Transcript lec9-welfare3

Civil Systems Planning
Benefit/Cost Analysis
Scott Matthews
12-706/19-702 / 73-359
Lecture 9
1
Monopoly - the real game
One producer of good w/o substitute
Not example of perfect comp!
Deviation that results in DWL
There tend to be barriers to entry
Monopolist is a price setter not taker
Monopolist is only firm in market
Thus it can set prices based on output
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Monopoly - the real game (2)
Could have shown that in perf. comp.
Profit maximized where p=MR=MC (why?)
Same is true for a monopolist -> she can
make the most money where additional
revenue = added cost
But unlike perf comp, p not equal to MR
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Monopoly Analysis
MC
In perfect competition,
Equilibrium was at
(Pc,Qc) - where S=D.
But a monopolist has a
Function of MR that
Does not equal Demand
Pc
So where does he supply?
MR
Qc
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D
4
Monopoly Analysis (cont.)
MC
Pm
Monopolist supplies
where MR=MC for
quantity to max.
profits (at Qm)
But at Qm, consumers
are willing to pay Pm!
Pc
What is social surplus,
Is it maximized?
Qm
MR
Qc
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D
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Monopoly Analysis (cont.)
MC
What is social surplus?
Orange = CS
Yellow = PS (bigger!)
Pm
Grey = DWL (from not
Producing at Pc,Qc) thus
Soc. Surplus is not
maximized
Pc
Qm
MR
Qc
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Breaking monopoly
D Would transfer DWL to
Social Surplus
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Natural Monopoly
Fixed costs very large relative to variable costs
Ex: public utilities (gas, power, water)
Average costs high at low output
AC usually higher than MC
One firm can provide good or service cheaper
than 2+ firms
In this case, government allows monopoly but usually
regulates it
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Natural Monopoly
Faced with these curves
Normal monop would
Produce at Qm and
Charge Pm.
a
Pm
We would have same
Social surplus.
d
P*
b
Qm
MR
e
AC
c
MC
Q*
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But natural monopolies
Are regulated.
D What are options?
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Natural Monopoly
Forcing the price P*
Means that the social
surplus is increased.
DWL decreases from
abc to dec
a
Pm
d
P*
b
Qm
MR
e
Society gains adeb
AC
MC
c
D
Q*
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Q0
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Monopoly
Other options - set P = MC
But then the firm loses money
Subsidies needed to keep in business
Give away good for free (e.g. road)
Free rider problems
Also new deadweight loss from cost
exceeding WTP
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Referent Groups (RG)
C: RG NB
At nonMarket
price
D: non-RG
NB at nonMarket price
A = RG
NB @
Market
prices
B: non-RG
NB at market
prices
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Pollution (Air or Water)
P
Typically supply (MC) only private, not
social costs. Social costs higher
for each quantity
S#:marginal
Social costs
S*: marginal
Private costs
P#
What do these curves,
Equilibrium points
tell us?
P*
D
Q#
Q*
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Q
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What is WTP by society to avoid?
P
Typically supply (MC) only private, not
social costs. Social costs higher
for each quantity
S#:marginal
Social costs
S*: marginal
Private costs
P#
P*
D
Q#
Q*
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Q
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What is WTP by society to avoid?
P
Differences in cost functions represent the
alternative ‘valuations’ of the product Thus difference between them
WTP to avoid costs
S#:marginal
Social costs
S*: marginal
Private costs
P#
P*
D
Q#
Q*
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Q
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Pollution (Air or Water)
P
Relatively too much gets produced,
At too low of a cost - how to
Reduce externality effects?
S#:marginal
Social costs
S*: marginal
Private costs
DWL
P#
P*
D
Q#
Q*
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Q
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Pollution (Air or Water)
P
Government can charge a tax ‘t’ on
Each unit, where t = distance between
What are CS, PS, NSB?
