The market for aluminum 5 Price of Aluminum Quantity of Aluminum 0 Demand private value Supply private cost The demand curve reflects the value to buyers, and the supply curve reflects t
Trang 1Externalities and Public Goods
Chapter 7
By Tran Thi Kieu Minh, MSc
Microeconomics
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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Trang 2The market for aluminum
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Price of
Aluminum
Quantity of Aluminum
0
Demand (private value)
Supply (private cost)
The demand curve reflects the value to buyers, and the supply curve reflects the costs
of sellers The equilibrium quantity, Q MARKET , maximizes the total value to buyers minus
the total costs of sellers In the absence of externalities, therefore, the market
equilibrium is efficient
QMARKET
Equilibrium
Externalities and Market Inefficiency
• Negative externalities
▫ Pollution
▫ Cost to society (of producing aluminum)
Larger than the cost to the aluminum producers
▫ Social cost - supply
Private costs of the producers
Plus the costs to those bystanders affected adversely
by the negative externality
▫ Social cost curve – above the supply curve
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Pollution and the social optimum
Price of
Aluminum
Quantity of
0
Demand (private value)
Supply (private cost)
QMARKET
Optimum
Social cost (private cost and external cost) External
Cost
QOPTIMUM
Equilibrium
Externalities and Market Inefficiency
• Positive externalities
▫ Education
Benefit of education – private
Externalities: better government, lower crime rate, higher productivity and wages
▫ Social value – demand
Higher than private value
▫ Social value curve
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Trang 3Education and the social optimum
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Price of
Aluminum
Quantity of Aluminum
0
Demand (private value)
Supply (private cost)
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
QMARKET
Equilibrium
Social value (private value and external benefit)
External Benefit
QOPTIMUM
Optimum
Externalities and Market Inefficiency
• Government – correct market failure
▫ Taxing goods that have negative externalities
▫ Subsidizing goods that have positive externalities
1 0
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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Trang 4Four types of goods
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Rival in consumption?
Excludable?
Yes
Private goods
- Ice-cream cones
- Clothing
- Congested toll roads
Natural monopolies
- Fire protection
- Cable TV
- Uncongested toll roads
No
Common resources
- Fish in the ocean
- The environment
- Congested nontoll roads
Public goods
- Tornado system
- National defense
- Uncongested nontoll roads 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
The Different Kinds of Goods
• Types of goods
▫ Private goods
Excludable & Rival in consumption
▫ Public goods
Not excludable & Not rival in consumption
▫ Common resources
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
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Trang 5Public Goods
• Some important public goods
▫ National defense
Very expensive public good
▫ Basic research
General knowledge
▫ Fighting poverty
Welfare system
Food stamps
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Public Goods
• The difficult job of cost–benefit analysis
▫ Government
Decide what public goods to provide
In what quantities
▫ Cost–benefit analysis
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
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
▫ 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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