externalities, commons and public goods perloff chapter 18
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Externalities, Commons and Public Goods
Perloff Chapter 18
Externalities
• When a person’s well being or a firm’s production capacity is affected directly by another’s actions.
• Negative– Chemical plant dumping waste into a lake.
• Positive– A firm installing shrubs and sculpture benefits
its neighbours
Marginal cost with and Externality
• Marginal Private Cost– The additional cost incurred when an additional
unit of output is produced.
• Marginal Social Cost– The full cost incurred by all of society in
producing another unit of output.– MCs=MCp+MCg
Welfare Effects of Pollution
Demand
MC p MC g
MC g
MCs = MCp + MC g
450
ps = 282
pc = 240
30
84
198
Qc = 105Qs = 84 2250
ec
e
A
B
F
C D
E
H
G
Q, Tons of paper per day
MC p
Pric
e of
pap
er,
p,$
per
ton
` Social Private Change
CS A A+B+C+D B+C+D
PSp B+C+F+G F+G+H H-B-C
Cg C+G C+D+E+G+H D+E+H
PSp-Cg B+F F-C-D-E -B-C-D-E
Cs+PSs A+B+F A+B+F-E -E=DWL
s
Emissions Standard
• Regulate pollution (or output) in order to achieve the social optimum.
• In the paper example constrain output to 84 units per day. Need to know:– Demand curve– Marginal social cost curve– Relationship between paper production and
pollution.
• Enforcement is costly.
Emissions Fee• Tax the pollution
that is produced.• Tax output
(assuming a fixed relationship with pollution)
• Either:– vary tax with
output (t(Q))
– fixed tax (t)Demand
MCp
MCg
MCs = MC p + t (Q)
MCp + t
t = 84
450
p s =
282
MC
p =
198
MC
g =
84
Qs = 84 2250
es
Q, Tons of paper per day
Pric
e o
f p
ap
er,
p,
$ p
er
ton
Cost benefit Analysis
• Compares the costs and benefits of a movement away from the market equilibrium.
• Costs:– Reduced output of paper– Consumer surplus reduced– Producer surplus reduced
• Benefits– Reduced costs of polution
CBA of polution
Cost: less paper
Benefit: less gunk
Maximumnetbenefit
84 631050
84105
G, Units of gunk per day
Q, Tons of paper per day
G, Units of gunk per day
Q, Tons of paper per day
(a) Cost and Benefit
(b) Marginal Cost and Marginal Benefit
4,000
2,000
105
84
0
MC
MB
Ben
efit,
Cos
t, $
Mar
gina
l ben
efit,
Mar
gina
l cos
t, $
Externality With Monopoly
DemandMR
MC p
MC g
MC s = MC p + MC g
450
330310
282
240
30
84 105 22570600
em
ec
es
et
A B CDP
rice
of p
aper
, p,
$ p
er t
on
Regulation of a Monopoly with an Externality
• It may be that the monopoly is preferable to competition if regulation is not possible.
• Charging a tax equal to the MC of pollution may reduce welfare if monopoly output is below social optimum.
• Achieving the social optimum may entail subsidisation of a monopoly.
Property rights
• An exclusive right to use an asset
• Private ownership of asset
• Right to be free of noise pollution– Courts could be used to enforce the right– You could sell the right to someone who wants
to be noisy.
• In many cases the rights are not assigned.
0 1 2
0
1
2
Coase Theorem: No property Rights
$0$0
$10$0
$15$0
$0$14
$10$10
$15$2
$0$15
$10$5
$15-$3
Chemical firm: tonnes dumped per day.
Boat firm: Boats rented per day
If property rights are with boat owner:
Minimum price per unit of pollution is $5
Maximum price is $10
If property rights are with chem. firm:
Minimum price per unit of pollution is $5
Maximum price is $7.50
0 1 2
0
1
2
$14$0
$0
$3$7
$1$14
$0
$3$17
$1$16
$0$15
$3$12
$1$11
Coase theorem: Property rights with boat firm
Chemical firm: tonnes dumped per day.
Boat firm: Boats rented per day
Pollution priced at $7 per tonne
0 1 2
0
1
2
$2$12
-$12
$16-$6
$15$0
$12
$16$4
$15$2
$12$3
$16-$1
$15-$3
Coase theorem: property rights with chemical firm
Chemical firm: tonnes dumped per day.
Boat firm: Boats rented per day
Pollution priced at $6 per tonne
Coase Therorem: Summary
• Assigning property rights results in the efficient outcome.
• Efficiency is achieved regardless of who has the property rights.
• The distribution of welfare in the efficient outcome is dependent on the initial allocation of property rights.
Common Property
• Unlike private property people cannot be excluded.
• When deciding how much to use, people ignore the impacts on others so the resource is overused.
• Common pool, water, gas, oil.• Internet• Roads• Fisheries
Public Goods
• Non-Excludability– People cannot be prevented from consuming a good.
• Non rivalry– The good is not used up when one person uses it.
Markets for public goods• Only exist for excludable goods.• Demand curve is the vertical summation of individual willingness-to-
pay or demand curves
Guards per hour
Supply, MC
25
18
13
10
87
32
5 7 940
ep es
D 1
D
D 2
Pric
e of
gua
rd s
ervi
ce,
$ pe
r ho
ur
Free riding
Voting for the provision of a public good