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Externalities, Commons and Public Goods

Externalities, Commons and Public Goods. Perloff Chapter 18. Externalities. When a person’s well being or a firm’s production capacity is affected directly by another’s actions. Negative Chemical plant dumping waste into a lake. Positive

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Externalities, Commons and Public Goods

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  1. Externalities, Commons and Public Goods Perloff Chapter 18

  2. Externalities • When a person’s well being or a firm’s production capacity is affected directly by another’s actions. • Negative • Chemical plant dumping waste into a lake. • Positive • A firm installing shrubs and sculpture benefits its neighbours

  3. Marginal cost with and Externality • Marginal Private Cost • The additional cost incurred when an additional unit of output is produced. • Marginal Social Cost • The full cost incurred by all of society in producing another unit of output. • MCs=MCp+MCg

  4. Welfare Effects of Pollution 450 Price of paper, p,$ per ton s p g = + MC MC MC A p MC e s E p = 282 s B D C e p = 240 c c H 198 p g MC MC G F 84 g MC 30 Demand = = 0 Q 84 Q 105 225 s c Q , Tons of paper per day

  5. Emissions Standard • Regulate pollution (or output) in order to achieve the social optimum. • In the paper example constrain output to 84 units per day. Need to know: • Demand curve • Marginal social cost curve • Relationship between paper production and pollution. • Enforcement is costly.

  6. p = 282 s p MC = 198 g MC = 84 Emissions Fee • Tax the pollution that is produced. • Tax output (assuming a fixed relationship with pollution) • Either: • vary tax with output (t(Q)) • fixed tax (t) Price of paper, p, $ per ton 450 s p = + MC MC t ( Q ) p + MC t e s p MC = 84 t g MC Demand = 0 Q 84 225 s Q , Tons of paper per day

  7. Cost benefit Analysis • Compares the costs and benefits of a movement away from the market equilibrium. • Costs: • Reduced output of paper • Consumer surplus reduced • Producer surplus reduced • Benefits • Reduced costs of polution

  8. (a) Cost and Benefit CBA of polution Cost: less paper 4,000 Benefit, Cost, $ Benefit: less gunk 2,000 Maximum net benefit 0 105 84 63 Q , Tons of paper per day G , Units of gunk per day (b) Marginal Cost and Marginal Benefit MC 105 Marginal benefit,Marginal cost, $ 84 MB 0 105 84 Q , Tons of paper per day G , Units of gunk per day

  9. Externality With Monopoly 450 s p g = + MC MC MC Price of paper, p, $ per ton e t 330 e m 310 e s p MC D 282 C A B e 240 c g MC 30 MR Demand 0 60 70 84 105 225

  10. Regulation of a Monopoly with an Externality • It may be that the monopoly is preferable to competition if regulation is not possible. • Charging a tax equal to the MC of pollution may reduce welfare if monopoly output is below social optimum. • Achieving the social optimum may entail subsidisation of a monopoly.

  11. Property rights • An exclusive right to use an asset • Private ownership of asset • Right to be free of noise pollution • Courts could be used to enforce the right • You could sell the right to someone who wants to be noisy. • In many cases the rights are not assigned.

  12. Coase Theorem: No property Rights Boat firm: Boats rented per day $0 $14 $15 Chemical firm: tonnes dumped per day. $0 $0 $0 $0 $10 $5 $10 $10 $10 $0 $2 -$3 $15 $15 $15 If property rights are with boat owner: Minimum price per unit of pollution is $5 Maximum price is $10 If property rights are with chem. firm: Minimum price per unit of pollution is $5 Maximum price is $7.50

  13. Coase theorem: Property rights with boat firm Pollution priced at $7 per tonne Boat firm: Boats rented per day $0 $14 $15 Chemical firm: tonnes dumped per day. $0 $0 $0 $7 $17 $12 $3 $3 $3 $14 $16 $11 $1 $1 $1

  14. Coase theorem: property rights with chemical firm Pollution priced at $6 per tonne Boat firm: Boats rented per day -$12 $2 $3 Chemical firm: tonnes dumped per day. $12 $12 $12 -$6 $4 -$1 $16 $16 $16 $0 $2 -$3 $15 $15 $15

  15. Coase Therorem: Summary • Assigning property rights results in the efficient outcome. • Efficiency is achieved regardless of who has the property rights. • The distribution of welfare in the efficient outcome is dependent on the initial allocation of property rights.

  16. Common Property • Unlike private property people cannot be excluded. • When deciding how much to use, people ignore the impacts on others so the resource is overused. • Common pool, water, gas, oil. • Internet • Roads • Fisheries

  17. Public Goods • Non-Excludability • People cannot be prevented from consuming a good. • Non rivalry • The good is not used up when one person uses it.

  18. Markets for public goods • Only exist for excludable goods. • Demand curve is the vertical summation of individual willingness-to-pay or demand curves 25 D Price of guard service,$ per hour 1 D 18 13 e e p s 10 Supply, MC 8 7 2 D 3 2 0 4 5 7 9 Guards per hour

  19. Free riding

  20. Voting for the provision of a public good

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