Econ 101 - Principles of Microeconomics Lecture Notes - Week 13

ECON 101 – Principles of Microeconomics Instructor: Kairon Shayne D. Garcia TA: Keanu Hua Office: SSPA 351 Office: SSPA 323 Office Hours: 9:00am-11:00am M/W Office Hours: 3:30pm-4:30pm W/Th (in-person) (in-person) Email: k...

ECON 101 – Principles of Microeconomics Instructor: Kairon Shayne D. Garcia TA: Keanu Hua Office: SSPA 351 Office: SSPA 323 Office Hours: 9:00am-11:00am M/W Office Hours: 3:30pm-4:30pm W/Th (in-person) (in-person) Email: [email protected] Email: [email protected] Announcements Exam 3 is scheduled on December 04th in class Coverage: Modules 27-34, 36 That is, Modules 37-39 won’t be covered. Final Exam is scheduled on December 18th 12:30pm-2:30pm Coverage: Comprehensive (i.e., Modules covered from Day 1 until today) 50 Questions (worth 2pts each) But modules 37-39 won’t be covered either Announcements Same rules apply as in Exam 2 for both the remaining exams You are allowed one-sided print paper reviewer sheet (everything should be handwritten) Calculators are allowed Everyone gets +15pts for Exam 3 (we reached 70% survey response. Thanks!) Announcements I’ve uploaded Exam 3 Practice Answer key will be uploaded on Wednesday (11/20) We’ll review them too in class Announcements Because we are not covering Modules 37-39 anymore, no need to answer Achieve Assignment 10: Modules 37-39. Everyone will be awarded a score of 100% for that assignment Don’t forget to complete Achieve Assignment 9 though; it’s due 11/24! You still need to do that. Module 36: Public Goods and Common Resources Learning Points Public goods and its characteristics Common resources and overconsumption  FOUR TYPES OF GOODS 1. Private goods are excludable and rival in consumption, like wheat. 2. Public goods are nonexcludable and nonrival in consumption, like a public sewer system. 3. Common resources are goods that are nonexcludable but rival in consumption, like water in a river. 4. Artificially scarce goods are excludable but nonrival in consumption, like on-demand movies on Amazon Prime. FOUR TYPES OF GOODS Figure 36-1 PRIVATE GOODS  PRIVATE GOODS Private goods are goods that are excludable and rival in consumption, like wheat. – Excludable: the farmer can sell a bushel to one consumer without having to provide wheat to everyone in the county – Rival in consumption: If you eat bread baked with a farmer’s wheat, that wheat cannot be consumed by someone else.  WHY MARKETS CAN SUPPLY ONLY PRIVATE GOODS EFFICIENTLY Markets cannot supply goods and services efficiently unless they are private goods—excludable and rival in consumption.  WHY MARKETS CAN SUPPLY ONLY PRIVATE GOODS EFFICIENTLY Why is excludability crucial? – Suppose that a farmer had only two choices: 1. to produce no wheat or 2. provide a bushel of wheat to every resident of the county who wants it, whether or not that resident pays for it – It seems unlikely that anyone would grow wheat under those conditions  WHY MARKETS CAN SUPPLY ONLY PRIVATE GOODS EFFICIENTLY Why is excludability crucial? – Yet suppose an operator of a municipal sewage system faces a similar scenario: A sewage system makes the whole city cleaner and healthier – but that benefit accrues to all the city’s residents, whether or not they pay the system operator.  WHY MARKETS CAN SUPPLY ONLY PRIVATE GOODS EFFICIENTLY Why is excludability crucial? – The general point is that if a good is nonexcludable, self-interested consumers won’t be willing to pay for it –they will take a “free ride” on anyone who does pay.  WHY MARKETS CAN SUPPLY ONLY PRIVATE GOODS EFFICIENTLY Nonexcludable goods have the free-rider problem: many individuals are unwilling to pay for consumption of nonexcludable goods and instead will take a “free ride” on anyone who does pay. ▪ Example: in a student group project, shirkers free ride on someone else’s effort.  WHY MARKETS CAN SUPPLY ONLY PRIVATE GOODS EFFICIENTLY Because of this free-rider problem, the forces of self-interest alone do not lead to an efficient level of production for a nonexcludable good. Even though consumers would benefit from increased production of the good, no one individual is willing to pay for more, and so no producer is willing to supply it. As a result, nonexcludable goods suffer from inefficiently low production—they are undersupplied. – In the face of the free-rider problem, self-interest may not ensure that any amount of the good —let alone the efficient quantity – is produced.  