Transcript Fourth Edition - Virginia Community College System

Chapter 13: Positive Externalities and
Public Goods
Externalities (Spillovers)
Externalities - the market fails to register fully costs and benefits.
• External costs:
• When the actions of an individual or group incur a
cost to 3rd party.
• External benefits:
• Present when the actions of an individual or group
generate benefits for 3rd parties.
External Benefit
• The demand curve understates the total value of
the output.
Price
S1
P2
Ideal price
and output
Actual price
and output
D2(including external benefits)
P1
D1
Q1 Q 2
Quantity/time
• From the viewpoint of efficiency, too few units may
be produced.
The Effect of Externalities
Private cost The cost borne by the producer of a
good or service.
Social cost The total cost of producing a good or
service, including both the private cost and any
external cost.
Private benefit The benefit received by the
consumer of a good or service.
Social benefit The total benefit from consuming a
good or service, including both the private benefit
and any external benefit.
The Positive Externalities of New Technology
If a firm builds a factory or buys a piece of
equipment, the firm receives all the economic
benefits that result from the investments.
When a firm invests in new technology, the private
benefits, or profits, that the firm receives are only a
portion of the overall social benefits.
The social benefits of an innovation take into
account the value of all the positive externalities of
the new idea or product, whether enjoyed by other
companies or society as a whole, as well as the
private benefits received by the firm that developed
the new technology.
The Clean Air Act: How a Government Policy
Reduced Infant Mortality
The benefit of reducing air pollution in 1970 was much higher
than the benefit from a proportional reduction in air pollution
would be today, when the level of pollution is much lower.
In the two years following passage of the Clean Air Act, there
was a sharp reduction in air pollution and also a reduction in
infant mortality.
Technological breakthroughs of the 2000s:
• GPS (2000)
• Toyota Prius (2000)
• AT&T texting (2000)
• Wikipedia (2001)
• Napster (2001)
• Friendster (2003)
• Human Genome (2003)
• Search engines (2003)
• Nintendo Wii (2006)
• Apple iPhone (2007)
private firms in a market economy under
invest in research and technology
Rate of Return
D Private (million $)
D Social (million $)
2%
$72
$84
4%
$52
$72
6%
$38
$62
8%
$30
$52
10%
$26
$44
Why Invest in Human Capital?
1. private rate of return
-the estimated returns to education going to the
individual worker.
2. social rate of return
-the estimated returns to education going to
society from a better educated workforce.
Median Full-Time
Earnings (over 25)
Less than High
School
High School Degree,
no College
Bachelor’s
Degree
$479
$659
$1,174
When There Is a Positive Externality, a
Subsidy Can Bring About the Efficient Level
of Output
People who do not
consume college
educations can benefit
from them.
As a result, the social
benefit from a college
education is greater
than the private
benefit to college
students.
If the government pays
a subsidy equal to the
external benefit,
students will internalize
the externality.
When There Is a Positive Externality, a
Subsidy Can Bring About the Efficient Level
of Output
The subsidy will cause
the demand curve to shift
up, from D1 to D2.
As a result, the market
equilibrium quantity will
shift from QMarket, where
an inefficiently low level of
college educations is supplied,
to QEfficient, the economically efficient equilibrium quantity.
Producers receive the price PEfficient, while consumers pay a price P,
which is equal to PEfficient minus the amount of the subsidy.
How Governments Can Encourage Innovation
1. Intellectual property rights
a. guaranteeing the innovator an exclusive right to
that new product or process
b. include
1) patents - giving the inventor the exclusive
legal right to make, use, or sell the invention for
a limited time.
2) copyright laws - giving the author an
exclusive legal right over works of literature,
music, film/video, and pictures.
Patents Filed and Granted, 1981–2008
2. Government Spending on Research and
Development
Sources of R & D
Funding
Amount ($
billions)
Percent of Total
Federal
Government
$103.7
26.08%
Industry
$267.8
67.35%
Universities and
Colleges
$10.6
2.67%
Non-profits
$12
3.02%
Non-federal
government
$3.5
.88%
$397.67
100%
Total
U.S. Research and Development Expenditures, 2008
3. Tax Breaks for Research and Development
- giving firms a reduction in taxes depending on
how much research and development they do.
