ECONOMICS

1. ECONOMICS What Does It Mean To Me? Part VI: The Role of Government in Microeconomics/ Externalities

2. Economic functions of Government: 1) Enforce laws and contracts. 2) Maintain competition. 3) Redistribute income--providing an economic safety net. 4) Provide public goods -nonexclusion -shared consumption

3. 5) Correct Market Failures -provide market information -correct negative externalities -subsidize goods with positive externalities 6) Stabilize the economy - fight unemployment - encourage price stability - promote economic growth

4. EXTERNALITIES

5. Externality When one person’s actions imposes a cost or benefit on the well-being of a bystander. Externalities usually result in market failure.

6. Externalities can be: 1) Positive: an external benefit is imposed on someone. (examples: gardens, restored historic buildings, research) 2) Negative: an external cost is imposed on someone. (examples: exhaust from autos, barking dogs, noise from airplanes)

7. Externalities cause markets to allocate resources inefficiently.

8. This happens through: 1) CONSUMPTION: consuming a good results in externality. 2) PRODUCTION: producing a good results in externality. In general, an external cost means the market overproduces the good (ie, paint). An external benefit means the market underproduces the good (ie, gardens)

9. Are there benefits for other people in the parking lot when someone puts their car alarm on?

10. ANSWER: Yes, because thieves don’t know which cars have alarms. What about the club? Are there benefits for other people in the parking lot when someone puts the club on their car?

11. ANSWER: No . . .because the thief can SEE the club.

12. Your neighbor puts in a nice garden. Are you receiving a benefit?

13. When you admit you are receiving a positive benefit, your neighbor asks you to pay him $100 a month for the benefit. When you say no, he puts up a fence.

14. What if you lived next door to this? Do you receive a benefit?

15. PROPERTY RIGHTS is the issue? Who owns the air? The rivers? The parks?

16. If we can figure out who pollutes the stream, we punish the offender because we are not sure who owns the stream, but we DO know who pollutes it. We get into trouble when we use this criteria regarding the air.

17. The tendency for a society to overuse and therefore abuse common resources is called: TRAGEDY OF THE COMMONS

18. What is the difference between a public good and a private good? Exclusion vs. non-exclusion and Shared consumption (rival good) vs. non-shared consumption (non-rival good)

19. What defines property rights? Property rights are established by formal and informal rules about the privileges and limitations on the ownership, use, and transfer of goods and resources. These rights are specified in various municipal ordinances, other legislation, court decisions (common law), tradition and custom.

20. Property rights need to be: 1) clearly defined 2) exclusive 3) enforceable 4) transferable

21. Consider each of the items below: Are they . . . . .? Clearly Defined? Exclusive? Transferable? Enforceable? skateboard gun library book hamburger Garden view Bottled water Lake water Stream water

22. What is a free-rider? Someone who uses the good but doesn’t pay for it. Free riders occur when there are nonexclusion and shared consumption. Spraying for mosquitoes Police & fire protection National defense Street lights

23. An Overview of U.S. Water Law Riparian Common Law - people who own land along streams, lakes and springs have a right to “reasonable use” of the water. First -in-time, First-in-right - the first person to divert water and use it has the first right. People who come later can take what is left. Use-it or Lose-it - If a person with water rights doesn’t use all the water he claims a right to, he permanently loses his right to the portion he doesn’t use.

24. An Overview of U.S. Water Law (cont.) Salvaged water rule - If a person is able to save water (I.e. by better irrigation system), he cannot sell the extra water or even keep his right to it. Beneficial use - People may not establish water rights unless they are using the water for “beneficial use”. (I.e.) Agriculture is recognized in all states, but only a few states recognize recreation or fishing. Public Interest - Water rights--especially the right to transfer--are limited by the “public interest>” Laws and courts define “public interest” as things like protecting an economic area or environment or public health and safety.

