Transcript 슬라이드 1 - Konkuk

Further Topics
Chapter 7
Scope of Issues

How does the distribution of property rights
affect the working of the economy?

What happens if some consumers get
excluded from enjoying a particular public
good?

The distribution of incomes across
consumers and over time
Eliminating Production Externalities

The basic problem with externalities is the
lack of markets for the associated goods or
bads (e.g. clean air or pollution amounts)

The absence of markets for goods or bads
involved into the production of externalities
results in the inefficient (in the Pareto sense)
allocation of resources
Costs of Reducing Emission
by Two Firms
Million $
Million $
Marginal Costs of Reducing
Emission
FIRM 1
FIRM 2
10
8
Quantity of
Emissions
Reduced
6
10
16
16
Emission Standards

The control authority wants to halve total emission level from the
current 32 tons down to 16 tons. For example, emission limits of 8 tons
may be imposed on each firm.

This approach is the easiest one in the absence of perfect information
on the firms’ marginal costs

For the interval of emission levels below 10 tons first firm’s marginal
costs are lower than the second firm’s marginal costs of reducing
emission

This solution is not cost-effective: one can reduce social costs of
reducing emission (i.e. the sum of the total costs for each firm of
reducing its level of emission) by decreasing the limit of emission to 6
tons for the first firm (and increasing the limit for the second firm to 10
tons)
Uniform Emission Charge

A uniform charge is the price a firm has to pay for each ton of emission it
produces

Firms reduce their emission levels depending on the uniform charge and their
marginal costs of reducing emissions



For a uniform charge of $10 million the first firm will choose to reduce 10 tons of
emission (verify using graph)
For a uniform charge exceeding $10 million the first firm will choose to reduce all its
emission
The second firm will be indifferent between all possible levels of reduction if the
uniform charge is exactly $10 million

In order to solve the problem by imposing uniform charges on emission levels,
the authority must possess perfect knowledge about the firms’ production costs

Since perfect information is a utopia, the authority has to take a blind guess or
engage in grid search, both options being too expensive
Transferable Emission Permit System

Each firm is required to have a certain amount of permits to
emit

For example, a firm possessing five permits is allowed to produce
five tons of emission

Permits are freely transferable meaning the market for emission
permits exists

Suppose the authority gives eight permits to emit to each firm.
That opens the possibility for trade

In this way, by establishing the clear-cut property rights the
authority achieves efficient level of emission reduction costs
without the perfect knowledge of these costs, relying solely on
the market
Markets May Still Fail

What if firms cannot afford to invest in emissionreducing equipment or to pay for the permits?

What if a resource is a common property and access
to it is free?



Remember the Tragedy of the Commons
Ozone layer, fisheries
The inefficiency results from the absence of a mechanism to
restrict use
The Coase Theorem: An Example
Dick owns a dog named Spot.
Negative externality:
Spot’s barking disturbs Jane,
Dick’s neighbor.
The socially efficient outcome
maximizes Dick’s + Jane’s well-being.
 If Dick values having Spot more
than Jane values peace & quiet,
the dog should stay.
Coase theorem: The private market will reach the
efficient outcome on its own…
The Coase Theorem: An Example

CASE 1:
Dick has the right to keep Spot.
Benefit to Dick of having Spot = $500
Cost to Jane of Spot’s barking = $800

Socially efficient outcome:
Spot goes bye-bye.

Private outcome:
Jane pays Dick $600 to get rid of Spot,
both Jane and Dick are better off.

Private outcome = efficient outcome.
The Coase Theorem: An Example

CASE 2:
Dick has the right to keep Spot.
Benefit to Dick of having Spot = $1000
Cost to Jane of Spot’s barking = $800

Socially efficient outcome:
See Spot stay.

Private outcome:
Jane not willing to pay more than $800,
Dick not willing to accept less than $1000,
so Spot stays.

Private outcome = efficient outcome.
The Coase Theorem: An Example
CASE 3:
Jane has the legal right to peace & quie
t.
Benefit to Dick of having Spot = $800
Cost
to market
Jane of
Spot’sthebarking
$500 r
The
private
achieves
efficient=outcome

egardless of the initial distribution of rights.

Socially efficient outcome: Dick keeps
Spot.

Private outcome: Dick pays Jane $600
to put up with Spot’s barking.

