Chapter Seventeen

In this chapter, we examine seven main topics Externalities The Inefficiency of Competition with Externalities Regulating Externalities Market Structure and Externalities Allocating Property Rights to Reduce Externalities Open-Access Common Property Public Goods Externalities, Open Access, and Public Goods © 2008 Pearson Addison Wesley. All rights reserved.

Externality The direct effect of the actions of a person or firm on another person’s well-being or a firm’s production capability rather than an indirect effect through changes in prices. Externalities © 2008 Pearson Addison Wesley. All rights reserved.

Externalities may either help or harm others. An externality that harms someone is called a negative externality. A positive externalitybenefits others. Externalities © 2008 Pearson Addison Wesley. All rights reserved.

南投有雞舍養了10萬隻雞，業者收集雞糞卻不注意衛生問題，任由蒼蠅滋生，雞糞的臭味沖天，只要風一吹，附近村落全都聞到臭味；更讓附近居民氣憤的是，雞舍主人在空地隨便挖個大洞，就把垃圾、雞屎、污水倒進去，由於雞舍位處水源上游，因此在下游的民眾擔心，他們喝到的都是雞屎臭水。南投有雞舍養了10萬隻雞，業者收集雞糞卻不注意衛生問題，任由蒼蠅滋生，雞糞的臭味沖天，只要風一吹，附近村落全都聞到臭味；更讓附近居民氣憤的是，雞舍主人在空地隨便挖個大洞，就把垃圾、雞屎、污水倒進去，由於雞舍位處水源上游，因此在下游的民眾擔心，他們喝到的都是雞屎臭水。雞糞滋生蒼蠅　臭味沖天惹民怨資料來源：http://tw.news.yahoo.com/article/url/d/a/090516/8/1jm4w.html 更新日期:2009/05/16 17:35 黃茂松 (TVBS)

…第一市場管委會表示，近年來流動攤販愈來愈多，但很少聽到店家抱怨搶生意，反而是民眾經常投訴道路堵塞…公家機關關切攤販是否因盤據道路騎樓，影響交通安全或民眾的通行權益。…潭子鄉長簡文祥指出，要解決流動攤販衍生的問題，沒有兩全其美的辦法，鄉公所雖可轉請警察取締，但取締不是要逼流動攤販無法生存，而是退到不妨害交通的適當地點營業……第一市場管委會表示，近年來流動攤販愈來愈多，但很少聽到店家抱怨搶生意，反而是民眾經常投訴道路堵塞…公家機關關切攤販是否因盤據道路騎樓，影響交通安全或民眾的通行權益。…潭子鄉長簡文祥指出，要解決流動攤販衍生的問題，沒有兩全其美的辦法，鄉公所雖可轉請警察取締，但取締不是要逼流動攤販無法生存，而是退到不妨害交通的適當地點營業… 景氣差攤販增加影響通行權益資料來源：http://tw.news.yahoo.com/article/url/d/a/090511/78/1j9q4.html 更新日期：2009/05/11 04:09 截錄自：自由時報

Competitive firms and consumers do not have to pay for the harms of their negative externalities, so they create excessive amounts. Because producers are not compensated for the benefits of a positive externality, too little of such externalities is produced. The Inefficiency of Competition with Externalities © 2008 Pearson Addison Wesley. All rights reserved.

Private cost The cost of production only, not including externalities Social cost The private cost plus the cost of the harms from externalities The Inefficiency of Competition with Externalities © 2008 Pearson Addison Wesley. All rights reserved.

We use a supply-and-demand diagram to illustrate that a competitive market produces excessive pollution because the firms’ private cost is less than their social cost. Supply-and-Demand Analysis © 2008 Pearson Addison Wesley. All rights reserved.

The competitive equilibrium, , is determined by the intersection of the demand curve and the competitive supply or private marginal cost curve, , which ignores the cost of pollution. Figure 17.1 Welfare Effects of Pollution in a Competitive Market © 2008 Pearson Addison Wesley. All rights reserved.

The social optimum, , is at the intersection of the demand curve and the social marginal cost curve, , where is the marginal cost of the pollution (gunk). Private producer surplus is based on curve, and social producer surplus is based on the curve. Figure 17.1 Welfare Effects of Pollution in a Competitive Market © 2008 Pearson Addison Wesley. All rights reserved.

The figure illustrates two main results with respect to negative externalities. First, a competitive market produces excessive negative externalities. Second, the optimal amount of pollution is greater than zero. Supply-and-Demand Analysis © 2008 Pearson Addison Wesley. All rights reserved.

By using a cost-benefit analysis, we obtain another interpretation of the pollution problem in terms of the marginal cost and benefit of the pollution itself. Welfare is maximized by reducing output and pollution until the marginal benefit from less pollution equals the marginal cost of less output. Cost-Benefit Analysis © 2008 Pearson Addison Wesley. All rights reserved.

The benefit curve reflects the reduction in harm from pollution as the amount of gunk falls from the competitive level. The cost of reducing the amount of gunk is the fall in output, which reduces consumer surplus and private producer surplus. Welfare is maximized at 84 tons of paper and 84 units of gunk, the quantities at which the difference between the benefit and cost curves, the net benefit, is greatest. Figure 17.2 Cost-Benefit Analysis of Pollution © 2008 Pearson Addison Wesley. All rights reserved.

The net benefit is maximized where the marginal benefit, , which is the slope of the benefit curve, equals the marginal cost, , the slope of the cost curve. Figure 17.2 Cost-Benefit Analysis of Pollution © 2008 Pearson Addison Wesley. All rights reserved.

If a government has sufficient knowledge about pollution damage, the demand curve, costs, and the production technology, it can force a competitive market to produce the social optimum. Regulating Externalities © 2008 Pearson Addison Wesley. All rights reserved.

