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13.0) Chapter 10 Review and Week 15 Agenda�13.1) Externalities�13.2) Public Goods and Common Resources

Ch13. Externalities and Public Goods

ECO 1002. Principles of Microeconomics

Week 15

Dr. Christopher Paik

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13.1) Externalities

Externalities can arise from both consumption and production

Vectorstock.com

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13.1) Externalities

Spillovers arise when actions or market transactions by an individual or a firm cause some other party not involved in the activity or transaction to benefit or be harmed

Beneficial spillover

This is a positive externality, creating an external benefit
E.g., getting the flu shot, acquiring more education, and maintaining beehives next to apple orchards

Costly spillover

This is a negative externality, creating an external cost
E.g., air and water pollution, littering, and chemical runoff that affects fish stocks

The presence of externalities leads to a misallocation of resources

Markets fail to provide a socially optimal level of goods or services
This leads to market failure

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13.1) Externalities

Positive Externalities

Demand reflects the expected value of private benefit (called utility)
Demand reflects the expected value of private benefit
If there is no external benefit (positive externalities),

marginal private benefit (MPB) = marginal social benefit (MSB)

Cost and benefit

Demand

Marginal Private Benefit

Quantity

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13.1) Externalities

Positive Externalities

When private market transactions generate benefits for others, positive externalities exist

E.g., college education (low-interest student loans, grants, and scholarships)

MR = D

Socially Optimal

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13.1) Externalities

Negative Externalities

When a market transaction harms people not involved in the transaction, negative externalities exist

E.g., pollution – optimal pollution?

MC = P

Socially Optimal

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13.1) Externalities

Positive Externalities (external benefits)

A benefit received by people other than the consumers or producers in the market transaction, a benefit to bystanders

Price/Costs

Q of Vaccines

Demand

(Private Value)

Supply

(Private Costs)

Demand

(Social Value)

External Benefit

Efficient Equilibrium

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13.1) Externalities

Positive Externalities (external benefits)

A benefit received by people other than the consumers or producers in the market transaction, a benefit to bystanders

Private cost < Social benefit
The society desire to have more shots
The market equilibrium Q is underused and creates DWL

Therefore, we get undersupplied of the vaccination
Q. What method can resolve the underuse in the market equilibrium of a good with positive externalities?

Price/Costs

Q of Vaccines

Demand

(Private Value)

Supply

(Private Costs)

Demand

(Social Value)

Private cost of the last person

takes the shot

Social value from the last person

takes the shot

Underuse

DWL

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13.1) Externalities

Positive Externalities (external benefits)

A Pigouvian subsidy internalizes the external benefit
For determining the efficient level of output, include everyone's benefits

Price/Costs

Q of Vaccines

Private Value + Subsidy = Social Value

Market Equilibrium

= Efficient Equilibrium

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13.1) Externalities

Negative Externalities (external costs)

A cost received by people other than the consumers or producers in the market transaction, a benefit to bystanders

Price/Costs

Level of CO2

Demand

(Private Value)

Supply

(Private Costs)

External Cost

Efficient Equilibrium

Supply

(Social Costs)

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13.1) Externalities

Negative Externalities (external costs)

A cost received by people other than the consumers or producers in the market transaction, a benefit to bystanders

Price/Costs

Level of CO2

Demand

(Private Value)

Supply

(Private Costs)

External Cost

Efficient Equilibrium

Supply

(Social Costs)

Private benefit < Social cost
The society desire to have less pollution
The market equilibrium Q is overused and creates DWL

Therefore, we get oversupplied the pollution
Q. What method can resolve the overuse in the market equilibrium of a good with negative externalities?