25. Even though water is essential for life and diamonds are not, water is cheap and diamonds are expensive? Why?

26. It has to do with the elasticity of the supply curve and the amount of consumer/producer surplus With DIAMONDS, supply is very inelastic. With WATER, supply is very elastic. S Consumer Surplus P Price Price Producer Surplus S P D D Q Q Quantity Quantity

27. Why would a farmer in the desert of Southern California grow rice--a crop that requires a great deal of water?

28. How much water do you NEED to live per day? Answer: 1 1/2 liters What is the average per capita consumption of water per day in the State of Florida? Answer: 169 gallons

29. Compare this to 130 gal/day in Massachusetts and Rhode Island And 325 gal/day in Nevada

30. When is a basketball an alternative to water? When is coal an alternative to a waterfall?

31. What are some other ways to conserve water? Drip irrigation Compost Night watering Safflower oil Xeriscape Rocks Massage Broom Denim Mulch

32. If I were your neighbor, what could you do to stop me from polluting?

33. What if we decide it’s YOUR property? 1) Call the police 2) Assault and battery?? 3) Pay me to stop.---You’ve upped my opportunity cost---at some point it’s worth it to me to stop.

34. What if we decide it’s MY property? 1) Outdo my Opportunity Cost (money, friendship) 2) Petition or threaten (fine, tax) 3) You can PAY me to stop (what is it worth to you?)

35. People’s use responds to incentives. Consider the following taxing methods to control water usage: Mayor asks bill = $.002/gal. Flat fee = $10/month MC = 0 Flat fee = $30/month Billed at $.01/gal. MC >MB Billed at $.05/gal.

36. The government has dealt effectively with most water issues. BUT. . . . .what about GARDENS???

37. So . . . Your neighbor plants a garden and it is beautiful. But 5 years later, the garden has grown and you can no longer see the lake. Do you have a right to your view?

38. Today, there are thousands of lawsuits over condos and owner’s rights or trees loosing leaves in your neighbor’s yard. If your cat is in your neighbor’s yard, is it your neighbor’s cat? What if your cat kills a bird in your neighbor’s yard?

39. Coase Theorem The proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own.

40. Is this pollution?

41. Exercise

42. In review: Externalities Negative (+cost) Positive (+benefit) Consumption (cigarettes) Consumption (education) Production (pollution) Production (honey)

43. What is efficient? Efficiency occurs when MC = MB for society. PRICE S = MC to Society For a perfectly competitive market with no externalities and for a good that is not a public good, the market is efficient. D = MB to Society QUANTITY

44. What is efficient? Another way to measure efficiency would be where Profit Maximizing Output is found where P = MC MC PRICE Market Price QUANTITY

45. What happens when the firms’ marginal cost of production is not equal to the marginal cost to society? Or if the marginal benefit to consumers is not equal to the marginal benefit to society?

46. NEGATIVE EXTERNALITY IN PRODUCTION: Example: Pollution Because of the externality, the cost to society is larger than the cost to producers. MSC PRICE S = MPC to Firm MC is the private cost to the firm. Marginal social cost (MSC) is cost to society = MC + externality. D = MB to Society QUANTITY Qmarket Qoptimum The market overproduces and charges a price that is too low.

47. POSITIVE EXTERNALITY IN PRODUCTION: Example: Honey MPC to firm PRICE S = MSC MC is the private cost to the firm. Marginal social cost (MSC) is cost to society = MC + externality. D = MB to Society QUANTITY Qoptimum Qmarket The market underproduces and charges a price that is too high.

48. NEGATIVE EXTERNALITY IN CONSUMPTION: Example: Cigarettes Overproduction in this case raises MC. D gives the private benefit in consumption. Marginal social benefit (MSB) = D + externality. PRICE MC D = MB to Buyer MSB QUANTITY Qmarket The market overproduces and charges a price that is too high.

49. POSITIVE EXTERNALITY IN CONSUMPTION: Examples: Education, Charities The social value of education is greater than the private value. Underproduction in this case lowers MC. PRICE MC D gives the private benefit in consumption. Marginal social benefit (MSB) = D + externality. MSB D = MB to Buyer QUANTITY Qoptimum Qmarket The market underproduces and charges a price that is too low.

50. SOLUTIONS: 1) Assign property rights => internalize externality (Negotiate if mutually beneficial) 2) Government involvement Tax on negative externality (Pigovian tax) Subsidy for positive externality Permits