Transcript Principles of Economics, Case and Fair,8e

Chapter
15
Externalities, Public Goods,
Imperfect Information,
and Social Choice
Prepared by:
Fernando & Yvonn Quijano
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
Externalities, Public Goods,
Imperfect Information,
and Social Choice
15
Chapter Outline
Externalities and Environmental Economics
Marginal Social Cost and Marginal-Cost
Pricing
Private Choices and External Effects
Internalizing Externalities
Public (Social) Goods
The Characteristics of Public Goods
Mixed Goods
Income Distribution as a Public Good?
Public Provision of Public Goods
Optimal Provision of Public Goods
Local Provision of Public Goods: Tiebout
Hypothesis
Imperfect Information
Adverse Selection: Asymmetric Information
Moral Hazard
Market Solutions
Government Solutions
Social Choice
The Voting Paradox
Government Inefficiency: Theory of Public
Choice
Rent-Seeking Revisited
Government and the Market
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
EXTERNALITIES, PUBLIC GOODS, IMPERFECT
INFORMATION, AND SOCIAL CHOICE
market failure Occurs when resources are
misallocated or allocated inefficiently.
The existence of externalities, public goods,
and imperfect information are examples of
market failure.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
EXTERNALITIES AND ENVIRONMENTAL
ECONOMICS
externality A cost or benefit resulting from
some activity or transaction that is imposed
or bestowed on parties outside the activity
or transaction. Sometimes called spillovers
or neighborhood effects.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
EXTERNALITIES AND ENVIRONMENTAL
ECONOMICS
MARGINAL SOCIAL COST AND MARGINAL-COST
PRICING
marginal social cost (MSC) The total cost
to society of producing an additional unit of
a good or service. MSC is equal to the sum
of the marginal costs of producing the
product and the correctly measured damage
costs involved in the process of production.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
EXTERNALITIES AND ENVIRONMENTAL
ECONOMICS
FIGURE 15.1 Profit-Maximizing Perfectly Competitive Firms Will Produce
Up to the Point That Price Equals Marginal Cost (P = MC)
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
EXTERNALITIES AND ENVIRONMENTAL
ECONOMICS
Acid Rain and the Clean Air Act
Acid rain is an excellent example of an externality
and of the issues and conflicts in dealing with
externalities.
The case of acid rain highlights the fact that
efficiency analysis ignores the distribution of gains
and losses. That is, to establish efficiency we need
only to demonstrate that the total value of the gains
exceeds the total value of the losses.
Other Externalities
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
EXTERNALITIES AND ENVIRONMENTAL
ECONOMICS
PRIVATE CHOICES AND EXTERNAL EFFECTS
FIGURE 15.2 Externalities in a College Dormitory
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
EXTERNALITIES AND ENVIRONMENTAL
ECONOMICS
marginal private cost (MPC) The amount
that a consumer pays to consume an
additional unit of a particular good.
marginal damage cost (MDC) The
additional harm done by increasing the level
of an externality-producing activity by one
unit. If producing product X pollutes the
water in a river, MDC is the additional cost
imposed by the added pollution that results
from increasing output by one unit of X per
period.
When economic decisions ignore external costs, whether those costs are borne by one
person or by society, those decisions are likely to be inefficient.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
EXTERNALITIES AND ENVIRONMENTAL
ECONOMICS
INTERNALIZING EXTERNALITIES
Five approaches have been taken to solving
the problem of externalities:
(1) government-imposed taxes and subsidies,
(2) private bargaining and negotiation,
(3) legal rules and procedures,
(4) sale or auctioning of rights to impose
externalities, and
(5) direct government regulation.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
EXTERNALITIES AND ENVIRONMENTAL
ECONOMICS
Taxes and Subsidies
FIGURE 15.3 Tax Imposed on a Firm Equal to Marginal Damage Cost
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Information, and Social Choice
EXTERNALITIES AND ENVIRONMENTAL
ECONOMICS
Bargaining and Negotiation
Coase theorem Under certain conditions,
when externalities are present, private
parties can arrive at the efficient solution
without government involvement.