- referred to as the research and experimentation
(R&E) tax credit.
4. Cooperative Research
- State and federal governments support research
in a variety of ways
-
National Institutes of Health
National Academy of Scientists
National Academy of Engineers,
The Agriculture and Food Research Initiative
(AFRI) at USDA
The Public Goods Problem
Private remedies to environmental
degradation (eg law suits) run into what
economists call the public goods problem
Public goods are goods enjoyed in common
– non-rivalrous (e.g. the warning service
provided by a lighthouse)
Another characteristic of public goods is
that they are “non-excludable”
Rivalry The situation that occurs when one
person’s consuming a unit of a good means no one
else can consume it.
Excludability The situation in which anyone who
does not pay for a good cannot consume it.
1. Which of the following goods or services are
non-excludable? Yes No
a. police protection
b. streaming music from satellite transmission
programs
c. Roads
d. primary education
e. cellphone service
2. Are the following goods non-rivalrous in
consumption? Yes No
a. slice of pizza
b. laptop computer
c. public radio
d. Ice cream cone
Four Categories of Goods
Goods and services can be
divided into four categories
on the basis of whether
people can be excluded
from consuming them and
whether they are rival in
consumption.d or service is
rival in consumption if one
person consuming a unit of
a good means that another
person cannot consume that
1.unit.
Private good. A
good that is both rival and excludable.
2. Public good. A good that is both nonrival and
nonexcludable.
Free riding Benefiting from a good without paying for it.
3. Quasi-public goods. Goods that are excludable but not
rival.
4. Common resource. A good that is rival but not
excludable.
Which of the four categories for these?
(a)TV broadcast
(b) home mail delivery
(c) education in a public school
(d) education in a private school
(e) hiking in a park surrounded by a fence
(f) hiking in a park without a fence
(g) an apple.
The four categories:
1. Private goods are goods that are
both rival and excludable.
(b) home mail delivery (you’ll be
excluded if you don’t use a stamp),
(d) education in a private school,
(g) an apple.
2. Public goods are goods that are both
nonrival and nonexcludable :
TV broadcast
(f)hiking in a park without a fence
Also
National defense
Free riding is benefiting from a good
without paying for it.
3. Quasi-public goods are goods that are
excludable but not rival :
(e)Hiking in a park surrounded by a fence
also
Tennis courts
4. Common resource is a good that is rival but
not excludable:
(c)Education in a public school—at least for people
within the school district who won’t be excluded.
It is rival because as more students crowd into a
classroom, the amount of attention the teacher
gives to each student declines.
In cases where it isn’t rival, it would be a public
good for those who are eligible.
Public Goods Problems for the
Free Market
Public goods pose a problem to the free
market for two reasons:
Free riding: people benefit from public goods (like
law suits) regardless of whether or not they
pay for them.
High Transaction Costs: public goods provision
require groups of people to undertake action.
In addition, information about environmental
damages is costly for groups to obtain. These
features add extra “transactions costs”.
Tragedy of the commons The tendency for a
common resource to be overused.
For a common resource
such as wood from a
forest, the efficient
level of use, QEfficient,
is determined by the
intersection of the
demand curve—which
represents the
marginal benefit
received by
consumers—and S2,
which represents the
marginal social cost of
cutting the wood.
Tragedy of the commons The tendency for a
common resource to be overused.
Because each individual
tree cutter ignores the
external cost, the
equilibrium quantity of
wood cut is QActual,
which is greater than
the efficient quantity.
At the equilibrium level of output, there is a
deadweight loss, as shown by the yellow triangle.
Is There a Way Out of the
Tragedy of the Commons?
1. With small area and small number of people
involved, access to the commons can be
restricted through community norms and laws.
2. If the area or the number of people involved
is large, legal restrictions through taxes,
quotas, and tradable permits on access to the
commons are required.
