AU 26 Microeconomics 2001.01 Chapter 9: Externalities and Public Goods

What are the important cases in which free markets fail to maximize social surplus?

• externalities

• public goods

• common pool resources

What plays a role in improving market outcomes when they fail to maximize social surplus? (solutions)

• government intervention

• private solutions

externality

spill over benefit/cost that comes from some type of economic activity

negative externality

an economic activity that has a negative spillover effect

• free markets produce and cosumes too much

postive externality

an economic activity that has a positive spillover effect

• Free markets produce and consume too little

pecuniary externaility

when a market exchange affects other people through market prices

coase theorem

state that private bargaining will result in an efficient allocation of resources

End Result: government intervention is not necessary to solve externality problems, private bargaining does the job instead

private bargaining

negotiations between private individuals or organizations to resolve disputes, allocate resources, or internalize externalities without government intervention

Why can we not rely too much on private solutions for externalities?

• transaction costs can be too high

• property right may not be clearly defined

• too many agents at the bargaining table

How does the government responf to exteralities? (2)

• command and control policies

• market based policies

command and control policies

government directly regulates the allocation of resources

market based policies

the government provides incentives for private organizations to internalize the externality

Pigouvian Tax

the tax necessary to incentivize to producer the social optimal level of output

• adresses negative externalities by penalizing the producer of the externality so they can interalize the MEC (making them pay for their actions)

Pigouvian Subsidy

subsidy necessary to make and economic agent increase consumption to the socially optimal level

• adesses postive externalities by encouraging consumers to increase demand to elimainate the externality

Rival Good

goods that only one person can consume at a time

nonrival goods

goods than more than one person at a time can consume

excludable goods

must be paid for in order to consume them

non excludable goods

can be consumed, even if they are not paid for

Excludability High/Rivalry High

ordinary private goods

(clothes, food, furniture)

Excludability High/Rivalry Low

club goods

(cable TV, Wifi, music downloads)

Excludability Low/Rivalry High

common pool resource goods

(fish, water, natural forests)

Excludability Low/Rivalry Low

public goods

(national defense, early warning systems, earth protection programs)

free rider problem

when an individual does not pay for a good because it is non excludable

free rider problem (solution)

the government makes paying for it mandatory

Marginal External Cost

unplanned spillover cost that the buyer or seller did not pay for

Marginal Private Cost

the extra cost a producer or consumer pays to make or consume one more unit of a good or service, excluding any costs or benefits affecting third parties

Marginal Social Cost

the total cost to society of producing or consuming one additional unit of a good or service

Marginal Private Benefit

• same as demand

the extra satisfaction, utility, or revenue an individual consumer or firm gains from consuming or producing one additional unit of a good or service

Marginal Social Benefit

the total benefit that society gains from producing or consuming one additional unit of a good or service

private provision of public goods

takes pace when private citizens make contribution to the production or maintenance of a public good

What’s wrong with charity?

• money may not go to the areas of most cirtical need

• too variable

• when economy is in downturn (needed the most), giving decreases

tragedy of the commons

when common pool resources are overused

tragedy of the commons (solutions)

• private ownership (defined by the governement)

• government regulation (limits on fishing)

• tax on use