Public goods and externalities two more market failures
Public goods and externalities: two more “market failures” • another market failure (discussed in the previous lecture) is due to “monopoly power” • these three market failures plus income distribution are the main rationales for government intervention in a market economy
Public Goods • Two Key properties • non-rivalry in consumption – if I consume more, others do not need to consume less • non-excludability – you cannot prevent people from consuming the good – free rider problem
National Defense
Fire Protection
Police
Lighthouse?
How much of a public good should be produced? • Mimic the market: – produce up to the point where marginal benefit equals marginal cost • examples: – number of police on the street – size of national defense force
Cost-Benefit Analysis • when the choice is to produce or not produce • Because benefits come in the future they must be discounted
Numerical Example: Should PAPD buy a new computer?
Present Discounted Value of Benefits • PDV = 500/(1+i) + 600/(1+i)2 • if i =. 05 then • PDV = 500/(1. 05) + 600/(1. 05)2 = 476 + 544 = 1020 – thus the PAPD should make the investment in the computer
Higher discount rates mean that fewer projects will meet cost-benefit test. Thus discounting enters political debate.
Externalities • Definition: When the costs of producing or the benefits of consuming spill over to other people. • Negative externalities • Positive externalities
A Negative Externality: Pollution
Positive Externalities • Education • Innovative ideas • Research
The Economic Impact of Negative Externalities
The Economic Impact of Positive Externalities
What are the possible remedies for externalities? • Private Remedies Let the individuals work it out themselves – Need to define property rights – But transaction costs and free rider problem might prevent the private remedy
Command control • A common form of “social regulation” used by EPA – scrubbers – CAFÉ standards • Usually not very flexible or efficient
Using Taxes or subsidies • make them feel the pain or the gain • more flexible than command control • but can’t be sure about the total amount
The Tax Remedy for a Negative Externality
The Subsidy Remedy for a Positive Externality
Why don’t you draw it by hand?
Tradable Permits • Examples – SO 2 (acid rain) – CO (global warming) 2 • Permit allows each firm to emit a certain amount of pollutants • Total number of permits issued equals emission limit for the region each year • Firms that are better at reducing emissions sell permits to firms that are worse at it.
End of Lecture
- Slides: 25