Public Policy Study Guide Flashcards

Types of Policies to Improve Market Outcomes in Presence of Externalities

• Direct regulation (Command and control):

  • Government-imposed standards, targets, process requirements, or outright bans on activities causing externalities.

  • Example: air pollution regulations

• Financial incentives (tax and cap & trade):

  • Create incentives to induce people and companies to change their behavior

  • Examples: tax on cigarettes, putting a price on pollution, subsidizing renewable energy, subsidizing the purchase of electric cars

• Coasian bargaining:

  • Assign property rights to particular agents and allow bargaining, thereby creating a market in which property rights can be allocated to the highest used values.

  • Examples: LAX buying houses around LAX, Dupont buying houses on contaminated land, Dodgers and LA buying up houses on Chavez Ravine in 1950s

Identifying Efficiency in the Presence of Externalities

• Marginal social costs and benefits:

  • Represents the total benefit to society from consuming one additional unit of good or service, including both private and external benefits.

• Marginal social cost:

  • Represents the total cost to society from producing one additional unit, including both private and external costs.

• Marginal private costs and benefits:

  • Additional costs and benefits incurred by a firm or consumer when producing or consuming one more unit of a good or service.

• Marginal external costs and benefits:

  • Additional costs or benefits to society, beyond those born by the producer or consumer, that arise from the production or consumption of a good or service.

• Efficiency:

  • When markets fail, some intervention (government) is warranted, leading to increased efficiency.

Market Failure and Externalities

• Markets usually fail when it comes to externalities.

  • Leads to ineffective outcomes for society

  • When markets fail, some government intervention warranted leads to increase in efficiency

Examples of Negative Externalities

• Driving and Traffic Congestion:

  • Private costs: gas, own time, wear/tear on car, risk of accident to self.

  • External costs: adding time to other peoples’ commute.

  • Result: too much traffic

  • Policy to implement: congestion pricing

• Disease Transmission:

  • Private benefit of getting inoculated

  • External benefits to those around you that you don’t consider

  • Free-rider problem: others may decide not to get inoculated if they know you are

  • Result: too few vaccinations

• Pollution:

  • Companies consider private costs but not external costs of pollution on the community

  • Result: too much pollution

• Impact of presence of negative externalities on overproduction of good and too low a price of good that doesn’t capture full social costs (similarly for positive externalities that have the opposite effect on production and prices).

Internalizing the Externality

• Definition: Accounting for all social costs in the price of a good or service.

• Importance: If the tax equals cost per unit of output then all social costs are accounted for

• Social costs = Private costs + external costs

Market Failure from Negative Externality

• Social costs = private costs + external costs

• Firms ignore external costs, so the price consumers pay does not cover all costs of production

Consequences of Market Failure

• Price to consumers is lower than full costs of production; too much is produced.

Law of Demand

• The law of demand explains the relationship between the price of a product and the quantity demanded (or consumed) by consumers.

• States: "As the price of a product increases, the quantity demanded decreases, and as the price decreases, the quantity demanded increases, all else being equal."

• Key Points:

  • Inverse Relationship: Price ↑ → Quantity Demanded ↓, and Price ↓ → Quantity Demanded ↑.

  • "Ceteris Paribus" Assumption: The law assumes that all other factors (like income, tastes, and prices of other goods) remain constant.

• Why this happens:

  1. Substitution Effect: When the price of a product rises, consumers may switch to cheaper substitutes.

  2. Income Effect: A higher price reduces the consumer’s purchasing power, leading to less consumption.

Pigouvian Taxes

• Definition: Pollution taxes that increase private costs to reflect social costs.

