Transcript Lecture 7 - UBC Blogs

Economics 101
Principles of microeconomics
Externalities, Public Goods & Common Resources
2 0 1 6 FA L L T E R M
LEC T UR E 7
CHA PT ER 1 7
Content
Distinguish among private goods, public goods, and
common resources
Explain how the free-rider problem arises and how the
quantity of public goods is determined
Explain the tragedy of the commons and its possible
solutions
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Classification of goods
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Classifying Goods and Resources
◦ Goods, services and resources differ in the extent to which
people can be
◦ excluded from consuming them
◦ extent to which one person’s consumption rival other
people’s consumption.
◦ Goods, services, and resources can be classified according to
whether they are
◦ excludable or non-excludable
and
◦ rival or non-rival.
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Classifying Goods and Resources
Excludable
◦ A good is excludable if only the people who
pay for it are able to enjoy its benefits.
◦ Ex: Brink’s security services, Aquaculture’s
Farm fish, and a Coldplay concert.
Non-Excludable
◦ A good is non-excludable if it is impossible
(or extremely costly) to prevent anyone from
benefiting from it.
◦ Ex police, fish in the Pacific Ocean, and a
concert on network television
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Classifying Goods and Resources
Rival
◦ A good is rival if one person’s use of it decreases the quantity
available for someone else.
◦ Ex: Brink’s truck can’t deliver cash to two banks at the same
time. A fish can be consumed only once.
Non-Rival
◦ A good is non-rival if one person’s use of it does not decrease
the quantity available for someone else.
◦ Ex: services of the police keep us safer and a concert on
network television are non-rival.
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Classifying Goods and Resources
A Four-Fold Classification
◦ Private Goods
◦ A private good is both rival and excludable.
◦ A bottle of Coke and a fish on
Aquaculture’s Farm
◦ Public goods
◦ A public good is both non-rival and nonexcludable.
◦ A public good can be consumed
simultaneously by everyone, and no one
can be excluded from its benefits.
◦ National defense.
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Classifying Goods and Resources
Common Resources
◦ A common resource is rival and non-excludable.
◦ A unit of a common resource can be used only once, but no
one can be prevented from using what is available.
◦ common - Ocean fish
◦ rival - fish taken by one person isn’t available for anyone else.
◦ non excludable - difficult to prevent people from catching
them.
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Classifying Goods and Resources
Natural Monopoly Goods
◦ Natural monopoly – result of industry where there are high
fixed costs of distribution, such as exist when large-scale
infrastructure is required to ensure supply.
◦ Ex: cell phone firms
◦ natural monopoly good is non-rival and excludable.
◦ Ex: special case of natural monopoly arises when the good or
service can be produced at zero marginal cost. (wireless
charge!|)
◦ Such a good is non-rival. If it is also excludable, it is produced
by a natural monopoly.
◦ Ex: Internet and cable television.
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Classifying Goods and Resources
four-fold classification of goods and services.
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Public Goods
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Public Goods Defined
Pure public goods share two characteristics
◦ non-rival – Cost of another person consuming the good is zero
◦ non-excludable – Very expensive to prevent others from
consuming the good
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Examples of public and private goods
Public Goods
◦ National defense
◦ House cleaning in an
apartment with many
roommates
◦ Fireworks display
◦ Music file sharing
◦ Uncongested freeway
Private goods
◦
◦
◦
◦
Pizza
Health care
Congested freeway
Public housing
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Valuation of public goods
Everyone consumes same quantity of public good
Marginal benefit of public good varies by person
◦ In the housecleaning example, different roommates value the
clean apartment differently.
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Impure public goods
Most goods that are thought of as public goods may not strictly
satisfy the non-rival or non-excludable assumption.
◦ A scenic view is a public good without congestion, but the
quality diminishes as more the number of sightseers increases.
◦ Thus, a scenic view becomes rival.
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Public Goods
Why does the government provide weather forecasting?
◦ Environment Canada!
Why don’t we buy it in the marketplace, as we buy hamburgers?
◦ The answer is: Weather forecasting is a public good and has a
free-rider problem.
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Public Goods
The Free-Rider Problem
◦ A free rider enjoys the benefits of a good or service without
paying for it.
◦ Because no one can be excluded from the benefits of a public
good, everyone has an incentive to free ride.
Public goods create a free-rider problem.
◦ A free-rider problem is that the market would provide an
inefficient quantity of the public good.
◦ Marginal social benefit from a public good would exceed its
marginal social cost and a deadweight loss would be created.
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Consider a fireworks display as a public good – it is non-rival and nonexcludable.
Bigger displays give higher benefit.