Private outcome = efficient outcome.
Coase’s Theorem

If property rights are well-defined, trade
between agents results in a costefficient allocation of an externality

Coase’s Theorem

Under certain circumstances the efficient
outcome is independent of the assignment
of property rights
Willingness to Pay and Costs
of Reducing Pollution Levels




When the air is dirty, consumers’ WTP
for a reduction of even one ton is very
high
WTP decreases as air gets cleaner
When the air is dirty, reduction of
emissions by one ton is cheap
Higher air quality costs more to achieve
Coase’s Theorem
In the absence of transactions costs the
level of production of goods or services in
an industry in which there are externalities
is independent of whether or not the party
who perpetrates negative externalities is
legally liable for the costs of the
externalities on other parties.
$
Coase’s Theorem: an Illustration
MC
5. For any Q<Q* consumers
will bribe producers to
reduce emission levels to Q*
4. So that producers will
bribe consumers to allow
them to produce more
pollution
3. Is smaller than the
producers’ costs of
doing that
2. Consumers’
willingess to pay for
the reduction of
emission
1. At this level of
emission
P*
MWP
Q*
Emissions Reduced
Initial Property Rights Allocation
1.
2.
3.
Firms have the right to pollute without
limit: consumers bribe the firms,
moving to Q*
Consumers have the right to 100%
clean air: firms will bribe consumers to
move to Q*
Irrespectively of the property rights
allocation, bribery will result in a
socially efficient outcome
Coase Theorem: a Corollary




In case Coase is right, do we need the
government?
Government’s key role is to enforce
property rights
According to Coase, property rights
don’t matter from the point of view of
Pareto efficiency
Do we need the government to deal
with (negative) externalities?
Caveats of Coase’s Theorem

Redistributing property rights may affect
prices in other markets

Not all people may be indifferent to which
party must compensate and which party is
being compensated

The theorem works under the assumption of
perfect and costless information (remember
the prisoner’s dilemma case)
Internalizing the Externality by
Merging

When one or several economic agents start behaving in a way
that results in an efficient outcome, economists say they
internalize the externality

Suppose one firm’s production adversely affects the other firm’s
production (i.e. the first firm produces a negative externality on
the other firm)

If the two firms merge, it is in their interest to remove the
sources of the first firm’s negative externality so as to maximize
joint profits

In this way, mergers between firms are another market solution
to the problem of internalizing the externalities
Local Public Goods


A local public good is the one whose
consumption is limited to a particular
geographical area
Examples
Traffic lights
 Parks


Tiebout (1956): local governments face
competition because households can
move communities (voting with one’s
feet)
Tiebout Hypothesis


In order to attract residents, a local
community government must produce
high quality local public goods in the
cheapest way possible
Tiebout hypothesis: competition
between state and many local
governments results in efficient
provision of public good
Local Public Goods

Local public goods are only available to households living in the
same geographical area (traffic lights, parks)

Charles Tiebout hypothesis: Local governments face

In other words, competition with the other communities forces
local governments to provide public goods efficiently

Caveats
competition with the other governments since households that
are unhappy with the provision of local public goods may move
to a different community



Relocation costs may be substantial
Legal restrictions on relocation
Job market situation
Lump-Sum Taxation and Pareto Efficiency

Re-cap: unit or ad-valorem taxes decrease social welfare (the
sum of consumer and producer surplus) by inflicting a
deadweight loss on the society

Lump sum taxes (i.e. taxes independent of the amount of goods
purchased or sold) are not supposed to shift neither the
demand nor the supply curves

However, depending on the redistribution policies by the
government, shifts in supply or demand are possible


If the government redistributes tax earnings to the poor, the
aggregate demand curve may shift to the right
In general, lump sum taxation leaves the society on its utility
possibilities frontier
Tax Rates and Revenue
• A tax rate is the amount of tax people are required to pay
per unit of whatever is being taxed.
• In general, doubling the excise tax rate on a good or service
won’t double the amount of revenue collected because the
tax increase will reduce the quantity of the good or service
transacted.
• In some cases, raising the tax rate may actually
the amount of revenue the government collects.
reduce
Tax Rates and Revenue
(a) An excise tax of $20
Price of h
otel room
(b) An excise tax of $60
Price of h
otel room
$140
$140
120
120
Excise
tax = $
20 per
room
90
80
70
E
Area = tax r
evenue
D
Excise
tax = $
60 per
room
80
Area = tax revenue
110
S
S
E
D
50
40
40
20
20
0
6,000
7,500 10,000
15,000
Quantity of hotel rooms
0
2,500 5,000
10,000
15,000
Quantity of hotel rooms
A Tax Reduces Consumer and Producer Surplus
• A fall in the price of a good generates a gain in
consumer surplus.
• Similarly, a price increase causes a loss to
consumers.
• So it’s not surprising that in the case of an excise
tax, the rise in the price paid by consumers
causes a loss.
• Meanwhile, the fall in the price received by
producers leads to a fall in producer surplus.
 A tax reduces both, the CS and the PS.
A Tax Reduces Consumer and Producer Surplus
Pr ic e
Fall in consumer surplus d
ue to tax
P
C
A
Excise tax
=T
P
B
E
E
F
C
P
S
P
Fall in producer surplus du
e to tax
Q
T
Q
E
D
Quantity
The Deadweight Loss of a Tax
• Although consumers and producers are hurt by the
tax, the government gains revenue. The revenue the
government collects is equal to the tax per unit sold,
T, multiplied by the quantity sold, QT.
• But a portion of the loss to producers and
consumers from the tax is not offset by a gain to the
government.
• The deadweight loss caused by the tax represents
the total surplus lost to society because of the tax—
that is, the amount of surplus that would have been
generated by transactions that now do not take
place because of the tax.
The Deadweight Loss of a Tax
Price
S
Deadweight loss
P
Excise tax = T
P
P
C
E
E
P
D
Q
T
Q
E
Quantity
Are There Pareto Efficient Tax
Structures?


