Principles of Microeconomics: Externalities, Public Goods, and Common Resources PDF Fall 2024

Principles of Microeconomics: Externalities, Public Goods, and Common Resources Shuo Xu Fall 2024 Market Failure and Externalities I Market failure occurs when free markets fail to allocate resources efficiently. I Causes of market failure incl...

Principles of Microeconomics: Externalities, Public Goods, and Common Resources Shuo Xu Fall 2024 Market Failure and Externalities I Market failure occurs when free markets fail to allocate resources efficiently. I Causes of market failure include: I Externalities I Public Goods I Market Power I Asymmetric Information I Focus of Chapters 10 and 11: Externalities, Public Goods, and Common Resources. What is an Externality? I Definition: An externality is the uncompensated impact of one person’s actions on the well-being of a bystander. I Types of Externalities: I Negative Externality: Causes harm (e.g., pollution). I Positive Externality: Provides benefits (e.g., education). I Externalities lead to inefficient market outcomes. Welfare Economics and Market Efficiency I Welfare economics examines how resource allocation affects economic well-being. I Market efficiency is achieved when marginal benefit equals marginal cost. I Externalities disrupt this balance, leading to inefficiency. Negative Externalities I Definition: A negative externality occurs when an individual or firm imposes an unaccounted cost on others. I Examples: I Air pollution from factories I Second-hand smoke from cigarettes I Noise pollution from construction I Result: Overproduction and lower prices than socially optimal. Graph of Negative Externalities I The social cost includes both private cost and external cost. I Socially optimal quantity is less than the market equilibrium quantity. Supply (Social Cost) Price Supply (Private Cost) Demand Quantity Positive Externalities I Definition: A positive externality occurs when an individual or firm’s actions provide benefits to others. I Examples: I Vaccinations I Education I Research and development I Result: Underproduction and lower prices than socially optimal. Graph of Positive Externalities I Social benefit includes both private benefit and the external benefit. I Socially optimal quantity is greater than the market equilibrium quantity. Price Supply Demand (Social Benefit) Demand (Private Benefit) Quantity Public Policies to Address Negative Externalities I Command-and-Control Policies: I Direct government regulation (e.g., emission limits). I Market-Based Policies: I Corrective (Pigovian) taxes I Tradable pollution permits Corrective Taxes (Pigovian Taxes) I A corrective tax equal to the external cost can internalize a negative externality. I Example: A carbon tax on fossil fuel emissions. I Benefits: Reduces pollution to a socially optimal level, raises government revenue. Tradable Pollution Permits I Permits are issued allowing a set amount of pollution. I Firms can buy and sell permits in a market. I Encourages firms to reduce emissions if cheaper than buying permits. Public Policies for Positive Externalities I Subsidies: I Financial support for activities with positive externalities. I Examples: Grants for education, tax breaks for R&D. The Coase Theorem I Statement: If a property right is well-defined and transactions costs are low, resources will naturally gravitate to their highest-valued use, regardless of who owns the property right. I Significance: Private solution to externalities. I Intuition: The property right will always go to the person who values it the most. Thus whoever owns the right first doesn’t matter. Case Study: Climate Change and Carbon Taxes I Climate change as a global negative externality. I A carbon tax internalizes the social cost of greenhouse gas emissions. I Benefits: Incentivizes reductions in emissions; revenue can support environmental programs. Objections to Pollution Taxes I Ethical and fairness concerns. I Potential economic impacts: I Disproportionate effects on low-income households I Concerns over industrial competitiveness Quick Quiz Question: What is an externality? I A. The impact of one person’s actions on the well-being of a bystander. I B. A cost paid only by the producer. I C. A benefit received only by the consumer. I D. The loss of a market due to competition. Answer: A. The impact of one person’s actions on the well-being of a bystander. Example of Positive Externality: Education I Education provides benefits beyond the individual student: I Higher productivity and innovation I Lower crime rates I Informed voters and better governance I Result: Society benefits from subsidies to make education