Public good: holding Q constant, add together individual willingness-topay to get P.
Vertical summation.
Efficiency in public goods
market
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Vertical summation.
Efficiency in public goods
market
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Everyone consumes the same quantity, Q
Individual’s marginal benefit varies.
Efficiency requires that the sum of individual marginal benefits equals the
marginal cost.
Efficiency in public goods
market
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Although a competitive market will provide private goods efficiently, will
the same be true for public goods?
People may have incentives to hide their true preferences for a public
good.
◦ If Adam can get Eve to pay for the public good, he can use his income
for other purposes and still enjoy the public good.
Problems in the Efficiency in
public goods market
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This incentive to let others pay for the public good while still enjoying the
benefits is known as the “free rider problem.”
◦ The private market may therefore fall short of providing the efficient
amount of the public good. Make sure you know why!
◦ This incentive to free ride occurs because the public good is non-rival
and non-excludable.
◦ A person gets to consume the good even if they do not pay for it.
Problems in the Efficiency in
public goods market
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Government intervention can potentially lead to a more efficient
outcome.
◦ Government can use coercive power to force people to pay for public goods,
through taxation.
◦ Free riding is not always the case!
◦ Do it for the right reasons!
Solutions to the free
rider problem
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Privatization debate
Privatization means taking services that are supplied
by the government and turning them over to the
private sector for provision and/or production.
Examples with competing public/private provision
include policing, parks, and even the judicial system.
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Private production
Even if there is agreement that the public sector should provide a
good, it is not clear whether the public sector should produce it.
◦ Airport security workers are a timely example.
◦ Public sector managers may not have a strong incentive to control
costs because of the lack of profit motive or fears of takeovers or
bankruptcy.
◦ Quality of public services may be higher, however. This is more
relevant when contracts are incomplete.
◦ Consider Public goods – education? Health care?
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Recap of public goods
Public good definition
Derivation of aggregate demand curves
Inefficient provision of public goods
Free rider problem
Public versus private provision
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◦ Liz and Max the only people is an imagined society value weather
forecasts.
◦ Look at your textbook example too!
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Public Goods
Rational Ignorance
◦ FYI
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Tragedy of the commons
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Do you think that privatizing resources leads to more or less ecological
degradation?
◦ What are your reasons?
◦ Choose an instance, one way or the other, and play it out showing how
privatization did or didn’t lead to more resource depletion,
degradation or pollution.
Consider
◦ Should we privatize the atmosphere? The oceans? All the worlds fresh
water? The ozone layer?
◦ who should the key players be in the control, individual and collective of
common or private property?
◦ … to what social institutions would people appeal to if someone abused
their private property in such a way as to cause environmental
degradation of social health problems “downstream?”
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Tragedy of the Commons
Tragedy of the Commons is a
phrase used to refer to the conflict
for resources between individual
interests and the common good
(i.e., society).
The term was made popular by
Hardin in his 1968 essay The
Tragedy of the Commons.
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Tragedy of the Commons
Tragedy of the Commons suggests
that free access and unrestricted
demand for a finite resource
ultimately dooms the resource
through its over-exploitation.
Occurs because
◦ benefits of exploitation accrue to
individuals who are motivated to
maximize use of the resource
◦ costs of exploitation are distributed
between all those to whom the
resource is available.
individual benefits while the
group pays for the use,
extraction and
consequences.
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Tragedy of the Commons
Examples
◦ overuse basis public good being rival but non-excludable
◦ Overuse of parks
◦ Smog in cities – too many people driving or driving too much
◦ Congestion on the web – using up too much bandwidth
◦ Highways
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Common Resources: Sustainable
Curve
Unsustainable Use of a Common Resource
◦ Many common resources are renewable—they replenish
themselves by the birth and growth of new members of the
population.
◦ A common resource is being used unsustainably if its rate of
use persistently decreases its stock.
◦ A common resource is being used sustainably if its rate of use
is less than or equal to its rate of renewal so that the stock
either grows or remains constant.
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Common Resources: Sustainable
Curve
◦ As the stock of fish
increases, the sustainable
catch increases to a
maximum.
◦ As the stock increases
further, the fish must
compete for food and the
sustainable catch falls.
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Common Resources: Sustainable
Curve
◦ If the catch is less than the
sustainable catch at a given
stock, such as point Z, the
fish stock grows.
◦ If the catch exceeds the
sustainable catch at a given
stock, such as point A, the
fish stock shrinks.
◦ The SCC shows the
sustainable catch and an
unsustainable catch for a
given stock that keeps the
stock unchanged.