Lump sum taxes do not depend on the
consumed quantities so they are not
considered distortionary
Effects of lump sum taxes
Initially D and S do not move
 Depending how the government uses tax
proceeds, demand can move anywhere
(e.g. transfers to poor family shift demand
rightwards)

Lump Sum Taxes

Lump sum taxes are a convenient
means of income redistribution if
information on preferences is perfect

Able individuals will prefer not to
disclose information on their ability to
avoid higher taxation
Inelastic Supply of Factors

Taxing inelastic supply results in zero
DWL (verify)
Distortionary Taxation and
Pareto Efficiency

Equilibrium without taxation or lump
sum taxation: point A

Utilitarian equilibrium:


Point B under lump sum or no
taxation (utility possibilities frontier
PP) and redistribution by the
government
P
R
Rawlsian equilibrium: point D

Why is the distortionary taxation
utility possibilities frontier backward
bending?
Points C and D correspond to higher
social welfare compared to A
Utility
Possibilities
Frontier
A
C
Point C under distortionary taxation
(utility possibilities frontier RR) and
redistribution by the government


High income utility
B
D
R
Tax-distorted Utility
Possibilities Frontier
Low P
income
utility
Progressive Taxes: Case of
Sweden
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Dramatic increase in progressivity of income taxes in
1970s
Disposable incomes leveled out between high- and
low-income earners
But: interest payments tax deductible
 More incentives for the rich to take out loans
 Wealth distributed back to the rich in value of
owner-occupied housing
Progressive Taxation and
Welfare Maximization

In Sweden, income taxes became very progressive in 1970s

The idea was to redistribute tax proceeds from high income households to the
poor households

However, it is not clear whether poor households gained from this policy


Interest payments in Sweden are tax deductible

As a consequence, the opportunity cost of not applying for a mortgage loan to buy a
house are high

Wealthy people increase their demand for the housing driving up real estate prices

Since the wealth got redistributed back to the rich households, it is not clear whether
the sharpening of progressive taxation worked or not
Englund and Persson (1982): not clear who the
are
winners and losers
Can Taxation be Pareto Optimal?

In general, the government can redistribute income
from high-income groups to low-income groups by
raising (distortionary) tax revenue

In some cases (see previous slide) distortionary
taxation combined with redistribution of tax proceeds
may be a Pareto improvement compared to no
taxation (compare points C and D with A)

However, lump sum redistributions if such are
possible would yield even higher welfare levels
Intergenerational Equity

It is also possible to draw a utility
possibilities frontier between generations
of individuals (see the graph)

What is a fair intergenerational
distribution?



Current generations may use too much
scarce non-renewable resources (crude oil
for example), but how can we determine
each generation’s fair share of oil?
A diversification approach suggests
producing at the utility possibilities frontier
giving the largest potential for
intergenerational transfers
Utility of current generations
Utilitarian
Rawlsian
The problem of discount rates


How can we value consumption of future
generations in terms of today’s prices?
Utilitarian approach: zero discount rate


The problem of excess demand for
consumption today (no incentives to save for
the future)
Zero discount rate is not possible because
we do not know how many generations there
will exist (in that case we must use a nonzero positive discount rate)
Utility of future generations
Paretians and Libertarians

Pareto principle claims that if everyone prefers state A to state B
the whole society prefers state A to state B

Liberalism says that, irrespectively of the social welfare function,
certain choices should be left to individuals themselves
(sleeping on the back or on the belly for example)

Even if Pareto improvement is possible by making the
individuals choose actions that maximize the social welfare
function, libertarians would deny such an improvement

Is it possible to be both a Paretian and a libertarian?