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Chapter 18

Chapter 18. Externalities and Public Goods DERYA GÜLTEKİN-KARAKAŞ. Topics to be Discussed. Externalities Public Goods. Externalities. Negative Action by one party imposes a cost on another party Positive Action by one party benefits another party. External Cost. Scenario

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Chapter 18

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  1. Chapter 18 Externalities and Public Goods DERYA GÜLTEKİN-KARAKAŞ

  2. Topics to be Discussed • Externalities • Public Goods Chapter 18

  3. Externalities • Negative • Action by one party imposes a cost on another party • Positive • Action by one party benefits another party Chapter 18

  4. External Cost • Scenario • Steel plant dumping waste in a river • The entire steel market effluent can be reduced by lowering output (fixed proportions production function) Chapter 18

  5. External Cost • Scenario • Marginal External Cost (MEC) is the cost imposed on fishermen downstream for each level of production. • Marginal Social Cost (MSC) is MC plus MEC. Chapter 18

  6. The differences is the marginal external cost MEC. The profit maximizing firm produces at q1 while the efficient output level is q*. When there are negative externalities, the marginal social cost MSC is higher than the marginal cost. MSC MSCI MC S = MCI The industry competitive output is Q1 while the efficient level is Q*. Aggregate social cost of negative externality P* P1 P1 MECI MEC D q* q1 Q* Q1 External Costs Price Price Industry output Firm output Firmaların MC eğrilerinin

  7. External Cost • Negative Externalities encourage inefficient firms to remain in the industry and create excessive production in the long run. Chapter 18

  8. Externalities • Positive Externalities and Inefficiency • Externalities can also result in too little production, as can be shown in an example of home repair and landscaping. Chapter 18

  9. When there are positive externalities (the benefits of repairs to neighbors), marginal social benefits MSB are higher than marginal benefits D. MSB A self-interested home owner invests q1 in repairs. The efficient level of repairs q* is higher. The higher price P1 discourages repair. D P1 MC P* MEB q1 q* External Benefits Value Is research and development discouraged by positive externalities? Repair Level Chapter 18

  10. Public Goods • Question • When should government replace firms as the producer of goods and services? Chapter 18

  11. Public Goods • Public Good Characteristics • Nonrival • For any given level of production the marginal cost of providing it to an additional consumer is zero. • Nonexclusive • People cannot be excluded from consuming the good. Chapter 18

  12. Public Goods • Not all government produced goods are public goods • Some are rival and exclusive • Education • Parks Chapter 18

  13. When a good is nonrival, the social marginal benefit of consumption (D) , is determined by vertically summing the individual demand curves for the good. Marginal Cost D2 Efficient output occurs where MC = MB at 2 units of output. MB is $1.50 + $4.00 or $5.50. D $1.50 D1 Efficient Public Good Provision Benefits (dollars) $7.00 $5.50 $4.00 Output 0 1 2 3 4 5 6 7 8 9 10 Chapter 18

  14. Public Goods • Public Goods and Market Failure • How much national defense did you consume last week? Chapter 18

  15. Public Goods • Free Riders • There is no way to provide some goods and services without benefiting everyone. • Households do not have the incentive to pay what the item is worth to them. • Free riders understate the value of a good or service so that they can enjoy its benefit without paying for it. Chapter 18

  16. Public Goods • Establishing a mosquito abatement company • How do you measure output? • Who do you charge? • A mosquito meter? Chapter 18

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