WHY MARKETS CAN SUPPLY ONLY PRIVATE GOODS EFFICIENTLY Why is being non-rival crucial? – As long as the good is excludable, it is possible to earn a profit by making it available only to those who pay. – Therefore, producers are willing to supply an excludable good. – But the marginal cost of letting an additional viewer watch an on- demand movie is zero because it is nonrival in consumption. – So the efficient price to the consumer is also zero, or in other words, consumers should watch movies up to the point where their marginal benefit is zero.  WHY MARKETS CAN SUPPLY ONLY PRIVATE GOODS EFFICIENTLY Goods that are excludable and nonrival in consumption suffer from inefficiently low consumption—they are underconsumed. – Example: Amazon Prime has a marginal cost of zero but charges $4 per movie so that viewers will only consume movies up to the point where their marginal benefit is $4 instead of zero. – When consumers must pay a price greater than zero for a good that is nonrival in consumption, the price they pay is higher than the marginal cost of allowing them to consumer that good, which is zero.  WHY MARKETS CAN SUPPLY ONLY PRIVATE GOODS EFFICIENTLY Bottomline: private goods are the only goods that can be efficiently produced and consumed in a competitive market. 1. Because they are excludable: producers can charge for them and so have an incentive to produce them. 2. And because they are also rival in consumption: it is efficient for consumers to pay a positive price –a price equal to the marginal cost of production. If one or both of these characteristics are lacking, a market economy will not lead to efficient production and consumption of the good.  WHY MARKETS CAN SUPPLY ONLY PRIVATE GOODS EFFICIENTLY Fortunately for the market system, most goods are private goods. – e.g., clothing, shelter, and most other desirable things in life are excludable and rival in consumption so the markets can provide us with most things Yet, there are crucial goods that don’t meet these criteria –and in most cases, that means that the government must step in. PUBLIC GOODS  PUBLIC GOODS A public good is a good that is both nonexcludable and nonrival in consumption. Examples: 1. Public sewer system 2. Disease prevention 3. Defense 4. Scientific research  PUBLIC GOODS Because these goods are nonexcludable, they suffer from the free-rider problem, so no private firm would be willing to produce them. And because they are nonrival in consumption, it would be inefficient to charge people for consuming them. Society must find nonmarket methods for providing these goods.  PROVIDING PUBLIC GOODS Public goods are provided through a variety of means: Voluntary contributions – example: private donations for scientific research Individuals or firms who make money in an indirect way – example: broadcast television, supported entirely by advertising Social encouragement or pressure in small communities – example: volunteer fire departments The government and paid for by taxes – most important public goods—national defense, the legal system, disease control, and so on HOW MUCH OF A PUBLIC GOOD SHOULD BE PROVIDED? If the government provides the public good, how much should it produce? – Produce the quantity where marginal social benefit of a public good equals marginal cost of producing it. – The marginal social benefit of a public good is equal to the sum of the individual marginal benefits enjoyed by all consumers (the sum of each consumer’s willingness to pay for that unit). HOW MUCH OF A PUBLIC GOOD SHOULD BE PROVIDED? Imagine a city with two residents, Theo and Abby. Assume that Theo and Abby truthfully tell the government their willingness to pay for another unit of the public good—they tell the government their marginal benefits. – The efficient quantity of a public good is the quantity at which the marginal social benefit is equal to the marginal cost of providing it. HOW MUCH OF A PUBLIC GOOD SHOULD BE PROVIDED? The marginal social benefit of one more unit of a public good is always greater than the individual marginal benefit. – That is why no individual is willing to pay for the efficient quantity of the good. The problem of providing public goods is similar to the problem of positive externalities: there is a market failure that calls for government intervention. COMMON RESOURCES  COMMON RESOURCES A common resource is nonexcludable and rival in consumption. They tend to be overused if left to the market: individuals ignore the fact that their use depletes the amount of the resource remaining for others. When one person catches a fish, there are fewer fish available for everyone else. Each person has the incentive to fish before others. A COMMON RESOURCE Figure 36-2 In an unregulated market, the quantity of the common resource used, QMKT, exceeds the efficient quantity, QOPT.  