S#:marginal
Social costs
S*: marginal
Private costs
P#
t
P*
D
Q#
Q*
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Q
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Pollution (Air or Water)
P
CS = (loss) A+B
PS=(loss) E+F
S#:marginal
Social costs
S*: marginal
Private costs
P#
t
A
B
E
F
P*
P# - t
D
Q#
Q*
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Q
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Pollution (Air or Water)
P
Third parties: (gain) B+C+F
(avoided quantity between S curves)
Govt revenue: A+E
Total: gain of C
P#
C
A
B
E
F
S#:marginal
Social costs
S*: marginal
Private costs
t
C is reduced DWL
of pollution
eliminated by tax**
P*
P# - t
D
Q#
Q*
Q
**This cannot be a perfect reduction in practice - need to consider
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Distorted Market - Vouchers
Example: rodent control vouchers
Give residents vouchers worth $v of cost
Producers subtract $v - and gov’t pays them
Likely have spillover effects
Neighbors receive benefits since less
rodents nearby means less for them too
Thus ‘social demand’ for rodent control is
higher than ‘market demand’
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Distortion : p0,q0 too low
What is NSB? What are CS, PS?
S
P
Social
WTP
S-v
P0
P1
DM
Q0
Q1
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DS: represents
higher WTP
for rodent control
Q
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Social Surplus - locals
P
Make decisions based on S-v, Dm
What about others in society,
S
e.g. neighbors?
P
S-v
P1+v
P0
A
B
C
E
P1
DS
Because of vouchers,
Residents buy Q1
DM
Q0
Q1
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Q
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Nearby Residents
P
Added benefits are area between demand
above consumption increase
S
What is cost voucher program?
P
S-v
F
P1+v
P0
A
B
C
E
G
P1
DS
DM
Q0
Q1
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Q
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Voucher Market Benefits
Program cost (vouchers):A+B+C+G+E ---Gain (CS) from target pop: B+E
Gain (CS) in nearby: C+G+F
Producers (PS): A+C
--------Net: C+F
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Notes about Public Spending
 Resource allocation to one project always comes at a
‘cost’ to other projects
E.g. Pittsburgh stadium projects
“Use it or Lose it”
There is never enough money to go around
 Thus opportunity costs exist
Ideally represented by areas under supply curves
Do not consider ‘sunk costs’
Three cases (we will do 2, see book for all 3)
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Opportunity Cost: Land
•
•
•
•
Case of inelastic supply (elastic supply in book, trivial)
Government decides to buy Q acres of land, pays P per acre
Alternative is parceling of land to private homebuyers
What is total cost of project?
Price
S
P
Can assume quantity
of land is fixed (Q)
b
D
Q
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Opportunity Cost: Land
Government pays PbQ0, but society ‘loses’ CS that they
would have had if government had not bought land. This lost
CS is the ‘opportunity cost’ of other people using/buying land.
• Total cost is entire area under demand up to Q (colored)
Price
S
P
b
D
0
Q
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Example: Change in Demand for
Concrete Dam Project
If Q high enough, could effect market
Shifts demand -> price higher for all buyers
Moves from (P0,Q0) to (P1,Q1).. Then??
Price
D
D+q’
S
P1
P0
a
Q0
Q1
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Quantity
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Another Example: Change in
Demand
Original buyers: look at D, buy Q2
Total purchases still increase by q’
What is net cost/benefit to society?
Price
D
D+q’
S
P1
P0
a
Q2
Q0
Q1
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Another Example: Change in
Demand
 Project spends B+C+E+F+G on q’ units
 Project causes change in social surplus!
 Rule: consider expenditure and social surplus change
Price
D+q’
D
S
P1
P0
A
B
C
E
G
G
Q2
F
G
Q0
Q1
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Dam Example: Change in
Demand
 Decrease in CS: A+B (negative)
 Increase in PS: A+B+C (positive)
Net social benefit of project is B+G+E+F
Price
D+q’
D
S
P1
P0
A
B
C
E
G
G
Q2
F
G
Q0
Q1
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Quantity
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Final Thoughts: Change in
Demand
 When prices change, budgetary outlay does not equal the total
social cost
 Unless rise in prices high, C negligible
 So project outlays ~ social cost usually
 Opp. Cost equals direct expenditures adjusted by social surplus
changes
Quantity
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Secondary Markets
When secondary markets affected
Can and should ignore impacts as long as
primary effects measured and undistorted
secondary market prices unchanged
Measuring both usually leads to double
counting (since primary markets tend to show
all effects)
Don’t forget that benefit changes are a
function of price changes (Campbell pp. 167)
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Primary: Fishing Days
Government decides to buy Q acres of land, pays P per acre
What is total cost of project?
Price
a
MC0
b
MC1
P
D
Q0
Q1
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