Transcript Externalities 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, pollution
– Steel Factory S(K,L), output increases in K and
L: S(+,+)
– But S(K,L) = S+DW
Fishery F(L,DW)=F
Fishery 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
(doesn’t have to pay to get rid of it)
We get too much steel and too little fish
We know that firms hire workers and capital
according to the rules:
dQ
MRPL  PS
 W  MC L
dL
If steel producer 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 untill
dQ
dQ
MRPL  PS
 W  PDW
dL
dL
So the real (social) 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
THE CASE FOR GOVERNMENT INTERVENTION
• So we say MC of steel is less than the MSC
(marginal social cost) of steel:
(W=) MC<MSC (=W+”cleanup cost”)
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
Training
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
PUBLIC GOODS
• Goods which are ‘non-rival’ and ‘nonexclusive’
• Non-rival/Exclusive - my consumption does
not preclude yours, but you can be
prevented from consuming by the producer.
e.g. Concert
• Non-exclusive/Rival – cannot prevent you
from consuming, but your consumption (in
principle) precludes mine
e.g. drinking water from a public lake
PUBLIC GOODS
•
Non-rival and non-exclusive:
Cannot prevent access (for
practical purposes) and
consumption of one doesn’t
preclude consumption by someone
else.
–street lighting: A Public Good
Public Goods
Marginal benefit from Street lignts
Dr. Jeckyl
O
Q1
Quantity
Mr. Hyde
O
Q1
Quantity
Public Goods
Marginal benefit from Streetlignts
Dr. Jeckyl
O
Q1
Quantity
Maureen
Hyde
O
Q1
Quantity
Pricing at marginal
costs is not
socially optimal –
even if it is
possible (see next
slide).
MC
Marginal benefit from Street lignts
P1
Dr. Jeckyl
MC
O
Q1
P2
Mr. Hyde
P1
O
MC
Q1
Quantity
Q1 QS
Who pays ?
• The firm might sell to “the first person” –
charging at the marginal cost and using this
person’s demand function.
• This won’t work. First of all, it is not likely
that anyone will actually pay (why not just
wait for someone else to pay ?)
• Moreover, as shown on the previous slide,
this would not be socially optimal.