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

 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 leve

MICROECONOMICS: Theory & Applications

By Edgar K Browning & Mark A Zupan

John Wiley & Sons, Inc.

12 th Edition, Copyright 2015

Chapter 20: Public Goods and Externalities

Prepared by Dr Della Lee Sue, Marist College

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)

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

20.1 WHAT ARE PUBLIC GOODS?

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

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

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

20.2 EFFICIENCY IN THE PROVISION

OF A PUBLIC GOOD

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

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

Figure 20.1 - The Efficient Output of a Public Good

Efficiency in Production and

Distribution

 Conditions for economic efficiency:

– an efficient distribution of products among consumers

 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

20.3 EXTERNALITIES

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

aspects.

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

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

Figure 20.2 - External Costs and Taxes

Figure 20.3 - External Benefits and

Subsidies

20.4 EXTERNALITIES AND PROPERTY RIGHTS

Show how clearly defined and enforced property rights can resolve

externality problems and thereby ensure an efficient outcome.

Externalities and Property Rights

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

Market-based Pollution Control

Figure 20.4 - A Tax on Pollution

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

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