Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright ©...

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Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

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Page 1: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Public Goods, Externalities, and Information Asymmetries

Chapter 16

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Page 2: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill 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

Page 3: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Public Goods

• Private goods–Rivalry and excludability

• Public goods–Nonrivalry–Nonexcludability–Free-rider problem–No market demand

16-3

Page 4: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

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 vertically16-4

Page 5: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Demand for Public Goods

(1)QuantityOf Public

Good

(2)Adams’

WillingnessTo Pay (Price)

(3)Benson’s

WillingnessTo Pay (Price)

(4)Collective

WillingnessTo Pay (Price)

1

2

3

4

5

$4

3

2

1

0

$5

4

3

2

1

$9

7

5

3

1

+

+

+

+

+

=

=

=

=

=

Example: two individuals

Graphically…16-5

Page 6: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Demand for Public Goods$9

7

5

3

10

P

Q1 2 3 4 5

$654321

0

P

Q1 2 3 4 5

$6543210

P

Q1 2 3 4 5Adams

Benson

Collective Demand and Supply

D1

D2

DC

S

Adams’ Demand

Benson’s Demand

Collective Demand

$3 for 2 Items

$4 for 2 Items

$7 for 2 Items

$1 for 4 Items

$2 for 4 Items

$3 for 4 Items

Connect the Dots

CollectiveWillingness

To Pay

OptimalQuantity

16-6

Page 7: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

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

Page 8: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Externalities

• Market failure–Requires government action

• Negative externality–External cost–Overproduction

• Positive externality–External benefit–Underproduction

16-8

Page 9: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Externalities

Negative Externalities

Positive Externalities

0

D

S

St

Overallocation

NegativeExternalities St

Underallocation

PositiveExternalities

Qo QoQe Qe

P P

0 Q Q

D

Dt

16-9

Page 10: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Coase Theorem

• Externalities corrected by individual bargaining–Property ownership defined

–Small number people

–Bargaining costs negligible

• Limitations

• Liability rules and lawsuits16-10

Page 11: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Government Intervention

• Correct negative externality–Direct controls–Specific taxes

• Correct positive externality–Subsidize buyers or producers–Government provision

16-11

Page 12: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

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

Page 13: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Market for Pollution Rights

• Advantages• Real-world examples

D2008

D2018S=Supply of

PollutionRights

500 750 1000

$100

$200

P

0 Q

Pri

ce P

er P

ollu

tio

n R

igh

t

Quantity of 1-Ton Pollution Rights

16-13

Page 14: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Optimal Externality Reduction

• How much pollution abatement?• MC = MB

0

So

ciet

y’s

Mar

gin

al B

enef

it a

nd

Mar

gin

alC

ost

of

Po

llu

tio

n A

bat

emen

t (D

oll

ars)

Q1

MB

MC

SociallyOptimal AmountOf PollutionAbatement

16-14

Page 15: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Climate Change

• Earth has warmed over the last century

• Human activity contributing factor

• Carbon dioxide and greenhouse effect

• Kyoto Protocol 1997

• Climate change policies16-15

Page 16: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Climate Change

Carbon-Dioxide Emissions, Tons Per Capita, Selected Nations 2005

United StatesAustralia

CanadaCzech Republic

GermanyJapan

United KingdomSpain

ItalyFrance

0 5 10 15 20 25

Source: OECD Environmental Data16-16

Page 17: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Information Failures

• Asymmetric information• Inadequate buyer information

–Gasoline market–Licensing of surgeons

• Inadequate seller information–Moral hazard problem–Adverse selection problem–Workplace safety

• Qualification16-17

Page 18: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

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

Page 19: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Key Terms

• private goods

• public goods

• free-rider problem

• cost-benefit analysis

• marginal-cost-marginal-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

Page 20: Public Goods, Externalities, and Information Asymmetries Chapter 16 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

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Public Choice Theoryand the EconomicsOf Taxation

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