external cost)
Supply
(private cost)

• Positive externalities
▫ Education

Optimum

 Benefit of education – private
 Externalities: better government, lower crime rate,
higher productivity and wages

Equilibrium

Demand
(private value)
0

QOPTIMUM

QMARKET

▫ Social value – demand

 Higher than private value

Quantity of
Aluminum

In the presence of a negative externality, such as pollution, the social cost of the good
exceeds the private cost. The optimal quantity, QOPTIMUM, is therefore smaller than the
equilibrium quantity, QMARKET.

▫ Social value curve
 Above demand curve
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Education and the social optimum
Price of
Aluminum
Optimum

Externalities and Market Inefficiency

Supply
(private cost)

External
Benefit

Equilibrium

Social value
(private value
and external benefit)

• Government – correct market failure
▫ Taxing goods that have negative externalities
▫ Subsidizing goods that have positive externalities

Demand
(private value)
0

QMARKET QOPTIMUM

Quantity of
Aluminum

In the presence of a positive externality, the social value of the good exceeds the private
value. The optimal quantity, QOPTIMUM, is therefore larger than the equilibrium quantity,
QMARKET.

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The Different Kinds of Goods
• Excludability
▫ Property of a good
▫ A person can be prevented from using it
• Rivalry in consumption
▫ Property of a good
▫ One person’s use diminishes other people’s use

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Four types of goods

The Different Kinds of Goods

Rival in consumption?
Yes

Yes
Excludable?

No

No

Private goods

Natural monopolies

- Ice-cream cones
- Clothing
- Congested toll roads

- Fire protection
- Cable TV
- Uncongested toll roads

Common resources

Public goods

▫ Public goods

- Fish in the ocean
- The environment
- Congested nontoll roads

- Tornado system
- National defense
- Uncongested nontoll roads

▫ Common resources

Goods can be grouped into four categories according to two characteristics:
(1) A good is excludable if people can be prevented from using it.
(2) A good is rival in consumption if one person’s use of the good diminishes other

people’s use of it.
This diagram gives examples of goods in each category.

• Types of goods
▫ Private goods
 Excludable & Rival in consumption
 Not excludable & Not rival in consumption
 Rival in consumption & Not excludable

▫ Natural monopoly
 Excludable & Not rival in consumption
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The Different Kinds of Goods
• Public goods & Common resources
▫ Not excludable
▫ People cannot be prevented from using them
▫ No price attached to it
▫ Positive externalities
▫ Negative externalities

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Public Goods
• The free-rider problem
▫ Free rider
 Person who receives the benefit of a good but avoids paying
for it

▫ Public goods – not excludable
 Free-rider problem prevents the private market from
supplying the goods
 Government - can remedy the problem





If total benefits of a public good > its costs
Provide the public good
Pay for it with tax revenue
Make everyone better off

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Public Goods

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Public Goods

• Some important public goods
▫ National defense

• The difficult job of cost–benefit analysis
▫ Government

 Very expensive public good

 Decide what public goods to provide
 In what quantities

▫ Basic research

▫ Cost–benefit analysis

 General knowledge

 Compare the costs and benefits to society of
providing a public good
 Doesn’t have any price signals to observe
 Government findings on the costs and benefits

▫ Fighting poverty
 Welfare system
 Food stamps

 Rough approximations at best

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Common Resources
• Common resources

▫ Not excludable
▫ Rival in consumption
• Some important common resources
▫ Clean air and water
▫ Congested roads
▫ Fish, whales, and other wildlife

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Common Resources
• The tragedy of the commons
▫ Parable - why common resources are used more than
desirable
 From society’s standpoint

▫ Social and private incentives differ
▫ Arises because of a negative externality
▫ Negative externality

 One person uses a common resource
 Diminishes other people’s enjoyment of it
 Common resources tend to be used excessively

▫ Government - can solve the problem
 Regulation or taxes
 Reduce consumption of the common resource
 Turn the common resource into a private good

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