more accessible. Example of Negative Externality: Air Pollution I Factories produce pollution that affects the health of nearby residents. I Private costs for the factory do not include health impacts. I Solutions: Regulations, pollution permits, and corrective taxes. Case Study: Smog in urban areas due to vehicle emissions. Challenges of the Coase Theorem I The Coase Theorem relies on low transaction costs, which are not always feasible. I Common challenges: I High costs in negotiation I Large number of affected parties I Legal and enforcement difficulties I Example: Pollution from large corporations affecting hundreds of households. Market-Based Policies: Subsidies for Positive Externalities I Governments can subsidize goods with positive externalities. I Example: Tax credits for clean energy installations. I Benefits: I Encourages production and consumption I Brings quantity closer to the social optimum Quick Quiz Question: Which of the following is a positive externality? I A. A factory pollutes a river, affecting local fishers. I B. A homeowner plants a beautiful garden that others enjoy. I C. A car produces exhaust that contributes to air pollution. I D. A company dumps waste into a nearby lake. Answer: B. A homeowner plants a beautiful garden that others enjoy. Public Goods and Common Resources I Public goods and common resources are types of goods that can lead to market failures. I Characteristics: I Public Goods: Non-excludable and non-rival. I Common Resources: Non-excludable but rival. Types of Goods Rival Non-rival Excludable Private Goods Club Goods Non-excludable Common Resources Public Goods Characteristics of Public Goods I Non-excludable: People cannot be excluded from using them. I Non-rival: One person’s use does not reduce availability to others. I Examples: I National defense I Public fireworks display I Clean air The Free-Rider Problem I Occurs when people receive benefits without paying. I Example: People benefit from national defense without contributing. I Solution: Government provision funded through taxes. Common Resources and the Tragedy of the Commons I Common resources are rival but non-excludable, leading to overuse. I Example: Overfishing in oceans. I Solution: Regulations or usage quotas. Case Study: Why is the Ocean Overfished? I The ocean is a common resource, accessible to all. I Lack of ownership leads to overuse. I Possible solutions: Fishing licenses, quotas, or exclusive fishing zones. Government Solutions to the Free-Rider Problem I Public provision of goods funded through taxes. I Examples: I National defense I Public broadcasting Detailed Example of Public Goods: National Defense I Characteristics of national defense: I Non-rival: One person’s protection does not reduce others’ protection. I Non-excludable: Difficult to exclude individuals from being protected. I Government provides national defense as individuals cannot be excluded from its benefits. Case Study: Public Health as a Public Good I Vaccinations reduce the spread of disease, benefiting everyone. I Public health measures are non-excludable and benefit society. I Governments may subsidize or provide vaccinations to encourage public health. Tragedy of the Commons I Definition: The overuse and depletion of a common resource due to individual incentives. I Examples: I Overfishing in international waters I Overgrazing on public lands I Traffic congestion in city centers I Result: Resources are depleted faster than they can be replenished. Solutions to the Tragedy of the Commons I Possible solutions include: I Government regulation and quotas I Privatization of resources I Creating property rights I International agreements (for resources like oceans and air) I Example: Fishing quotas and protected marine areas to prevent overfishing. Quick Quiz - Final Question Question: Which of the following is a common resource? I A. A privately owned farm I B. A public park I C. A toll road with no congestion I D. A river open for fishing by anyone Answer: D. A river open for fishing by anyone Key Takeaways I Public goods and common resources create unique challenges. I Government intervention can help achieve efficient outcomes. I Important to balance benefits and costs of public provision. Quick Quiz Question: What is a common resource? I A. Non-rival and non-excludable I B. Rival and excludable I C. Rival and non-excludable I D. Non-rival and excludable Answer: C. Rival and non-excludable Conclusion and Final Thoughts I Externalities, public goods, and common resources lead to market failure. I Government intervention can correct inefficiencies. I Understanding these concepts is essential for effective policy-making.