Overuse

DWL

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13.1) Externalities

Negative Externalities (external costs)

A Pigouvian tax equals to the external cost

Price/Costs

Level of CO2

Demand

(Private Value)

Efficient Equilibrium

Private cost + Tax = Social cost

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13.1) Externalities

How do we achieve the socially optimal production? (Solutions)

Potential solutions for negative externalities:

Taxes (Subsidies)

Impose a tax on producers to reduce production and negative externalities
(Subsidize on consumers to increase consumption and positive externalities)
Monitoring is difficult and the cost is high

Regulation (Command-and-Control Policies)

Technology-specific method to restrict the quantity produced
Cost of monitoring is low, but there are no incentives to find innovative technologies
Can result in inefficient outcome and another side effects (e.g., Department of Energy in 2007 - washing machine case)

Comparison between two Solutions

A tax and subsidy approaches allow consumers or/and producers flexibility to find more efficient way to reduce externalities problems

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13.1) Externalities

How do we achieve the socially optimal production?

Market solutions to externality problems:

Property rights (the Coase Theorem)

If transaction costs are minimal (near zero), the resulting bargain or allocation of resources will be efficient
This is achieved if property rights are:

Well defined (ownership)
Divisible (tradable)
Defendable (enforceable)

The costs of negotiation are known (e.g., tradable permits)

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13.1) Externalities

Policies to Reduce Greenhouse Gas Emissions (from carbon tax to cap-and-trade)

https://www.cbpp.org/research/policies-to-reduce-greenhouse-gas-emissions

Emissions Taxes: Carbon tax is the tax that is the government sets a price that emitters must pay for each ton of greenhouse gas emissions they emit.

Tradable Permits: Cap-and-trade allows emissions trading in a market and limits overall emissions from a group of emitters by setting a cap on maximum emissions.

Q. In order to reduce greenhouse gas emissions, which policy is more efficient and based on what efficiency?

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13.2) Public Goods

Market failure comes from public goods and common resources

Public goods: nonrival and nonexcludable

Nonrival: the consumption by one does not reduce the utility to others
Nonexcludable: once a good is provided, it’s not possible to exclude others

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13.2) Public Goods

Market failure comes from public goods and common resources

Public goods: nonrival and nonexcludable

Nonrival: the consumption by one does not reduce the utility to others
Nonexcludable: once a good is provided, it’s not possible to exclude others

Market failure

Free Rider Problem: an individual who avoids paying for a good (e.g., light house)

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13.2) Common Resources

Market failure comes from public goods and common resources

Common resource: Rival and nonexcludable

Rival: the consumption by one reduces the utility to others
Nonexcludable: once a good is provided, it’s not possible to exclude others

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13.2) Common Resources

Market failure comes from public goods and common resources

Common resource: Rival and nonexcludable

Rival: the consumption by one reduces the utility to others
Nonexcludable: once a good is provided, it’s not possible to exclude others

Market failure

Tragedy of the Commons: the tendency for commonly held resources to be overused and overexploited

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13.2) Common Resources

Market failure comes from public goods and common resources

Common resource: Rival and nonexcludable

Rival: the consumption by one reduces the utility to others
Nonexcludable: once a good is provided, it’s not possible to exclude others

Market failure

Tragedy of the Commons: the tendency for commonly held resources to be overused and overexploited

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13.2) Solution for Tragedy of the Commons (Application)

Tuna in the ocean are an example of a common resource

Rival: One more tuna caught leaves one less tuna for everyone else
Nonexcludable: there are no property rights to fish in the ocean

Tragedy of the commons: in the case of tuna, the collapse of the fishing stock

Since 1960, the tuna catch has decreased by over 70%
Especially, Atlantic bluefin tuna are becoming endangered

Q. Why tragedy of the commons happen here?
A. No one owns the stock of fish (the tuna fisherman doesn’t have any incentives to maintain the stock, therefore, we have the tragedy of the commons here)
Q. Solution?
A. Making a common resource excludable = creating property rights

New Zealand case, they created tradable allowances in fish (e.g., Individual Transferable Quotas)

Sum of ITQs = total allowable catch per year
ITQs can be bought and sold (tradable)
No restriction on boats and equipment

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