Market Failure (?): Public Goods, Common Property & Externalities

1. Market Failure (?):Public Goods, Common Property & Externalities Dr. D. Foster Microeconomics

2. When do markets fail? When will even perfectly competitive markets fail to produce the allocatively efficient level of output? • Public goods • Common property • Positive externalities • Negative externalities

3. Public Goods Non-rival in consumption One person doesn’t use it up. Non-excludable Non-payers can’t be (easily) excluded. • For example: • National defense • Legal system • Lighthouses • TV and radio • Roads

4. Public Goods Not all “publicly-provided” goods meet the test of being public goods. • For example: • Education • Trash collection • Social security • National parks . . . • Roads & lighthouses ! • The legal system ?!

5. Public Goods Non-excludability problem leads to free riders. How do markets deal with this problem? • “Charge” differently - TV & radio ads • Find way to exclude - TV & cable/satellite • Tie-in sales - lighthouses - shopping malls - gated communities

6. Graphical Analysis Price Price Price For private goods, the market demand is the horizontal summation of individual demands. Everyone pays the same price, consumes differing amounts $10 $10 $5 $5 MC $3 Quantity Quantity Quantity 15 25 40 Sally Tom The Market

7. $ Graphical Analysis $15 $11 MC Everyone consumes the same amount, pays differing prices. Q 20 $ The Market $10 For public goods, the market demand is the vertical summation of individual demands. $8 Q 20 Sally $ $5 $3 Q 20 Tom

8. Caveats Government provision may not be desirable: --The free rider problem is replaced with the forced rider. --Government may be inefficient, imposing higher costs such that we would be better off without this good/service!

9. Common Property • Weak incentive to preserve/protect. • Weak incentive to maximize value. • Who owns common property? • Fish in the ocean This is another free rider problem.

10. Supply P D1 D2 P1 Q - Fish Q1 Q2 Qmx Q* Common Property

11. Common Property • What to do?-- Assign private property rights.-- Regulate use . . . -standards, -limits, -prohibit.

12. Some observations • Elephants in Africa1970s - 1.2 million1980s - 600,000 2007 150,000

13. S’ P S” S D Q Can markets really work?What about non-renewable resources? • Hotelling Principle:People treat exhaustible resources like any asset and want to max. value over time. The Simple Version - We can’t run out of . . .

14. Positive Externalities • Some “consumers” benefit w/out paying.-- concert-- flower garden-- flu shot • What to do?-- Nothing.-- Subsidize producer/consumer - there is a cost to this!

15. MSB Q2 Positive Externalities P S To promote allocatively efficient level of output, subsidize by the vertical distance. P1 D = MPB Q Q1

16. Negative Externalities • Third parties bear part of the cost without receiving any of the benefit.-- In the case of pollution:the firm is facing zero-priced waste disposal. • How do we deal with this problem?-- Tax the producer/consumer. -- Set standards/quotas for pollution.-- Allow parties to negotiate.-- Sell pollution rights.

17. Pollution - Tax & Standard MSC P Tax raises costs;  production. Quota on production would (might?) serve the same purpose. Standards for pollution would also raise costs and production. S = MPC P1 D = MPB Q Q2 Q1

18. Pollution & The Coase Theorem • Assign property rights to the resource (!) • It doesn’t matter who gets the right . . .

19. NO !!! Q* Is zero the “right” level of pollution? $ MC MB Quantity of pollution • Problems: Holdouts and Free Riders

20. $1000 $ MC MB $400 Quantity of pollution 0 Qm Q* The Free Rider Problem • The firm owns the rights . . .

21. $ MC $20,000 MB Quantity of pollution $2000 0 Qm Q* The Holdout Problem • The downstream users own the rights . . .

22. Market Failure (?):Public Goods, Common Property & Externalities Dr. D. Foster Microeconomics