A governmental limit on the amount of air or water pollution that may be released is called an emission standard. A tax on air pollution is called an emissions fee, and a tax on discharges into the air or waterways is an effluent charge. Regulating Externalities © 2008 Pearson Addison Wesley. All rights reserved.

Internalize the externality To bear the cost of the harm that one inflicts on others (or to capture the benefit that one provides to others) Regulating Externalities © 2008 Pearson Addison Wesley. All rights reserved.

Placing a tax on the firms equal to the harm the gunk, , causes them to internalize the externality, so their private marginal cost is the same as the social marginal cost, . As a result, the competitive after-tax equilibrium is the same as the social optimum, . Figure 17.3 Taxes to Control Pollution © 2008 Pearson Addison Wesley. All rights reserved.

Alternatively, applying a specific tax of per ton of paper, which is the marginal harm from the gunk at , also results in the social optimum. Figure 17.3 Taxes to Control Pollution © 2008 Pearson Addison Wesley. All rights reserved.

Emissions Fees versus Standards under Uncertanity • We have seen that the government can induce a firm to produce efficiently if it sets either a fee or a standard optimally. • Although either regulation would be optimal in a world of certainty, these regulations are not optimal if the actual marginal cost curve is higher or lower than the expected curve. © 2008 Pearson Addison Wesley. All rights reserved.

Two of our main results concerning competitive markets and negative externalities—that too much pollution is produced and that a tax equal to the marginal social cost of the externality solves the problem—do not hold for other market structures. Market Structure and Externalities © 2008 Pearson Addison Wesley. All rights reserved.

Although the competitive market with an externality always produces more output than the social optimum, a monopoly may produce more than, the same as, or less than the social optimum. Monopoly and Externalities © 2008 Pearson Addison Wesley. All rights reserved.

Which effect dominates depends on the elasticity of demand for the output and on the extent of the marginal damage the pollution causes. Monopoly and Externalities © 2008 Pearson Addison Wesley. All rights reserved.

In the absence of externalities, welfare is greater under competition than under an unregulated monopoly. However, with an externality, welfare may be greater with monopoly than with competition. Monopoly Versus Competitive Welfare with Externalities © 2008 Pearson Addison Wesley. All rights reserved.

At the competitive equilibrium, , more is produced than at the social optimum, . As a result, the deadweight loss in the competitive market is . The monopoly equilibrium, , is determined by the intersection of the marginal revenue and the private marginal cost, , curves. Figure 17.5 Monopoly, Competition, and Social Optimum with Pollution © 2008 Pearson Addison Wesley. All rights reserved.

The social welfare (based on the marginal social cost, , curve) under monopoly is . Here the deadweight loss of monopoly, , is less than the deadweight loss under competition, . Figure 17.5 Monopoly, Competition, and Social Optimum with Pollution © 2008 Pearson Addison Wesley. All rights reserved.

Trying to solve a negative externality problem is more complex in a noncompetitive market than in a competitive market. Taxing Externalities in Noncompetitive Markets © 2008 Pearson Addison Wesley. All rights reserved.

To achieve a social optimum in a competitive market, the government only has to reduce the externality, possibly by decreasing output. In a noncompetitive market, the government must eliminate problems arising from both externalities and the exercise of market power. Taxing Externalities in Noncompetitive Markets © 2008 Pearson Addison Wesley. All rights reserved.

Instead of controlling externalities directly through emissions fees and emissions standards, the government may take an indirect approach by assigning a property right: an exclusive privilege to use an asset. If no one holds a property right for a good or a bad, the good or bad is unlikely to have a price. Allocating Property Rights to Reduce Externalities © 2008 Pearson Addison Wesley. All rights reserved.

For many bads, such as pollution, and for some goods, property rights are not clearly defined. No one has exclusive property rights to the air we breathe. Because of this lack of a price, a polluter’s private marginal cost of production is less than the full social marginal cost. Allocating Property Rights to Reduce Externalities © 2008 Pearson Addison Wesley. All rights reserved.

According to the Coase Theorem (Coase, 1960), the optimal levels of pollution and output can result from bargaining between polluters and their victims if property rights are clearly defined. Coase Theorem © 2008 Pearson Addison Wesley. All rights reserved.

If there are no impediments to bargaining, assigning property rights results in the efficient outcome at which joint profits are maximized. Efficiency is achieved regardless of who receives the property rights. Coase Theorem © 2008 Pearson Addison Wesley. All rights reserved.

Who gets the property rights affects the income distribution. The property rights are valuable. The party with the property rights may be compensated by the other party. Coase Theorem © 2008 Pearson Addison Wesley. All rights reserved.

First, if transaction costs are very high, it might not pay for the two sides to meet. Second, if firms engage in strategic bargaining behavior, an agreement may not be reached. Third, if either side lacks information about the costs or benefits or reducing pollution, a nonefficient outcome may occur. Problems with the Coase Approach © 2008 Pearson Addison Wesley. All rights reserved.

If high transaction costs preclude bargaining, we may be able to overcome this problem by using a market, which facilitates exchanges between individuals. Under this cap and trade system, the government gives firms permits, each of which confers the right to create a certain amount of pollution. Each firm may use its permits or sell them to other firms. Markets for Pollution © 2008 Pearson Addison Wesley. All rights reserved.

By using a market, the government does not have to collect this type of detailed information to achieve efficiency. Its only decision concerns what total amount of pollution to allow. Markets for Pollution © 2008 Pearson Addison Wesley. All rights reserved.

Because people do not have to pay to use open-access common property resources, they are overused. e.g. Overuse of Open-Access Common Property • Common Pools. • The Internet. • Roads • Fisheries. © 2008 Pearson Addison Wesley. All rights reserved.

Chapter Seventeen