Chapter Eighteen Externalities Open Access and Public Goods
Chapter Eighteen Externalities, Open. Access, and Public Goods
Topics § Externalities. § The Inefficiency of Competition with Externalities. § Market Structure and Externalities. § Allocating Property Rights to Reduce Externalities. § Open-Access Common Property. § Public Goods. © 2009 Pearson Addison-Wesley. All rights reserved. 2
Externalities § externality - the direct effect of the actions of a person or firm on another person’s wellbeing or a firm’s production capability rather than an indirect effect through changes in prices. w negative externality - an externality that harms someone. w positive externality – an externality that benefits other. © 2009 Pearson Addison-Wesley. All rights reserved. 3
The Inefficiency of Competition with Externalities § Firms produce paper and by-products of the production process—such as air and water pollution—that harm people who live near paper mills. w we’ll call the pollution gunk. w each ton of paper that is produced increases the amount of gunk by one unit, w the only way to decrease the volume of gunk is to reduce the amount of paper manufactured. w no less-polluting technologies are available, w it is not possible to locate plants where the gunk bothers no one. © 2009 Pearson Addison-Wesley. All rights reserved. 4
The Inefficiency of Competition with Externalities (cont). § private cost - the cost of production only, not including externalities. § social cost - the private cost plus the cost of the harms from externalities © 2009 Pearson Addison-Wesley. All rights reserved. 5
Price of pape r, p, $ per ton Figure 18. 1 Welfare Effects of Pollution in a Competitive Market 450 MCp ec pc = 240 30 Demand 0 Q c = 105 225 Q, Tons of paper day 6
The Inefficiency of Competition with Externalities (cont). § social marginal cost (MCs) - is the cost of manufacturing one more ton of paper to the paper firms plus the additional externality damage to people in the community from producing this last ton of paper. © 2009 Pearson Addison-Wesley. All rights reserved. 7
Price of pape r, p, $ per ton Figure 18. 1 Welfare Effects of Pollution in a Competitive Market 450 MC s = MC p + MC g A MCp es ps = 282 B C D H pc = 240 198 F 84 E G ec MC p MC g 30 Demand 0 Q s = 84 Q c = 105 225 Q, Tons of paper day 8
Figure 18. 1 Welfare Effects of Pollution in a Competitive Market (cont. ) © 2009 Pearson Addison-Wesley. All rights reserved. 9
The Inefficiency of Competition with Externalities (cont). A deadweight loss results because the competitive market equates price with private marginal cost instead of with social marginal cost. © 2009 Pearson Addison-Wesley. All rights reserved. 10
The Inefficiency of Competition with Externalities (cont). § A competitive market produces excessive negative externalities. § The optimal amount of pollution is greater than zero. © 2009 Pearson Addison-Wesley. All rights reserved. 11
Table 18. 1 Industrial CO 2 Emissions, 2004 12
Reducing Externalities. § Kyoto agreement. w Reached in Kyoto, Japan, in 1997 w required most industrialized nations to reduce CO 2 emissions by an average of 5. 2% below 1990 levels by 2008– 2012. w To achieve this goal, the United States, Europe, and Japan need to curb their CO 2 emissions by 31%, 22%, and 35%, respectively, from the levels that would have been attained in the absence of a reduction policy. w The Bush administration rejected this agreement. © 2009 Pearson Addison-Wesley. All rights reserved. 13
Reducing Externalities (cont). § The government: w might control pollution directly by restricting the amount of pollution that firms may produce emissions standard w by taxing them for pollution they create. A governmental limit on the amount of air or water pollution emissions fee – tax on air pollution effluent charge - tax on discharges into the air © 2009 Pearson Addison-Wesley. All rights reserved. 14
Emissions Fee. § The government may impose costs on polluters by taxing their output or the amount of pollution produced. § internalize the externality - to bear the cost of the harm that one inflicts on others (or to capture the benefit that one provides to others) © 2009 Pearson Addison-Wesley. All rights reserved. 15
Price of paper, p, $ per ton Figure 18. 2 Taxes to Control Pollution 450 MCs = MCp + t(Q) MCp + t es ps = 282 MCp t = 84 MCp = 198 MCg = 84 Demand 0 Qs = 84 225 Q, Tons of paper day 16
