Econ 101 M9

Page 1: Introduction to Microeconomics

Module 09: Market Failure – Externalities and Public Goods
- Overview of modules and key references: Curtis and Irvine, Greenlaw and Shapiro.
- Contents outlined, including key concepts and learning outcomes.
Learning Outcomes:
- Understand externalities and their classifications.
- Analyze the impact of externalities on market outcomes.
- Explore private and public solutions to externalities.
- Examine characteristics that categorize goods (rivalry and excludability).
- Discuss property rights and the Tragedy of the Commons.

Definition of Market Failure:
- Occurs when free market does not allocate resources efficiently, leading to situations that are not socially optimal.
- Emphasis on issues such as externalities and public goods that prevent market efficiency.
Externalities:
- Defined as the impact of the actions of one party on a third party.
- Types:
  - Positive externality (external benefit): Benefits received by third parties without payment.
  - Negative externality (external cost): Costs suffered by third parties without compensation.
- Explanation of how government involvement is necessary in cases of market failure due to externalities.

Positive Externality (External Benefit):
- Definition: Uncompensated benefits received by unrelated parties.
- Example: Individuals in a classroom getting flu shots benefit from herd immunity without paying.
- Agricultural example: Increased yield for canola farmers due to nearby beekeeping operations.
- Graph representation of supply curves reflecting social vs. private marginal cost, indicating efficient production levels.

Definition:
- Uncompensated costs experienced by third parties.
Examples include:
- Flu virus spreading in a class, impacting everyone's health without compensation.
- COVID-19 spread due to gatherings, impacting unconnected individuals.
- Environmental damage from production, such as pollution from Suncor Energy.
- Illustration of equilibrium price and quantity shifts due to social costs.

Negative Externalities:
- Over-production and under-pricing of goods created by the presence of external costs.
- Examples illustrated through supply curves depicting the difference between private and social supply.
Positive Externalities:
- Under-production and over-pricing of goods with external benefits.
- Graphical representation of how social demand differs from private demand.
- Core message: Markets fail to reach the desired equilibrium in both cases due to externalities.

Three Options to Address Externalities:
1. Private Solutions: Individual actions without government intervention.
  - Examples: Moral codes, social sanctions, charitable actions, Coase Theorem.
2. Public Solutions: Government regulation through command and control or market-based solutions.
  1. Command and control: Legislation controlling quantities or behaviors.
  2. Market-based: Mechanisms like taxes, subsidies, tradable permits.
3. Do Nothing: When externalities are minor, no intervention may be deemed necessary.

Pigovian Tax:
- Tax equal to external costs aimed to achieve socially optimal equilibrium.
- Discussion on how taxes affect market equilibrium, with potential repercussions on buyers and sellers.
Utilization of taxes in environmental contexts (e.g., carbon tax, pollution tax).

Subsidies:
- Financial support provided by the government to encourage behaviors that yield positive externalities.
- Example: Incentives for energy-efficient appliances that balance out market failures.

Classification of Goods:
- Rival vs. Non-Rival and Excludable vs. Non-Excludable.
- Four categories of goods: Private goods, Public goods, Common resources, Club goods.
Common Resources:
- Defined as rival but non-excludable; leads to potential over-exploitation (e.g., fishing).
- Tragedy of the Commons: Overuse of non-excludable resources due to lack of individual accountability.

Property Rights: Vital for resource management to curb over-exploitation and ensure sustainable use.
Public Goods: Non-rival and non-excludable; leads to free rider problems impacting both provision and maintenance.
- Example: National defense, parks, roads.
- Government facilitates public goods funding through taxes or public-private partnerships.

Coase Theorem:
- Examines bargaining between parties to resolve externalities efficiently when property rights are defined.
- Limitations in situations involving large numbers of affected parties.

Appendix A: Overview of the Coase Theorem and its implications.
Appendix B: Insights into public goods and economic perspectives on environmental resources and policies.

Key questions formulated to evaluate understanding of concepts discussed, including specific examples of externalities, public goods, classification of goods, and externality solutions.