Transcript Lecture 20: Week 11: Chapter 11Externalities and Public Goods

Chapter 11
Externalities and
Public Goods
The role of Government
Externalities and Public Goods
• Externalities: Take different forms
– E.g. External costs of production, e.g. pollution
– Steel Factory S(K,L)
– Steel factory S(+,+)
– Steel Factory S(K,L) = S + DW
Fishery F(L,DW)
Fishery F(+, -)
Fishery F(L,DW) = F
Externalities and Public Goods
• Externalities
– External costs of production
– Steel Factory F(K,L) = S + DW
– Fishery F(L,DW)
So Steel Production Up, DW up
Fish down
What happens if the steel factory
does not take this into account?
Externalities and Public Goods
So Steel Production Up, DW up
Fish down
What happens if the steel factory does
not take this into account?
Selling Steel at price PS
‘Selling’ pollution at price 0
(don’t have to pay to get rid of it!)
And get too much steel and too little fish
Saw before firms hire workers and capital people up
to the point that
dQ
MRPL  PS
 W  MC L
dL
But if had to clean up the dirty water
dQ
MRPL  (PS  PDW )
W
dL
dQ
dQ
PS
 W  PDW
dL
dL
Saw before firms hire workers and capital people up
to the point that
dQ
dQ
MRPL  PS
 W  PDW
dL
dL
So to get the benefit of the steel
(MRPL), the real cost of producing is
wage plus the clean up cost of the
extra pollution
So for Capital and labour
dQ
dQ
MRPL  P
 W  PDW
dL
dL
dQ
dQ
MRPK  PS
 r  PDW
dK
dK
• So we say MC of steel is less than
• the MSC of steel
• I.e. MC<MSC
THE CASE FOR GOVERNMENT INTERVENTION
• Externalities
– External costs of production
MSC > MC
External costs in production
Costs and benefits
MC = S
P
D
O
Q1
Quantity
External costs in production
Costs and benefits
MSC
P
MC = S
D
External cost
O
Q1
Quantity
External costs in production
Costs and benefits
MSC
P
MC = S
D
O
Q2
Social optimum
Quantity
Q1
THE CASE FOR GOVERNMENT INTERVENTION
• Externalities
– External costs of production
MSC > MC
– External benefits of production
MSC < MC
Orchard
Training
and Honey
External benefits in production
Costs and benefits
MC = S
P
O
D
Q1
Quantity
External benefits in production
Costs and benefits
MC = S MSC
External benefit
P
O
D
Q1
Quantity
External benefits in production
Costs and benefits
MC = S MSC
P
O
D
Q1
Quantity
Q2
Social optimum
THE CASE FOR GOVERNMENT INTERVENTION
• Externalities
– External costs of production
MSC > MC
– External benefits of production
MSC < MC
– External costs of consumption
MSB < MB
Loud
parties on Dawlish Road
Costs and benefits
External costs in consumption
P
D
(MB)
MU = D
O
Q1
Quantity
Costs and benefits
External costs in consumption
External cost
P
D
(MB)
MU = D
MSB
O
Q1
Quantity
Costs and benefits
External costs in consumption
P
D
(MB)
MU = D
MSB
O
Social optimum
Q2
Q1
Quantity
THE CASE FOR GOVERNMENT INTERVENTION
• Externalities
– External costs of production
MSC > MC
– External benefits of production
MSC < MC
– External costs of consumption
MSB < MB
– External benefits of consumption
MSB > MB
Toothpaste
Costs and benefits
External benefits in consumption
P
D
(MB)
MU = D
O
Q1
Quantity
External benefits in consumption
Costs and benefits
External benefit
P
D
MSB
(MB)
MU = D
O
Q1
Quantity
Costs and benefits
External benefits in consumption
P
D
MSB
(MB)
MU = D
O
Q1
Quantity
Q2
Social optimum
PUBLIC GOODS
• Goods which are ‘non-rival’ and ‘nonexclusive’
• Non-rival/Exclusive- my consumption does
not preclude yours
– e.g. Concert
• Non-exclusive/Rival – cannot limit access
e.g. breathing in air
•
Non-rival and non-exclusive
–street lighting: A Public Good
Public Goods
Marginal benefit from Streetlignts
Dr. Jeckyl
O
Q1
Quantity
Maureen
Hyde
O
Q1
Quantity
Public Goods
Marginal benefit from Streetlignts
Dr. Jeckyl
O
Q1
Quantity
Maureen
Hyde
O
Q1
Quantity
So more provision
of public good
desirable at lower
per capita price
MC
Marginal benefit from Streetlignts
P1
Dr. Jeckyl
MC
O
Q1
P2
Maureen
Hyde
P1
O
MC
Q1
Quantity
Q1 QS