1. Identify the following situations as an example of a
negative or a positive externality:
a. You are a birder (bird watcher), and your
neighbor has put up several birdhouses in the yard
as well as planting trees and flowers that attract
birds.
b. Your neighbor paints his house a hideous color.
c. Investments in private education raise your
country’s standard of living.
d. Trash dumped upstream flows downstream right
past your home.
e. Your roommate is a smoker, but you are a
nonsmoker.
2. Identify whether the market supply curve will shift
right or left or will stay the same for the following:
a. Firms in an industry are required to pay a fine for
their emissions of carbon dioxide.
b. Companies are sued for polluting the water in a
river.
c. Power plants in a specific city are not required to
address the impact of their emissions on the quality
of air.
d. Companies that use fracking to remove oil and
gas from rock are required to clean up the damage.
1) An externality is
A) a benefit realized by the purchaser of a good or service.
B) a cost paid for by the producer of a good or service.
C) a benefit or cost experienced by someone who is not a producer or consumer of
a good or service.
D) anything that is external or not relevant to the production of a good or service.
2) What is a market failure?
A) It refers to the inability of the market to allocate resources efficiently up to
the point where marginal social benefit equals marginal social cost.
B) It refers to the inability of the market to allocate resources efficiently up to
the point where marginal social benefit equals marginal private cost.
C) It refers to a situation where an entire sector of the economy (for example,
the airline industry) collapses because of some unforeseen event.
D) It refers to a breakdown in a market economy because of widespread
corruption in government.
3) If you burn your trash in the back yard in spite of regulations against it, then
you are
A) acting economically irrationally and creating a social cost.
B) avoiding the private costs associated with disposing your trash some other way
and creating a social cost.
C) acting rationally and creating a positive externality.
D) saving landfill space and creating a social benefit.
4) Because producers do not bear the external cost of pollution
A) the economically efficient level of production is achieved.
B) private production is below the economically efficient level.
C) private production exceeds the economically efficient level.
D) the market price is too high.
5) If there is pollution in producing a product, then the market equilibrium price
A) is too high and equilibrium quantity is too low.
B) and equilibrium quantity are too low.
C) and equilibrium quantity are too high.
D) is too low and equilibrium quantity is too high.
6) What does the phrase "internalizing an external cost" mean?
A) limiting the extent to which domestic firms can outsource production
B) prohibiting economic activities that create externalities
C) forcing producers to factor into their production costs the cost of the
externalities created in the production of their output
D) finding a way to address cross-border pollution
7) What is the rationale behind a marketable emission allowance scheme?
A) to create of a market for externalities: the scheme brings together buyers and
sellers of marketable permits
B) to discipline polluting firms by specifying the maximum amount of emissions
allowed and giving them permits to pollute up to their allowance
C) to raise revenue for the government through the sale of emission permits and
at the same time set an emissions target
D) to provide firms with the incentive to consider less costly alternatives to
pollution reduction by making firms pay for the right to pollute beyond their
specified allowance
8) Which of the following displays these two characteristics: non-rivalry and nonexcludability in consumption?
A) public goods
B) private goods
C) quasi-public goods
D) common resources
9) Anyone can purchase sulfur dioxide emissions allowances on the Chicago
Mercantile Exchange. Several environmental groups have raised money to buy
allowances (which they subsequently destroy). As part of their fund-raising, these
groups have urged contributors to buy the allowances as gifts. As one newspaper
story put it, "For the environmentalist in your life, here's a gift that is sold by the
ton, fits in an envelope and will last forever."
Source for quote: Randall Edwards, "Dear Santa: Please Bring Me Sulfur Dioxide
for Christmas," Columbus Dispatch, December 19, 1999.
What would be the impact on the price of the emission allowances in the market?
A) The price rises.
B) The price falls to zero.
C) The price falls but not to zero.
D) The price remains unchanged because the allowances purchased by the
environmental groups are destroyed.
10) In economics, the term "free rider" refers to
A) a person who evades taxes.
B) a supervisor who delegates menial time-consuming activities to others.
C) one who volunteers her services.
D) one who waits for others to produce a good and then enjoys its benefits
without paying for it.