Chapter 16 - Public goods, externalities, and information asymmetries. After completing this unit, you should be able to: Public goods vs. private goods, the optimal quantity of a public good, cost-benefit analysis, externalities, information failures and government intervention.
Chapter 16 Public Goods, Externalities, and Information Asymmetries McGrawHill/Irwin Copyright © 2009 by The McGrawHill Companies, Inc. All rights reserved Chapter Objectives • Public goods vs private goods • The optimal quantity of a public good • Cost-benefit analysis • Externalities • Information failures and government intervention 16-2 Public Goods • Private goods – Rivalry and excludability • Public goods – Nonrivalry – Nonexcludability – Free-rider problem – No market demand 16-3 Optimal Quantity of a Public Good • Supplied by the government • Government estimates demand • Compare marginal benefit to marginal cost • Demand for a public good – Sum individual willingness to pay – Sum vertically 16-4 Demand for Public Goods Example: two individuals (1) Quantity Of Public Good (2) Adams’ Willingness To Pay (Price) (3) Benson’s Willingness To Pay (Price) (4) Collective Willingness To Pay (Price) $4 + $5 = $9 + = + = + = + = Graphically… 16-5 Demand for Public Goods P S Collective Demand $9 $7 for Items $3 for Items DC Collective Demand and Supply Benson’s Demand $4 for Items $2 for Items Adams’ Demand $3 for Items $1 for Items Collective Willingness To Pay Connect the Dots Optimal Quantity P $6 P $6 Q D2 Benson Q D1 Adams Q 16-6 Cost-Benefit Analysis • • • • Provide a public good? How much should be provided? Resources are limited Marginal-cost-marginal-benefit rule • Allocate government resources to maximize net benefit 16-7 Externalities • Market failure – Requires government action • Negative externality – External cost – Overproduction • Positive externality – External benefit – Underproduction 16-8 Externalities P P Negative Externalities St St Positive Externalities S Dt D D Overallocation Qo Qe Negative Externalities Q Underallocation Qe Qo Q Positive Externalities 16-9 Coase Theorem • Externalities corrected by individual bargaining – Property ownership defined – Small number people – Bargaining costs negligible • Limitations • Liability rules and lawsuits 16-10 Government Intervention • Correct negative externality – Direct controls – Specific taxes • Correct positive externality – Subsidize buyers or producers – Government provision 16-11 Market Based Approach • Tragedy of the commons – Resource lacks defined ownership – Air, lakes, etc – No incentive to maintain • Market for externality rights – Right to pollute – Can be bought and sold 16-12 Market for Pollution Rights • Advantages • Real-world examples Price Per Pollution Right P $200 D2008 D2018 S=Supply of Pollution Rights $100 500 750 1000 Q Quantity of 1-Ton Pollution Rights 16-13 Optimal Externality Reduction • How much pollution abatement? • MC = MB Society’s Marginal Benefit and Marginal Cost of Pollution Abatement (Dollars) MC Socially Optimal Amount Of Pollution Abatement MB Q1 16-14 Climate Change • Earth has warmed over the last century • Human activity contributing factor • Carbon dioxide and greenhouse effect • Kyoto Protocol 1997 • Climate change policies 16-15 Climate Change Carbon-Dioxide Emissions, Tons Per Capita, Selected Nations 2005 10 15 20 25 United States Australia Canada Czech Republic Germany Japan United Kingdom Spain Italy France Source: OECD Environmental Data 16-16 Information Failures • Asymmetric information • Inadequate buyer information – Gasoline market – Licensing of surgeons • Inadequate seller information – Moral hazard problem – Adverse selection problem – Workplace safety • Qualification 16-17 Lojack: A Case of Positive Externalities • Crime reduction expenditures $300 billion – Some redistribute vs reduce crime • Lojack car recoveries 95% vs 60% • External benefits – Catch thieves – Locate and stop chop shops • MSB 15 times the MC – Underallocation – Policy to encourage use of Lojack? 16-18 Key Terms • • • • • private goods public goods free-rider problem cost-benefit analysis marginal-costmarginal-benefit rule • externalities • Coase theorem • tragedy of the commons • market for externality rights • optimum reduction of an externality • cap-and-trade program • climate-change problem • asymmetric information • moral hazard problem • adverse selection problem 16-19 Next Chapter Preview… Public Choice Theory and the Economics Of Taxation 16-20 ... externality • cap-and-trade program • climate-change problem • asymmetric information • moral hazard problem • adverse selection problem 1 6- 19 Next Chapter Preview… Public Choice Theory and the Economics. .. Underallocation – Policy to encourage use of Lojack? 1 6- 18 Key Terms • • • • • private goods public goods free-rider problem cost-benefit analysis marginal-costmarginal-benefit rule • externalities • Coase... P $6 Q D2 Benson Q D1 Adams Q 1 6- 6 Cost-Benefit Analysis • • • • Provide a public good? How much should be provided? Resources are limited Marginal-cost-marginal-benefit rule • Allocate government