BE BLOCK 4.docx

Chapter 8: Public Goods, Common Resources and Merit Goods Public sector; that part of the economy where business activity is owned, financed and controlled by the state, and goods and services are provided by the state on behalf of the population as a whole. Private sector; that part of the economy...

Chapter 8: Public Goods, Common Resources and Merit Goods Public sector; that part of the economy where business activity is owned, financed and controlled by the state, and goods and services are provided by the state on behalf of the population as a whole. Private sector; that part of the economy where business activity is owned, financed and controlled by private individuals. The different kinds of goods Two characteristics of goods in the economy: Is the good excludable; the property of a good whereby a person can be prevented from using it when they do not pay for it. Is the good rival; the property of a good whereby one person’s use diminishes other people’s use. Using these two characteristics, we can divide goods into four categories: Private goods; goods that are both excludable and rival. Public goods; goods that are neither excludable nor rival. Common resources; goods that are rival but not excludable. Club goods; goods that are excludable but non-rival in consumption. Public goods Because people are not charged for their use of a public good, they have an incentive to free ride if the good was provided privately. Free rider; a person who receives the benefit of a good but avoids paying for it. The three most important examples of public good: National Defense Basic Research Fighting Poverty Governments provide public goods, making their decision about the quantity bases on const-benefit analysis. Cost-benefit analysis; a study that compares the costs and benefits to society of providing a public good. To overcome some of the problems associated with cost-benefit analysis, contingent valuation methods (CVM) can be used. Common resources Tragedy of the commons; a parable that illustrates why common resources get used more than is desirable from the standpoint of society as a whole. Some important common resources: Clean Air and Water Congested Roads Fish, Whales and Other Wildlife Because people are not charged for their use of common resources, they tend to use them excessively. Therefore, governments try to limit the use of common resources. Merit goods Merit goods; goods which can be provided by the market but may be under-consumed as a result of imperfect information about the benefits. Intertemporal choice; where decisions made toady can affect choices facing individuals in the future. Examples of merit goods: Education Health Care, Insurance and Pensions De-merit; goods that are over-consumed if left to the market mechanism and which generate both private and social costs which are not taken into account by the decision-maker Governments might intervene in the market to reduce consumption in some way either through the price mechanism (Levying taxes on these goods, for example), or through regulation and legislation. Chapter 9: Market Failure and Externalities Externalities Negative externality; the costs imposed on a third party of a decision. Positive externality; the benefits to a third party of a decision. Types of Externalities: The exhaust from cars is a negative externality because it creates smog that other people breathe. Restored historic buildings convey a positive externality because people who walk or drive by them can enjoy their beauty and the sense of history that these buildings provide.  Barking dogs create a negative externality because neighbors are disturbed by the noise. Research into new technologies provides a positive externality because it creates knowledge that other people can use. A program of vaccination against a flu virus or any other communicative disease protects those who receive it from the risk of contracting the virus. Externalities and market inefficiency Internalizing an externality; altering incentives so that people take account of the external effects of their actions. Positional externality; purchases or decisions which alter the context of the evaluation by an individual of the positional good. Positional arms race; a situation where individuals invest in a series of measures designed to gain them an advantage but which simply offset each other. Private solutions to externalities Types of private solution: Social Norms of Moral Behavior Charities Self-Interest Social Contracts Coase theorem; the proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities of their own. Why private solutions do not always work: Transaction Costs; the costs that parties incur in the process of agreeing and following through on a bargain Bargaining Problems Coordinating Interested Parties Asymmetric Information and the Assumption of Rational Behavior Public policies towards externalities Public policies refer to instances where governments step in to seek to correct a perceived market failure. Governments tend to respond in one of two ways: Command and control policies regulate behavior directly. Market-based policies provide incentives so that private decision-makers will choose to solve the problem on their own through manipulation of the price signal. Pigovian tax; a tax enacted to correct the effects of a negative externality. Marginal abatement cost; the cost expressed in terms of the last unit of pollution not emitted (abated) Public/Private policies towards externalities Property rights; the exclusive right of an individual, group or organization to determine how a resource is used. A government solution to the absence of property rights is to issue permits. For instance, the government could protect the environment by issuing a limited number of pollution permits. The end result of this policy is largely the same as imposing Pigovian taxes on polluters. Government failure Government failure; a situation where political power and incentives distort decision-making so that decisions are made which conflict with economic efficiency. Public interest; making decisions based on a principle where the maximum benefit is gained by the largest number of people at minimum cost. Public choice theory; the analysis of governmental behavior, and the behavior of individuals who interact with government (example: road congestion). Rational ignorance effect; the tendency of a voter to not seek out information to make an informed choice in elections. Special interest effect; where benefits to a minority special interest group are outweighed by the costs imposed on the majority. Logrolling; the agreement between politicians to exchange support on an issue. Rent seeking; where individuals or groups take actions to redirect resources to generate income (rents) for themselves or the group. Privatization; the transfer of publicly owned assets to private sector ownership. Cronyism; a situation where the allocation of resources in the market is determined in part by political decision-making and favors rather than by economic forces.