Public Goods and Externalities

What are the two categories of market failures?

Demand-side market failures

Supply-side market failures

When does a demand-side market failure occur?

When demand curves do not reflect consumers' full willingness to pay for a good or service

When does a supply-side market failure occur?

When supply curves do not reflect the full cost of producing a good or service

Why do demand-side market failures occur?

Because it is impossible in certain cases to charge consumers what they are willing to pay for a product

What is an example of a demand-side market failure?

Outdoors fireworks displays- people would be willing to pay to see it, but they don't have to because they are outdoors and in public

What is the result of a demand-side market failure?

It is hard for firms to raise enough revenue to cover producton costs

Why do supply-side market failures occur?

It is not possible for the market to correctly weigh costs and benefits in a situation in which some of the costs are completely unaccounted for

What is an example of a supply-side market failure?

Coal-burning power plant- firm pays for land, labor, and capital, but not for the costs that pollution has on people (global warming, toxins that affect wildlife, damage to agricultural crops)

What are the two conditions that must hold if a competitive market is to produce efficient outcomes?

1. Demand curve must reflect consumers' full willingness to pay

2. Supply curve must reflect all the costs of production

What is consumer surplus?

The benefit surplus received by a consumer or consumers in a market

Difference between the maximum price a consumer is willing to pay for a product and the actual price that they do pay

Why is there a collective utility surplus in nearly all markets?

Each consumer who buys the product only has to pay the equilibrium price, even though many of them would have been willing to pay more to obtain the product

The lower the price, the ______ the total quantity demanded as the price falls below the ________ of more and more consumres

Great

Maximum prices

Where is consumer surplus on a graph?

The area above equilibrium price and below the demand line

As prices increase, consumer surplus ________

Decreases

What is producer surplus?

The difference between the actual price a producer receives and the minimum acceptable price that a consumer would have to pay the producer to make a particular unit of output worthwhile

A producer's minimum acceptable price for a particular unit will equal that producer's ____________

Marginal cost

What is marginal cost?

The sum of the rent, wages, interest, and profit that the producer will need to pay to obtain land, labor, and capital

Where is producer surplus on a graph?

The area above the supply curve and below the equilibrium price

There is a ________ (positive or negative) relationship between equilibrium price and the amount of producer surplus?

Positive

Why is the equilibrium quantity the most allocatively efficient quantity?

Because marginal cost and marginal benefit are equal at that point

What are the three conditions that must exist simultaneously for allocative efficiency to occur at the market equilibrium quantity?

1. MB = MC

2. Maximum willingness to pay = minimum acceptable price

3. Total surplus (sum of consumer and producer surplus) is at a maximum

What are efficiency losses?

Reductions of combined consumer and producer surplus

What is deadweight loss?

The triangle between the actual quantity being produced and the equilibrium quantity

What two characteristics distinguish a private good from a public good?

Rivalry

Excludability

What is rivalry?

When one person buys and consumes a product, it is not available for another person to buy and consume

What is excludability?

Sellers can keep people who do not pay for a product from obtaining its benefits

What is nonrivalry?

One person's consumption of a good does not preclude the consumption of the good by others

What is nonexcludability?

There is no effective way of excluding individuals from the benefit of the good once it comes into existence

What are examples of private goods?

Automobiles

Clothing

Computers

Household appliances

Sporting goods

What are examples of public goods?

National defense

Street lighting

Environmental protection

What is the free-rider problem?

The willingness to pay of free riders is not expressed in the market, so demand is reduced from the viewpoint of producers

If all consumers freeride, demand collapses to zero

It is virtually impossible fro private firms to profitably produce public goods

Because of the freerider problem, what does society have to do if it wants a public good to be produced?

Direct government (or private philanthropy) to provide it

Why can the government provide a public good?

It can finance it through the taxation of other things, so does not have to worry about profitability

Why do private firms sometimes provide public goods?

When the production costs of the goods can be covered by the profits generated by closely related private goods

What is an example of this?

Private companies can make a profit providing broadcast TV (a public good) because they control who gets to air TV commercials (a private good)

How does society determine the optimal amount of a public good?

Surveys or public votes

Uses answers to compare the marginal benefit to marginal cost of providing it

How are willing-to-pay schedules for public goods different from that of private goods?

You don't add the quantities demanded at each possible price, but add the prices people are willing to pay at each quantity

What does economy in government mean?

Allocating resources between the private and public sectors and among public goods to achieve maximum net benefit

What are quasi-public goods?

Goods and services that could be produced and delivered in such a way that exclusion would be possible

What are examples of quasi-public goods?

Education

Streets and highways

Police and fire protection

Libraries and museums

Sewage disposal

Preventative medicine

Why does the government often provide quasi-public goods?

The benefit of these goods flow well beyond the benefit to individual buyers, so the goods would be underproduced by the market system

What do taxes do?

Reallocate resources from the production of private goods to the production of public and quasi-public goods

When does an externality occur?

When some of the costs or benefits of a good or service are passed onto or "spill over" onto someone other than the immediate buyer or seller

What type of failures do negative externalities cause?

Supply-side market failures

What type of failures do positive externalities cause?

Demand-side market failures

Why do negative externalities cause supply-side market failures?

Because producers do not take into account the costs that their negative externalities impose on others, so the supply curve shifts to the right

With negative externalities, resources are ______

Overallocated

Why do positive externalities cause demand-side market failures?

Demand curves fail to include the willingness to pay of the third parties who receive the external benefits caused by the positive externality, so the demand curve shifts to the left

With positive externalities, products are _____

Underproduced

What is an example of a positive externality?

Vaccinations- other people would pay more for the benefits they receive when one person is inoculated, but they cannot

How do governments use direct controls to counter negative externalities?

Pass legislation limiting the activities

What is an example of a direct control?

Clean Air Act of 1990, which forced factories to reduce emissions of toxic chemicals and use of CFCs

Direct controls _____ the marginal cost of production

Raise

What is the other approach the government can take to negative externalities?

To levy taxes or charges specifically on the related good

What is an example of specific taxes?

The government has placed an manufacturing excise tax on CFCs

What are the three ways that governments can correct underallocation of resources?

1. Buyer subsidies

2. Producer subsidies

3. Government provision

What is government provision?

Government provides the product for free for everyone

What is an example of government provision?

US government provided polio vaccine for free to all children

What are consumer subsidies?

Helping cover the costs of a product

What are producer subsidies?

Helping cover the costs to produce a product

What is an example of a consumer subsidy?

US government gives people money to buy plug-in electric cars

What is an example of a producer subsidy?

Agricultural subsidies

Why don't we eradicate all pollution?

Law of diminishing returns- cleaning up the second 10 percent of pollutants from a smokestack is more costly than the first 10 percent and so on

Marginal cost rises until it is equal to marginal benefit

When does optimal reduction of an externality occur?

When society's marginal cost and marginal benefit of reducing the externality are equal