• Named after Arthur Pigou, an early 20th-century economist

• Designed not to raise revenue but rather to change behavior

  • Also, A subsidy to encourage activity with positive externalities is a negative Pigouvian tax

Numerical Example of Pigouvian Tax

• Consider the private costs and external costs of producing energy from Coal

  • Private cost of generating electricity from coal: 10 cents per kilowatt-hour

  • External costs:

  • Human health cost power plant emissions: 5 cents per kilowatt-hour

  • Climate cost: 1 cent per kilowatt-hour

  • If clean energy power produces were subsidized by 6 cents per kwh

Inflation Reduction Act (IRA)

• U.S. law passed by Congress in 2022 with goals of:

  • Reducing the federal budget deficit

  • Lowering prescription drug prices

  • Investing in domestic energy production and clean energy, focusing on climate change

• Examples of IRA incentives:

  • Rebates for home energy

  • Tax credits to businesses that invest in clean energy production

  • Funding for communities to improve resilience to climate change

Cap and Trade

• Definition: A market-based system used to reduce pollution by setting a limit on total emissions and allowing companies to buy and sell permits to emit a certain amount.

• Example: California limits CO_2 emissions by stationary sources (manufacturing plants, oil refineries).

  • Each year, emitters must turn in one permit for each ton of CO_2 they emit.

  • The number of permits in circulation in California "caps" CO_2 emissions.

  • Emitters with too many permits can "trade" with emitters who have too few permits.

  • California facilitates a market for permits.

Auctioning Permits vs. Free Allocation

• Auctioning Permits:

  • Definition: Companies must buy permits in an open bidding process.

  • Revenue: The government earns revenue, which can be used for public projects or to offset other taxes.

  • Fairness: All firms compete equally, based on how much they're willing to pay.

  • Incentive: Stronger incentive for firms to reduce emissions (so they buy fewer permits).

• Free Allocation (Giving Away Permits):

  • Definition: The government distributes permits for free, often based on past emissions or industry lobbying.

  • Revenue: No direct revenue for the government.

  • Fairness: May favor certain industries or large polluters.

  • Incentive: Weaker incentive to reduce emissions compared to auctions.

• Selling the permit makes sense if the market price is greater than the cost of C0_2 abatement (reduction in emissions).

• Keep the permit and emit - only makes sense if the cost of abatement is greater than the market price of the permit.

Advantages and Disadvantages of Market-Based Approaches

• Advantages:

  • Allows companies to be their own best judge of whether they are better off emitting or abating.

  • Overall policy objective is met by the number of permits given out.

  • By allowing companies to pursue what is best for them (abate or pollute), the social cost of meeting policy objective is done at least cost.

• Disadvantages:

  • Some people are morally opposed to allowing companies to pay to pollute.

  • No obligation of any polluting firm to reduce pollution.

  • However, unless we want zero pollution, some firms will pollute. Why not let the firms who have the most difficulty in reducing pollution (they have the highest cost of abatement) be the ones who pollute?

Coase and Common Access Resources and Property Rights

• The problem with common access resources is that nobody owns (or everyone has access to them) so nobody has an incentive to maintain their productivity

• Ronald Coase was a British economist and author.

• Wrote in 1950’s and 1960’s when the environmental movement was gaining strength.

• He wondered whether every externality demanded government action.

• When the social benefit of ending pollution is greater than the social benefit of polluting, pollution will end.

• When the social benefit of ending pollution is less than the social benefit of polluting, pollution will continue

• Coase believes we simply need to live with negative externalities when the social benefit is much higher than benefit from elimination.

• Also believes society is better off controlling negative externalities.

Limitations to Coasian Bargaining

• A Coasian Bargain Strengthen property rights and then let affected parties bargain

  • Give company the right to pollute and then allow impacted parties to pay polluters not to pollute

  • If damage caused by pollution < benefit of being able to pollute then pollution will occur

  • If the cost of pollution > benefit of polluting then pollution will not occur

  • Or, give the downstream users the right to clean water, and then see if they want to sell the right.

• Limitations of Coasian Bargains:

  • Costs of organizing people damaged by pollution could be too high for a bargain to be made.

  • Costs rise with the number of people, size of the impacted area, and degree of uncertainty about costs of pollution.

  • If “transaction costs” of making the deal are too high, then it is not worth making the deal. In these cases – high transactions costs with bargaining and/or organizing – Coase breaks down/fails to achieve an efficient solution.

Policy Tools for the Provision of Public Goods

• Direct provision by the public sector is most effective.

• Voluntary contributions to non-profit organizations.

