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Public Goods and Externalities

Public Goods and Externalities. Public goods and externalities: two more “market failures”. another market failure (discussed in the previous lecture) is due to “monopoly power”

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Public Goods and Externalities

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  1. Public Goods and Externalities

  2. Public goods and externalities: two more “market failures” another market failure (discussed in the previous lecture) is due to “monopoly power” these three market failures plus income distribution are the main rationales for government intervention in a market economy

  3. Public Goods Two Key properties non-rivalry in consumption if I consume more, others do not need to consume less non-excludability you cannot prevent people from consuming the good free rider problem

  4. National Defense

  5. Fire Protection

  6. Police

  7. Lighthouse?

  8. Mimic the market: produce up to the point where marginal benefit equals marginal cost examples: number of police on the street size of national defense force How much of a public good should be produced?

  9. when the choice is to produce or not produce Because benefits come in the future they must bediscounted Cost-Benefit Analysis

  10. Numerical Example: Should PAPD buy a new computer?

  11. Present Discounted Value of Benefits • PDV = 500/(1+i) + 600/(1+i)2 • if i = .05 then • PDV = 500/(1.05) + 600/(1.05)2 = 476 + 544 = 1020 • thus the PAPD should make the investment in the computer

  12. Higher discount rates mean that fewer projects will meet cost-benefit test. Thus discounting enters political debate.

  13. Externalities • Definition: When the costs of producing or the benefits of consuming spill over to other people. • Negative externalities • Positive externalities

  14. A Negative Externality: Pollution

  15. Positive Externalities • Education • Innovative ideas • Research

  16. The Economic Impact of Negative Externalities

  17. The Economic Impact of Positive Externalities

  18. What are the possible remedies for externalities? • Private Remedies Let the individuals work it out themselves • Need to define property rights • But transaction costs and free rider problem might prevent the private remedy

  19. Command and control • A common form of “social regulation” used by EPA • scrubbers • CAFÉ standards • Usually not very flexible or efficient

  20. Using Taxes orsubsidies • make them feel the pain or the gain • more flexible than command and control • but can’t be sure about the total amount

  21. The Tax Remedy for a Negative Externality

  22. The Subsidy Remedy for a Positive Externality

  23. Why don’t you draw it by hand?

  24. Tradable Permits • Examples • SO2 (acid rain) • CO2 (global warming) • Permit allows each firm to emit a certain amount of pollutants • Total number of permits issued equals emission limit for the region each year • Firms that are better at reducing emissions sell permits to firms that are worse at it.

  25. End of Lecture

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