Solved Problem 18. 1 § For the market with pollution in Figure 18. 1, what constant, specific tax, τ, on output could the government set to maximize welfare? © 2009 Pearson Addison-Wesley. All rights reserved. 17
Cost-Benefit Analysis § Result from the supply-and-demand analysis: a competitive market produces too much pollution because the price of output equals the marginal private cost rather than the marginal social cost. § Cost-benefit analysis offers another interpretation of the pollution problem in terms of the marginal cost and benefit of the pollution itself. © 2009 Pearson Addison-Wesley. All rights reserved. 18
Figure 18. 3 Cost-Benefit Analysis of Pollution 19
Cost-Benefit Analysis (cont). Welfare is maximized by reducing output and pollution until the marginal benefit from less pollution equals the marginal cost of less output. © 2009 Pearson Addison-Wesley. All rights reserved. 20
Monopoly and Externalities The monopoly outcome may be less than the social optimum even with an externality. © 2009 Pearson Addison-Wesley. All rights reserved. 21
Figure 18. 4 Monopoly, Competition, and Social Optimum with Pollution 22
Monopoly and Externalities (cont). § The reason that a monopoly may produce too little or too much is that it faces two offsetting effects: w The monopoly tends to produce too little output because it sets its price above its marginal cost, but w the monopoly tends to produce too much output because its decisions depend on its private marginal cost instead of the social marginal cost © 2009 Pearson Addison-Wesley. All rights reserved. 23
Solved Problem 18. 2 § In Figure 18. 4, what is the effect on output, price, and welfare of taxing the monopoly an amount equal to the marginal harm of the externality? © 2009 Pearson Addison-Wesley. All rights reserved. 24
Allocating Property Rights to Reduce Externalities § property right - the exclusive privilege to use an asset © 2009 Pearson Addison-Wesley. All rights reserved. 25
Coase Theorem § Coase Theorem - the optimal levels of pollution and output can result from bargaining between polluters and their victims if property rights are clearly defined. © 2009 Pearson Addison-Wesley. All rights reserved. 26
Coase Theorem - Scenario § Two firms: a chemical plant and a boat rental company, that share a small lake. w The chemical manufacturer dumps its waste byproducts, which smell bad but are otherwise harmless, into the lake. The chemical company can reduce pollution only by restricting its output; it has no other outlet for this waste. w The resulting pollution damages the boat rental firm’s business. w There are other lakes nearby where people can rent boats. Therefore, because they dislike the smell of the chemicals, people rent from this firm only if it charges a low enough price to compensate them fully for the smell. © 2009 Pearson Addison-Wesley. All rights reserved. 27
No Property Rights. § If the firms do not negotiate, the chemical firm produces the output level that maximizes its profit, ignoring the effect on the boat rental firm. © 2009 Pearson Addison-Wesley. All rights reserved. 28
Table 18. 2 (a) Property Rights and Bargaining 29
Property Right to Be Free of Pollution. § If a court or the government grants the boat rental firm the property right to be free of pollution, the firm can prevent the chemical company from dumping at all. © 2009 Pearson Addison-Wesley. All rights reserved. 30
Table 18. 2 (b) Property Rights and Bargaining 31
Property Right to Pollute. § Now suppose that the chemical company has the property right to dump in the lake (for example, by paying a pollution tax). © 2009 Pearson Addison-Wesley. All rights reserved. 32
Table 18. 2 (c) Property Rights and Bargaining 33
Results from Coase Theorem § To summarize the results from the Coase Theorem: w If there are no impediments to bargaining, assigning property rights results in the efficient outcome at which joint profits are maximized. w Efficiency is achieved regardless of who receives the property rights. w Who gets the property rights affects the income distribution. The property rights are valuable. The party with the property rights may be compensated by the other party. © 2009 Pearson Addison-Wesley. All rights reserved. 34