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Information, and Social Choice
EXTERNALITIES AND ENVIRONMENTAL
ECONOMICS
Legal Rules and Procedures
injunction A court order forbidding the
continuation of behavior that leads to
damages.
liability rules Laws that require A to
compensate B for damages imposed.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
EXTERNALITIES AND ENVIRONMENTAL
ECONOMICS
Selling or Auctioning Pollution Rights
Singapore is known for its many
laws designed to reduce negative
externalities. Littering, chewing
gum in public, eating on a subway
car, failing to flush a toilet, and
vandalizing public property are all
considered serious offenses that
are punishable by imprisonment,
fines, and/or public chastisement.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
EXTERNALITIES AND ENVIRONMENTAL
ECONOMICS
Direct Regulation of Externalities
Taxes, subsidies, legal rules, and public auction
are all methods of indirect regulation designed
to induce firms and households to weigh the
social costs of their actions against their
benefits.
Direct regulation of externalities takes place at
the federal, state, and local level.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
PUBLIC (SOCIAL) GOODS
public goods (social or collective goods)
Goods that are nonrival in consumption
and/or their benefits are nonexcludable.
In an unregulated market economy with no government to see that they are produced,
public goods would at best be produced in insufficient quantity and at worst not produced
at all.
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Information, and Social Choice
PUBLIC (SOCIAL) GOODS
THE CHARACTERISTICS OF PUBLIC GOODS
nonrival in consumption A characteristic
of public goods: One person’s enjoyment of
the benefits of a public good does not
interfere with another’s consumption of it.
nonexcludable A characteristic of most
public goods: Once a good is produced,
no one can be excluded from enjoying its
benefits.
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Information, and Social Choice
PUBLIC (SOCIAL) GOODS
free-rider problem A problem intrinsic to
public goods: Because people can enjoy
the benefits of public goods whether they
pay for them or not, they are usually
unwilling to pay for them.
drop-in-the-bucket problem A problem
intrinsic to public goods: The good or
service is usually so costly that its provision
generally does not depend on whether or
not any single person pays.
Consumers acting in their own self-interest have no incentive to contribute voluntarily to the
production of public goods. Some will feel a moral responsibility or social pressure to
contribute, and those people indeed may do so. Nevertheless, the economic incentive is
missing, and most people do not find room in their budgets for many voluntary payments.
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Information, and Social Choice
PUBLIC (SOCIAL) GOODS
MIXED GOODS
mixed goods Goods that have
characteristics that are part public and part
private.
INCOME DISTRIBUTION AS A PUBLIC GOOD?
If we accept the idea that redistributing income generates a public good, private endeavors
may fail to do what we want them to do, and government involvement may be called for.
PUBLIC PROVISION OF PUBLIC GOODS
When members of society get together to form a
government, they do so to provide themselves with goods
and services that will not be provided if they act separately.
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Information, and Social Choice
PUBLIC (SOCIAL) GOODS
OPTIMAL PROVISION OF PUBLIC GOODS
Samuelson’s Theory
FIGURE 15.4 With Private Goods, Consumers Decide What Quantity to Buy;
Market Demand Is the Sum of Those Quantities at Each Price
The price mechanism forces people to reveal what they want, and it forces firms to produce
only what people are willing to pay for, but it works this way only because exclusion
is possible.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
PUBLIC (SOCIAL) GOODS
FIGURE 15.5 With Public Goods,
There Is Only One
Level of Output, and
Consumers Are
Willing to Pay
Different Amounts
for Each Level
For private goods, market demand is the
horizontal sum of individual demand
curves—we add the different quantities that
households consume (as measured on the
horizontal axis). For public goods, market
demand is the vertical sum of individual
demand curves—we add the different
amounts that households are willing to pay
to obtain each level of output (as measured
on the vertical axis).
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
PUBLIC (SOCIAL) GOODS
FIGURE 15.6 Optimal Production of a Public Good
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
PUBLIC (SOCIAL) GOODS
optimal level of provision for public
goods The level at which resources are
drawn from the production of other goods
and services only to the extent that people
want the public good and are willing to pay
for it. At this level, society’s willingness to
pay per unit is equal to the marginal cost of
producing the good.