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Common Resources: MB & MC
(private and social)
The Overuse of a Common
Resource
◦ Why does overfishing
occurs?
◦ The supply curve is the
marginal private cost curve,
MC.
◦ The demand curve is the
marginal social benefit curve,
MSB.
◦ Market equilibrium occurs at
800,000 tonnes per year and
$10 a kilogram.
Private
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Common Resources: MB & MC
(private and social)
The Overuse of a Common
Resource
◦ Why does overfishing
occurs?
Private &
External
Cost –
Social Cost
◦ The marginal social cost
curve is MSC.
◦ The efficient quantity is
300,000 tonnes per year.
◦ At the market equilibrium,
there is overfishing and a
deadweight loss arises.
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Solutions to the Tragedy of the
Commons
Achieving an Efficient Outcome
◦ It is harder to achieve an efficient use of a common resource
than to define the conditions under which it occurs.
◦ The three main methods used to achieve the efficient use of a
common resource are
 Property rights
 Production quotas
 Individual transferable quotas (ITQs).
 Privatization
 polluter-pays
 regulation.
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Solutions to the Tragedy of the
Commons
Why do we need these?
Hardin argues against the reliance
on conscience as a means of
policing commons. Morals and
conscience would favour selfish
individuals over those more farsighted (i.e., people act for own
self-interest).
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Solutions to the Tragedy of the
Commons
◦ Property Rights
◦ By converting the common
resource to private property,
fishers face the full social
cost of their actions.
◦ The marginal social cost
curve becomes the supply
curve and the resource is
used efficiently.
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Solutions to the Tragedy of the
Commons
Production Quotas
◦ By setting a production
quota at the efficient
quantity, the resource
might be used efficiently.
◦ Figure 17.9 shows the
profit on the marginal
tonne of fish.
◦ A fisher who cheats will
increase his profit. There is
an incentive to overfish.
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Solutions to the Tragedy of the
Commons
Individual Transferable Quotas
◦ An individual transferable quota (ITQ) is a production limit that
is assigned to an individual who is free to transfer (sell) the
quota to someone else.
◦ A market in ITQs emerges.
◦ If the efficient quantity of ITQs is assigned, the market price of
an ITQ confronts resource users with a marginal cost equal to
MC + price of ITQ.
◦ With MC + price of ITQ equal to MSB, the quantity produced is
efficient.
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Solutions to the Tragedy of the
Commons
◦ Figure 17.10 shows the
situation with an efficient
number of ITQs.
◦ The market price of an ITQ
increases the marginal
social cost to
MC + price of ITQ.
◦ Users of the resource make
MSB equal
MC + price of ITQ, and the
outcome is efficient.
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Toll Highways
Toll on Highways
The Tragedy of the Commons is often used proponents of
free trade and market-based strategies.
The example is a toll-road (ETR407) versus a governmentmaintained road (Highway 401). The 401 is congested,
while ERT407 has less traffic.
If roads were privately owned, owners would charge tolls
and people would take the toll into account in deciding
whether to use them. Owners of private roads would
engage in peak-load pricing (i.e., charging higher prices
during times of peak demand and lower prices at other
times).
When governments own roads financed with tax dollars,
tolls are not normally charged. The government makes
roads into a commons. The result is congestion.
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Cap & Trade:
Emissions Trading Systems
Also known as cap and trade – market-based
In order to pollute a specific amount (say 10
tons), companies have to hold that number of
allowances, or credits (10 tons of credits).
An overall regional cap is placed on the number
of allowances, to ensure good air quality. Cap can
be lowered over time to improve air quality.
Companies that need to increase their emission
allowances must buy credits from those who
pollute less.
The transfer of allowances is referred to as a
trade.
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Cap & Trade:
Emissions Trading Systems
Examples:
◦ U.S. national cap-and-trade system for sulfur dioxide, established under
the Acid Rain Program of the 1990 Clean Air Act (first cap-and-trade
system in the U.S.)
◦ Texas banking & trading system for precursors that form the air
pollutant ground-level ozone (nitrogen oxides and volatile organic
compounds)
◦ http://www.tceq.texas.gov/airquality/banking/banking.html
◦ Baseline and credit program – each company has a regulatory limit.
Companies can bank and sell credits if they reduce pollution below
their regulatory limit.
◦ European Union trading scheme for greenhouse gases
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Triple Bottom Line
Triple bottom line accounting: expanding
the traditional reporting framework to
take into account ecological and social
performance in addition to financial
performance
Company’s responsibility is to
stakeholders, not only shareholders.
Requires a corporate commitment to
social responsibility.
Who would stakeholders be?
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questions
Posted later!
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End of slides
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