Transcript Primary and Distorted Markets

Civil Systems Planning
Benefit/Cost Analysis
Chapters 4 and 5
Scott Matthews
Courses: 12-706 and 73-359
Lecture 5 - 9/15/2003
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Announcements
Homework 1 Due Today
Will insert 2 lectures (wed, next Monday)
Syllabus adjusted on web
Guest Lecturer next Wed
12-706 and 73-359
2
Externalities
Recall that external effects happen to third
parties (non-consumers, producers)
Cause distortions in the market
Are by-products with no markets
Since number of externalities is large,
CBA can/should be used before
government intervenes to correct
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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
4
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
6
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
administrative costs of program12-706 and 73-359
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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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Quantity
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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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Quantity
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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)
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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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