Lecture 9: Externalities and Public goods

Lecture 9: Externalities and Public goods Charit Tingsabadh M.Sc. Programme in Environmental and natural resource economics Semester 1/2005

outline • Concepts • Specification • Empirics

concept • Externality: By-products of consumptions and production may benefit or harm other people • Definition:when a person’s well-being or a firm’s capability is directly affected by the actions of other consumers of firms rather than indirectly through changes in prices. • Examples: any suggestion?

Externalities: examples • Supply side: a wedge between private cost and social cost (can be + or - ) • Example: • Polluting factory causes fish deaths in river • Building a road allows other people to travel more conveniently • Coal-burning power station emits SO2 which causes acid rain • Demand side: wedge between (marginal) private benefit and (marginal) social benefit • (+ or - ) • Example: • vaccination reduces health risk for all, not only the individual taking the jab; • Network: the more people have telephone, the more benefit to each subscriber • Forest conservation improves water supply and reduces greenhouse gas concentration

More generally.. excludability low high high rivalry low Externality arises from low excludability

Effect on the market:supply side • Negative externality raises social cost over private cost D price M Social cost M Private Cost D quantity Result: price too low, too much is demanded and produced

Effect on the market:demand side • Positive externality raises social benefit cost over private benefit D M Social benefit price M private benefit Cost D quantity Result: price too low, too little is demanded and produced

conclusion • Because of externalities • Market (private) prices do not reflect social prices • Wrong (inefficient) resource allocation • Would improve if external cost(benefit) can be internalised. • Internalisation through property rights-give ownership, but of what ? And to whom? • Institutional economics to the rescue..

Public Good • Extreme case of low rivalry and low excludability • Pure public good: • no rivalry-if available to one consumer, is avaliable to all consumers • No excludability-cannot exclude anybody from consumption • So, if one consumes, all consume.

Graphing public good • Demand side: • Individual demand, normal downward sloping demand curve • Market demand, vertical summation of individual demand curves, because same amount is consumed. Samuelson condition.

Market for public good Price Total demand S D2 D1 quantity

Description of market • Total demand is vertical sum of individual demand • Supply is shared in same quantity • Cost is more than individual benefit • Will there be market supply? • If one pays for supply, all others will have it also, • So wait for the “public” spirited person, free riding by others • If not, no supply. • Clear case of market failure!!!!

Correcting for externalities • Pigouvian tax • How to set the tax rate? • Property rights allocation (Coase theorem) • Whose rights-who pays? • Rule-based control • To reduce transaction cost

The Commons • Commons: high rivalry, low excludability • Example: public park, roads, fishing • Capacity limits to use • Over-capacity use results in congestion • Demand-side management vs. supply expansion • Fees, quota, controlling access, etc.

Chapter 18 Externalities, Commons, and Public Goods

Figure 18.1 Welfare Effects of Pollution in a Competitive Market

Table 18.1Industrial CO2 Emissions, 1998

Figure 18.2Taxes to Control Pollution

Figure 18.3Cost-Benefit Analysis of Pollution

Application (Page 634) Emissions Standards for Ozone

Figure 18.4 Monopoly, Competition, and Social Optimum with Polution

Table 18.2Property Rights and Bargaining

Table 18.2aProperty Rights and Bargaining

Table 18.2bProperty Rights and Bargaining

Table 18.2cProperty Rights and Bargaining

Table 18.3 Rivalry and Exclusion

Figure 18.5 Inadequate Provision of a Public Good

Table 18.4Private Payments for a Public Good

Table 18.5Voting on $300 Traffic Signals

Cross-Chapter Analysis (Page 657)Emissions Fees Versus Standards Under Uncertainty

Lecture 9: Externalities and Public goods