• Public safety, national defense, public health.

Policy Tools to Combat Inequality

• Public education.

• Family income support.

• Healthcare provision.

• Universal income.

Importance of Evidence in Informing Policy

• The legislature and most state agencies have little scientific expertise.

• Must rely on outside sources for information.

• Plastic bag example

  • It was a decade ago when California became the first state in the nation to ban single-use plastic bags, ushering in a wave of anti-plastic legislation from coast to coast.

  • According to a report by the consumer advocacy group CALPIRG, 157,385 tons of plastic bag waste was discarded in California the year the law was passed.

  • By 2022, however, the tonnage of discarded plastic bags had skyrocketed to 231,072 — a 47% jump.

Good and Bad Lobbying

• Good lobbying:

  • Source of information/data for staff and representatives.

  • Data and analysis often generated by special interest groups conducting or funding studies.

• Bad lobbying:

  • The data analysis problems provided by special interest groups tend to be in favor of their preferred policies.

  • lobbyists try to mold public opinion to fit their preferred narrative

• Exxonmobil example

Special Interest Groups and Credibility

• Need to look up the data cited by special interest groups.

• Are they credible?

• Is the analysis tainted by bias?

Discussion of Milton Friedman and Government Power

• Habeas corpus - has been suspended in the past, can only be suspended by congress due to rebellion or invasion

• Separation of powers -is a fundamental principle of governance where the functions of government are divided among separate and independent branches. This division of power, typically between the legislative, executive, and judicial branches, aims to prevent any one branch from becoming too dominant or tyrannical.

• Article 1 of constitution - establishes the legislative branch of the federal government — the Congress. It outlines the structure, powers, and responsibilities of the legislative branch.

• Kristi Noem, Homeland Security- in charge of ICE, Immigration control, former governor of South Dakota

Coercion

• Walmart should stop blaming tariffs as the reason for raising prices throughout the chain

Lower Costs of Information (and Misinformation) on Social Media

• Much lower cost of disseminating mis-information, traditional role of media as a gatekeeper gone.

• Alternative facts – Kellyanne Conway

  • People are entitled to their own opinion but not to their own facts, fact is fact. But now it is seemingly OK to come up with alternative facts and reality.

Nichols article and misinformation

• Experts know the science, data, and causality of things.

• Citizens know their own priorities

• Good policy is made by having conversations between citizens regarding what they want and experts regarding what is possible and how to get what citizens want

• Citizens today “…want to weigh in and have their opinions treated with deep respect and their preferences honored not on the strength of their arguments or on the evidence they present but based on their feelings, their emotions, and whatever stray information they may have picked up here or there along the way.”

Correlation vs. Causation

• Correlation means that two phenomena seem to be related

  • Computer note takers have higher test scores

• Causality means that one phenomena causes another

  • Taking notes with computers increases test scores

• You can have correlation without causation

• Some other causal phenomenon might cause the correlation

• Might need to account for a “left-out” factor

Objectives of Policy Solutions

• What are we trying to achieve?

  • More economic growth or improved distribution of income/wealth

Justification for Proposed Policy

• Negative externality

• Lack of competition

• Underprovided public good

• Lack of equity in outcomes

Evaluation Criteria for Policy Solutions

• Efficiency: Do benefits exceed the costs? Are we using resources wisely or wasting them?

• Equity: Are the outcomes fair?

  • Does the distribution of income improve?

  • Do benefits accrue only to wealthy?

• Political feasibility: Can decision-makers support the proposed actions?

Determining Causation vs Correlation

• Randomized Control Trials (RCTs) and role in identifying causation vs correlation

• Experiments to determine if a “treatment” works require that the treated group and the untreated group are identical except for one group receiving the treatment.

• Any difference in outcome can then be attributed to the treatment.

• Social experiments apply medical experiment methods to social science

Randomized Control Trials

• Ceteris paribus - everything else being equal.

Early Childhood Education Programs

• Challenge: Break cycle of poverty – children who grow up in disadvantaged socioeconomic background are more likely to remain trapped in poverty as adults (even after accounting for differences in ability).

