Transcript Market Failure

Market Failure (?):
Public Goods, Common Property &
Externalities
Dr. D. Foster
Microeconomics
When do markets fail?
When will even perfectly competitive
markets fail to produce the allocatively
efficient level of output?
•
•
•
•
Public goods
Common property
Positive externalities
Negative externalities
Public Goods
Non-rival in consumption
One person doesn’t use it up.
Non-excludable
Non-payers can’t be (easily) excluded.
•
•
•
•
•
For example:
National defense
Legal system
Lighthouses
TV and radio
Roads
Public Goods
Not all “publicly-provided” goods
meet the test of being public goods.
For example:
•
•
•
•
Education
Trash collection
Social security
National parks . . .
• Roads & lighthouses !
• The legal system ?!
Public Goods
Non-excludability problem
leads to free riders.
How do markets deal with this problem?
• “Charge” differently
- TV & radio ads
• Find way to exclude
- TV & cable/satellite
• Tie-in sales
- lighthouses
- shopping malls
- gated communities
Graphical Analysis
Price
Price
Price
$10
$10
$5
$5
MC
$3
15
Tom
Quantity
Quantity
25
Sally
40
Quantity
The Market
For private goods, the market demand is the
horizontal summation of individual demands.
Everyone pays the same price,
consumes differing amounts
$
$15
Graphical
Analysis
$11
MC
$
20
Q
The Market
$10
$8
Q
$
20 Sally
$5
$3
20
Q
Tom
For public goods, the
market demand is the
vertical summation of
individual demands.
Everyone consumes
the same amount,
pays differing prices.
Caveats
Government provision may not be desirable:
--The free rider problem is replaced with the
forced rider.
--Government may be inefficient, imposing
higher costs such that we would be better
off without this good/service!
Common Property

Weak incentive to preserve/protect.
Weak incentive to maximize value.
Who owns common property?

Fish in the ocean


This is another free rider problem.
Common Property
Supply
P
D1
D2
P1
Q1
Qmx
Q*
Q2
Q - Fish
Common Property

What to do?
-- Assign private property rights.
-- Regulate use . . .
-standards,
-limits,
-prohibit.
Some observations

Elephants in Africa
1970s - 1.2 million
1980s - 600,000
With property rights
2007
1970s
2000
Zimbabwe 30,000
70,000
Botswana 20,000
68,000
150,000
Without prop. rts.
Kenya
140,000
16,000
Tanzania 250,000
61,000
Uganda
20,000
1,600
Can markets really work?
What about non-renewable resources?

Hotelling Principle:
People treat exhaustible resources like any
asset and want to max. value over time.
P
S”
S’
S
The Simple Version - We
can’t run out of . . .
D
Q
Hotelling Principle

The more complicated story:



Asset value must grow at the market rate of
interest to find equilibrium extraction.
If asset value grows more slowly, extraction.
If asset value grows faster, extraction.
%
r'
i = market return
r = asset return
If we start “running out?”
r
i
Q’
Q*
Q
Positive Externalities


Some “consumers” benefit w/out paying.
-- concert
-- flower garden
-- flu shot
What to do?
-- Nothing.
-- Subsidize producer/consumer
- there is a cost to this!
Positive Externalities
P
S
P1
MSB
D = MPB
Q
Q1
Q2
To promote allocatively efficient level of output,
subsidize by the vertical distance.
Negative Externalities


Third parties bear part of the cost without
receiving any of the benefit.
-- In the case of pollution:
the firm is facing zero-priced waste disposal.
How do we deal with this problem?
-- Tax the producer/consumer.
-- Set standards/quotas for pollution.
-- Allow parties to negotiate.
-- Sell pollution rights.
Pollution - Tax & Standard
MSC
P
S = MPC
Tax raises costs;
 production.
Quota on
production would
(might?) serve the
same purpose.
P1
D = MPB
Q
Q2 Q 1
Standards for
pollution would also
raise costs and
 production.
Pollution & The Coase Theorem

Assign property rights to the resource (!)

It doesn’t matter who gets the right . . .
Is zero the “right” level of pollution?
$
MC
NO !!!
MB
Q*

Quantity
of
pollution
Problems: Holdouts and Free Riders
The Free Rider Problem
$
MC
MB
$1000
$400
0

Q*
Qm
Quantity
of
pollution
The firm owns the rights . . .
The Holdout Problem
$
MC
$20,000
MB
0

$2000
Q*
Qm
Quantity
of
pollution
The downstream users own the rights . . .
Selling Pollution Rights (!)
Reduce Pollution by 3 Units
Cost to
Firm X Firm Y
reduce by:
Firm Z
1st unit
$50
$70
$800
2nd unit
$75
$130
$1000
3rd unit
$100
$200
$2000
How? Cost? Price of permits? Issue 2 each?
Reduce Pollution by 3 Units

Cut back equally (by 1 unit each):


Cut back most cheaply (by 3 units total):


Cost = $50 (X) + $70 (Y) + $75 (X) = $195
Charge a price of . . .


Cost = $50 + $70 + $800 = $920
$90 per permit.
Give out 2 each . . .

Firm Z will buy 1 from X.
Market Failure (?):
Public Goods, Common Property &
Externalities
Dr. D. Foster
Microeconomics