At the optimal level, society’s total willingness to pay per unit is equal to the marginal cost of
producing the good.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
PUBLIC (SOCIAL) GOODS
The Problems of Optimal Provision
To produce the optimal amount of each public
good, the government must know something
that it cannot possibly know—everyone’s
preferences.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
PUBLIC (SOCIAL) GOODS
LOCAL PROVISION OF PUBLIC GOODS:
TIEBOUT HYPOTHESIS
Tiebout hypothesis An efficient mix of
public goods is produced when local
land/housing prices and taxes come to
reflect consumer preferences just as they
do in the market for private goods.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
IMPERFECT INFORMATION
ADVERSE SELECTION: ASYMMETRIC
INFORMATION
adverse selection Can occur when a
buyer or seller enters into an exchange
with another party who has more
information.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
IMPERFECT INFORMATION
MORAL HAZARD
moral hazard Arises when one party to
a contract passes the cost of its
behavior on to the other party to the
contract.
It is impossible to know everything about behavior and intentions. If a contract absolves one
party of the consequences of its action, and people act in their own self-interest, the result is
inefficient.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
IMPERFECT INFORMATION
MARKET SOLUTIONS
There is an efficient quantity of information
production.
Like consumers, profit-maximizing firms will gather information as long as the marginal
benefits from continued search are greater than the marginal costs.
GOVERNMENT SOLUTIONS
Information is essentially a public good and is
nonrival in consumption.
When information is very costly for individuals to
collect and disperse, it may be cheaper for
government to produce it once for everybody.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
SOCIAL CHOICE
social choice The problem of deciding
what society wants. The process of
adding up individual preferences to
make a choice for society as a whole.
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Information, and Social Choice
SOCIAL CHOICE
THE VOTING PARADOX
impossibility theorem A proposition
demonstrated by Kenneth Arrow
showing that no system of aggregating
individual preferences into social
decisions will always yield consistent,
nonarbitrary results.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
SOCIAL CHOICE
FIGURE 15.7 Preferences of Three Top University Officials
TABLE 15.1 Results of Voting on University’s Plans: The Voting Paradox
VOTES OF:
Vote
VP1
VP2
Dean
Result a
A versus B
B versus C
C versus A
A
B
A
B
B
C
A
C
C
A wins: A > B
B wins: B > C
C wins: C > A
aA
> B is read “A is preferred to B.”
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Information, and Social Choice
SOCIAL CHOICE
voting paradox A simple demonstration
of how majority-rule voting can lead to
seemingly contradictory and inconsistent
results. A commonly cited illustration of
the kind of inconsistency described in the
impossibility theorem.
logrolling Occurs when congressional
representatives trade votes, agreeing to
help each other get certain pieces of
legislation passed.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
SOCIAL CHOICE
GOVERNMENT INEFFICIENCY: THEORY OF
PUBLIC CHOICE
To understand the way government functions,
we need to look less at the preferences of
individual members of society and more at the
incentive structures that exist around public
officials.
RENT-SEEKING REVISITED
Theory may suggest that unregulated markets fail to produce an efficient allocation of
resources. This should not lead you to the conclusion that government involvement
necessarily leads to efficiency. There are reasons to believe that government attempts to
produce the right goods and services in the right quantities efficiently may fail.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
GOVERNMENT AND THE MARKET
GOVERNMENT INEFFICIENCY: THEORY OF
PUBLIC CHOICE
There is no question that government must be
involved in both the provision of public goods
and the control of externalities.
The question is not whether we need
government involvement. The question is how
much and what kind of government involvement
we should have.
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CHAPTER 15: Externalities, Public Goods, Imperfect
Information, and Social Choice
REVIEW TERMS AND CONCEPTS
adverse selection
Coase theorem
drop-in-the-bucket problem
externality
free-rider problem
impossibility theorem
injunction
liability rules
logrolling
marginal damage cost
(MDC)
marginal private cost (MPC)
marginal social cost (MSC)
market failure
mixed good
moral hazard
nonexcludable
nonrival in consumption
optimal level of provision for
public goods
public goods (social or
collective goods)
social choice
Tiebout hypothesis
voting paradox
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