  • more likely to be unemployed or underemployed, engage in crime, suffer chronic health problems.

• Early childhood intervention offers some hope to break cycle.

Approach to Benefit Cost Analysis

• Net benefits = benefits minus cost

  • Measures the level of wealth created from projects

• Benefit-cost ratio (benefits divide by costs)

  • Measures the level of benefits per dollar of cost

Steps for Benefit-Cost Analysis

1. Identify the problem.

2. Identify the alternatives.

3. Evaluate the alternatives.

Highway Example

• Identify the problem:

  • Current commute times too long, current highways unsafe.

• Identify the alternatives (two alternatives/options):

  • Construct new 4-lane highway.

  • Construct new 8-lane highway.

• Evaluate the alternatives

  • Net Benefits - benefits minus cost

  • Benefit Cost Ratio - measures the level of benefits per dollar of cost

Let's break down marginal social costs and benefits, and how they relate to private and external costs and benefits:

• Marginal Social Benefit (MSB): This is the total benefit society receives from one additional unit of a good or service. It includes both the private benefit to the consumer and any external benefits to others.

  • Imagine someone gets a flu shot. The private benefit is that they are less likely to get the flu. The external benefit is that they are less likely to spread the flu to others. The MSB is the sum of these benefits to society.

• Marginal Social Cost (MSC): This is the total cost to society from producing one additional unit of a good or service. It includes both the private cost to the producer and any external costs to others.

  • Think about a factory producing steel. The private cost is the cost of resources like iron ore, labor, and energy. The external cost could be the pollution emitted, which affects the health of nearby residents. The MSC is the sum of these costs to society.

• Marginal Private Benefit (MPB): The benefit that a consumer directly receives from consuming one more unit of a good or service. This doesn't include any benefits to third parties.

  • For example, the satisfaction you get from eating a slice of pizza is your private benefit.

• Marginal Private Cost (MPC): The cost that a producer directly incurs from producing one more unit of a good or service. This doesn't include any costs imposed on third parties.

  • For a bakery, the cost of flour, sugar, and labor to bake one more cake is the private cost.

• Marginal External Benefit (MEB): The benefit to society, beyond the consumer, from the consumption of a good or service.

  • When you maintain a beautiful garden, your neighbors enjoy the view. That's an external benefit.

• Marginal External Cost (MEC): The cost to society, beyond the producer, from the production of a good or service.

  • A noisy construction project disrupts the peace of the neighborhood. That's an external cost.

Let's break down marginal social costs and benefits, and how they relate to private and external costs and benefits:

• Marginal Social Benefit (MSB): This is the total benefit society receives from one additional unit of a good or service. It includes both the private benefit to the consumer and any external benefits to others.

  • Imagine someone gets a flu shot. The private benefit is that they are less likely to get the flu. The external benefit is that they are less likely to spread the flu to others. The MSB is the sum of these benefits to society.

• Marginal Social Cost (MSC): This is the total cost to society from producing one additional unit of a good or service. It includes both the private cost to the producer and any external costs to others.

  • Think about a factory producing steel. The private cost is the cost of resources like iron ore, labor, and energy. The external cost could be the pollution emitted, which affects the health of nearby residents. The MSC is the sum of these costs to society.

• Marginal Private Benefit (MPB): The benefit that a consumer directly receives from consuming one more unit of a good or service. This doesn't include any benefits to third parties.

  • For example, the satisfaction you get from eating a slice of pizza is your private benefit.

• Marginal Private Cost (MPC): The cost that a producer directly incurs from producing one more unit of a good or service. This doesn't include any costs imposed on third parties.

  • For a bakery, the cost of flour, sugar, and labor to bake one more cake is the private cost.

• Marginal External Benefit (MEB): The benefit to society, beyond the consumer, from the consumption of a good or service.

  • When you maintain a beautiful garden, your neighbors enjoy the view. That's an external benefit.

• Marginal External Cost (MEC): The cost to society, beyond the producer, from the production of a good or service.

  • A noisy construction project disrupts the peace of the neighborhood. That's an external cost.