696 PART • Information, Market Failure, and the Role of Government But will the preference of the median voter be the efficient level of spending? In this case yes, because $1200 is efficient But the preference of the median voter is often not the efficient spending level Suppose the third citizen’s preferences were the same as the second’s In that case, although the median voter’s choice would still be $1200 per pupil, the efficient level of spending would be less than $1200 (because the efficient level involves an average of the preferences of all three citizens) In this case, majority rule would lead to too much spending on education If we reversed the example so that the first and second citizens’ preferences were identical, majority rule would generate too little educational spending Thus, although majority-rule voting allows the preferences of the median voter to determine referenda outcomes, these outcomes need not be economically efficient Majority rule is inefficient because it weighs each citizen’s preference equally: The efficient outcome weighs each citizen’s vote by his or her strength of preference SUMMARY An externality occurs when a producer or a consumer affects the production or consumption activities of others in a manner that is not directly reflected in the market Externalities cause market inefficiencies because they inhibit the ability of market prices to convey accurate information about how much to produce and how much to buy Pollution is a common example of an externality that leads to market failure It can be corrected by emissions standards, emissions fees, marketable emissions permits, or by encouraging recycling When there is uncertainty about costs and benefits, any one of these mechanisms can be preferable, depending on the shapes of the marginal social cost and marginal benefit curves Sometimes it is the accumulated stock of a pollutant, rather than current level of emissions, that causes damage An example of such stock externality is the buildup of greenhouse gases, which may lead to global warming Inefficiencies due to market failure may be eliminated through private bargaining among the affected parties According to the Coase theorem, the bargaining solution will be efficient when property rights are clearly specified, when transactions costs are zero, and when there is no strategic behavior But bargaining is unlikely to generate an efficient outcome because parties frequently behave strategically Common property resources are not controlled by a single person and can be used without a price being paid As a result of free usage, an externality is created in which current overuse of the resource harms those who might use it in the future Goods that private markets are not likely to produce efficiently are either nonrival or nonexclusive A good is nonrival if for any given level of production, the marginal cost of providing it to an additional consumer is zero A good is nonexclusive if it is expensive or impossible to exclude people from consuming it Public goods are both nonrival and nonexclusive A public good is provided efficiently when the vertical sum of the individual demands for the good is equal to the marginal cost of producing it Majority-rule voting is one way for citizens to voice their preference for public goods Under majority rule, the level of spending provided will be that preferred by the median voter This level need not be the efficient outcome QUESTIONS FOR REVIEW Which of the following describes an externality and which does not? Explain the difference a A policy of restricted coffee exports in Brazil causes the U.S price of coffee to rise—an increase which in turn also causes the price of tea to rise b An advertising blimp distracts a motorist who then hits a telephone pole Compare and contrast the following three mechanisms for treating pollution externalities when the costs and benefits of abatement are uncertain: (a) an emissions fee, (b) an emissions standard, and (c) a system of transferable emissions permits When externalities require government intervention? When is such intervention unlikely to be necessary?