Problems with the Coase Approach. § If transaction costs are very high, it might not pay for the two sides to meet. § If firms engage in strategic bargaining behavior, an agreement may not be reached. § If either side lacks information about the costs or benefits of reducing pollution, a nonefficient outcome may occur. © 2009 Pearson Addison-Wesley. All rights reserved. 35
Markets for Pollution § cap-and-trade system - the government gives firms permits, each of which confers the right to create a certain amount of pollution. Each firm may use its permits or sell them to other firms. © 2009 Pearson Addison-Wesley. All rights reserved. 36
Markets for Pollution (cont). § Suppose that the cost in terms of forgone output from eliminating each ton of pollution is $200 at one plant and $300 at another. w If the government tells both plants to reduce pollution by 1 ton, TC = $500. w With tradable permits, the first plant can reduce its pollution by 2 tons and sell its allowance to the second plant, so the total social cost is only $400. © 2009 Pearson Addison-Wesley. All rights reserved. 37
Open-Access Common Property § open-access common property resources to which everyone has free access © 2009 Pearson Addison-Wesley. All rights reserved. 38
Overuse of Open-Access Common Property § § Common Pools. The Internet. Roads. Fisheries. © 2009 Pearson Addison-Wesley. All rights reserved. 39
Solving the Commons Problem § Government Regulation of Commons. § Assigning Property Rights. © 2009 Pearson Addison-Wesley. All rights reserved. 40
Public Goods § public good - a commodity or service whose consumption by one person does not preclude others from also consuming it. w rivalry - only one person can consume the good w exclusion - means that others can be prevented from consuming the good. © 2009 Pearson Addison-Wesley. All rights reserved. 41
Table 18. 3 Rivalry and Exclusion 42
Public Goods (cont). § A public good produces a positive externality, and excluding anyone from consuming a public good is inefficient. © 2009 Pearson Addison-Wesley. All rights reserved. 43
Markets for Public Goods § Markets for public goods exist only if nonpurchasers can be excluded from consuming them. w Thus, markets do not exist for nonexclusive public goods. w Usually, if the government does not provide a nonexclusive public good, no one provides it. © 2009 Pearson Addison-Wesley. All rights reserved. 44
Demand for Public Goods. § Because a public good lacks rivalry, many people can get pleasure from the same unit of output. w As a consequence, the social demand curve or willingness-to-pay curve for a public good is the vertical sum of the demand curves of each individual. © 2009 Pearson Addison-Wesley. All rights reserved. 45
Demand for Public Goods (cont). § Guards patrolling the mall provide a service without rivalry: w All the stores in the mall are simultaneously protected. w Each store’s demand for guards reflects its marginal benefit from a reduction in thefts due to the guards. © 2009 Pearson Addison-Wesley. All rights reserved. 46
Figure 18. 5 Inadequate Provision of a Public Good 47
Free Riding. § free ride - to benefit from the actions of others without paying. © 2009 Pearson Addison-Wesley. All rights reserved. 48
Free Riding - Example § Two stores in a mall that are deciding whether to hire one guard or none. w The cost of hiring a guard is $10 per hour. w The benefit to each store is $8. w Because the collective benefit, $16, is greater than the cost of hiring a guard, the optimal solution is to hire the guard. © 2009 Pearson Addison-Wesley. All rights reserved. 49
Table 18. 4 Private Payments for a Public Good 50
Reducing Free Riding § Methods that may be used include w social pressure, w mergers, w compulsion, w privatization. © 2009 Pearson Addison-Wesley. All rights reserved. 51
Valuing Public Goods § The government may try to determine the value that consumers place on the public good through: w surveys w voting results. © 2009 Pearson Addison-Wesley. All rights reserved. 52
Table 18. 5 Voting on $300 Traffic Signals 53
Cross Chapter Analysis: Emissions Fees Versus Standards Under Uncertainty 54
Appendix 18 A: Welfare Effects of Pollution in a Competitive Market © 2009 Pearson Addison-Wesley. All rights reserved. 55
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