Econ 206(A) Tutorial 8

1. Econ 206(A) Tutorial 8 Externalities & Public Goods

2. Seminar Topic 1 • Is the market always the most efficient solution to the problem of resource allocation?

3. Externalities • Defn: indirect products of production or consumption (can be positive or negative) • In the presence of externalities, the market mechanism does not produce the optimum level of production. • In this case we have `market failure’ (social optimum does not equal private optimum)

4. Seminar Topic 2 • What is meant by social opportunity cost? Provide examples.

5. Negative Externalities • Social Cost incorporates private opportunity cost (given by market supply) and social opportunity cost. • Production externalities affect supply. • Social cost > private cost when there are negative externalities. • The market produces too much of a good/service.

6. Negative Externalities in Production MSC Price, p MPC = S E* p* E1 p1 MPB = D 0 q* q1 Quantity, q

7. Positive Externalities - Production • Social cost < private cost when there are positive production externalities. • For instance: production of the good by one firm reduces the cost of production of other firms. • The market produces too little of a good/service. • An example is general training provided by firms.

8. Externalities in Production: Benefits Price, p MPC = S MSC E1 p1 E* p* MPB = D 0 q1 q* Quantity, q

9. Externalities in Consumption • Negative: Social benefit < Private Benefit when there are negative consumption externalities. • i.e. another individuals consumption of a good, reduces others benefit. • For instance; negative effects of car travel on others consumption (pollution, increased congestion). • Too much is consumed in the market

10. Externalities in Consumption: Costs Price, p E* E1 s p* MPB = D MSB 0 q* q1 Quantity, q

11. Externalities in Consumption • Positive: Private Benefit < Social Benefit when there are positive consumption externalities. • i.e. another individuals consumption of a good increases others benefit. • For instance; increased use of public transport reduces traffic congestion and increases others benefit from less congestion, pollution etc. • Too little is consumed in the market (from society’s point of view)

12. Externalities in Consumption: Benefits Price, p E1 E* s p* MSB MPB = D 0 q1 q* Quantity, q

13. Market Failure • Where the market produces a sub-optimal level of production (either too little or too much). • This occurs because producers and consumers do not consider the full `social’ costs (or benefits) of production/consumption when making economic decisions.

14. Seminar Topic 3 • Should students contribute to the cost of their university education?

15. Private vs Public Goods Public goods have the following features: • They are non-rival (consumption of the good/service by one individual does not reduces its value to others) • They are non-excludable. You cannot prevent someone from consuming the good/service.

16. Public goods • Many non-rival goods have high external benefits but low individual private benefit. • This means individuals would not provide the good as the private costs far exceed the private benefits (think infrastructure, roads, street lights, telephone lines). • Non-excludable goods have a `free rider’ problem. Why pay for something that you can use for free?