THE EFFICIENT USE AND MAINTENANCE OF A COMMON RESOURCE Because common resources pose problems similar to those created by negative externalities, the solutions are also similar: – Tax or regulate the use of the common resource. – Create a system of tradable licenses for the right to use the common resource. – Make it excludable and assign property rights to it. THE EFFICIENT USE AND MAINTENANCE OF A COMMON RESOURCE 1. A Pigouvian tax can reduce the use of a common resource to the efficient quantity. For example, when visitors to national parks pay a fee, the number of visitors falls. THE EFFICIENT USE AND MAINTENANCE OF A COMMON RESOURCE 2. Create a system of tradable licenses: The policy maker issues the number of licenses that corresponds to the efficient level of use of the good. Example: individual transferable quotas, or ITQs, help reverse the collapse of fisheries because each ITQ holder has a financial interest in the long-term maintenance of his fishery. 3. The most natural solution is to assign property rights: Make the good excludable and assign property rights over it to someone. The owner then will have an incentive to protect the good. ARTIFICIALLY SCARCE GOODS  ARTIFICIALLY SCARCE GOODS An artificially scarce good is a good that is excludable but nonrival in consumption. – Example: on-demand movies. The marginal cost of allowing one more person to consume the good is zero. However, because it is excludable, sellers charge a positive price, which leads to inefficiently low consumption. The problems of artificially scarce goods are similar to those posed by a natural monopoly. iClicker Question  iClicker QUESTION 1 Street cleaning is best characterized as a: a) private good. b) nonrival private good. c) common resource. d) public good. iClicker Question  iClicker QUESTION 2 Toilet paper is a rival good because: a) there is a lot of competition in the toilet paper market. b) it is a substitute good for a bidet. c) if one person uses several sheets of toilet paper, no one else can. d) it is made from natural resources. iClicker Question iClicker QUESTION 3 Characterize each of the following items as excludable or nonexcludable. I. Central Park, New York (no entrance fee) II. Cable television a) Both I and II are excludable. b) I is excludable; II is nonexcludable. c) I is nonexcludable; II is excludable. d) Both I and II are nonexcludable. iClicker Question  iClicker QUESTION 4 The rise of the internet and file sharing has the ability to turn media such as movies and music into public goods. How? a) It has made those goods nonexcludable. b) It has made those goods excludable. c) It has made those goods rival. iClicker Question iClicker QUESTION 5 London recently started charging a fee to drive in certain parts of the city during peak traffic times to address the problem of traffic congestion. It has worked! This fee has: a) encouraged consumers to drive less than they otherwise would. b) encouraged consumers to drive at times when traffic congestion is less of a problem. c) made a common resource excludable: those who pay for the right to drive can drive, and those unwilling to pay must forgo driving. d) Answers (a), (b), and (c) are all true. iClicker Question iClicker QUESTION 1 (Answer) Street cleaning is best characterized as a: a) private good. b) nonrival private good. c) common resource. d) public good. (correct answer) iClicker QUESTION 2 (Answer) Toilet paper is a rival good because: a) there is a lot of competition in the toilet paper market. b) it is a substitute good for a bidet. c) if one person uses several sheets of toilet paper, no one else can. (correct answer) d) it is made from natural resources. iClicker QUESTION 3 (Answer) Characterize each of the following items as excludable or nonexcludable. I. Central Park, New York (no entrance fee) II. Cable television a) Both I and II are excludable. b) I is excludable; II is nonexcludable. c) I is nonexcludable; II is excludable. (correct answer) d) Both I and II are nonexcludable. iClicker QUESTION 4 (Answer) The rise of the internet and file sharing has the ability to turn media such as movies and music into public goods. How? a) It has made those goods nonexcludable. (correct answer) b) It has made those goods excludable. c) It has made those goods rival. iClicker QUESTION 5 (Answer) London recently started charging a fee to drive in certain parts of the city during peak traffic times to address the problem of traffic congestion. It has worked! This fee has: a) encouraged consumers to drive less than they otherwise would. b) encouraged consumers to drive at times when traffic congestion is less of a problem. c) made a common resource excludable: those who pay for the right to drive can drive, and those unwilling to pay must forgo driving. d) Answers (a), (b), and (c) are all true. (correct answer)