P
Q
S =Marginal Social Cost (MSC) =Marginal Private Cost (MPC)
D =Marginal Social Benefit (MSB) =Marginal Private Benefit (MPB)
P
Q
When Markets Work(a) Producers are responsible for all costs & those costs are reflected in the price of the good or service.
The private costs and social costs are both reflected in the
supply curve
P
Q
S=Marginal Social Cost (MSC) =Marginal Private Cost (MPC)
D =Marginal Social Benefit (MSB) =Marginal Private Benefit (MPB)
P
Q
When Markets Work(a) Producers are responsible for all costs & those costs are reflected in the price of the good or service.
(b) Paying customers are the only beneficiaries of the good or service.
The private benefits and social benefits are both reflected in
the demand curve
When Markets Don’t Work
Market FailureExternalities
When someone other than the buyer and seller receives a cost or benefit for which they didn’t ask/pay
When Markets Don’t Work
Market FailureExternalities
AKA
or Third Party Spillover
Costs/Benefits
Negative Externality (or spillover)
Example:
Factory pollution contaminating water supply
The firm is passing on – externalizing- the cost to villagers
Negative Externality
Example: Factory Pollution
P
Q
Marginal Private Cost (MPC)
D =Marginal Social Benefit (MSB) =Marginal Private Benefit (MPB)
Pmarket
Qm
Marginal Social Cost (MSC)
Psocial
Qso
MSC > MPC
There is an OVERALLOCATION (making too much) of the good at too low a price
Negative Externality
Why is this bad?
P
Q
MPC
MSB
Pm
Qm
Pso
Qso
MSC
TO FIND THE AREA OF THE DEADWEIGHT LOSS FOLLOW THE MARKET Q UP TO THE MSC CURVE. IT’S THE AREA BETWEEN MSC, MSB AND QMARKET
Deadweight loss
Negative Externality
P
Q
MPC
MSB
Pm
Qm
Pso
Qso
MSC
TO FIND THE AREA OF THE DEADWEIGHT LOSS FOLLOW THE MARKET Q UP TO THE MSC CURVE. IT’S THE AREA BETWEEN MSC, MSB AND QMARKET
Deadweight lossWhy is this bad?Why does this happen?
Where there is no clear ownership of rights to a natural resource, the users of the resource are
likely to overexploit it.
Drilling for Oil
http://www.petroleum.co.uk/geograph/page4.htm
Pump as much oil as fast as you can to get theoil before someone else does--
Private Bathroom in Doctor’s office
Access is restricted
Clean, decorated, well stocked
Public High School Bathroom
Possible Solutions:
Negative Externality
Property Rights: establishing ownership can provide motivation to include external costs into the price
http://ens.lycos.com/ens/oct2000/2000L-10-16-15.html
http://www.fayettevilleobserver.com/news/archives/1998/tx98aug/n19buff.htm
You better quick and hunt them before someonebeats you to the punch.
The hunters shootthe buffalo.
The herdsget smaller.
Barb wire saved the buffalo by establishingproperty rights at a relatively low cost. Prior tobarb wire, it was too expensive to establish propertyrights.
Did barb wire helpor hurt the buffalopopulation?
Possible Solutions:
Negative Externality
Property Rights: establishing ownership can provide motivation to include external costs into the price
But, this often isn’t a plausible option
Coase Theorem: as long as transaction costs are low, it doesn’t matter which party has property rights, they will negotiate a solution to the externality without the need for gov’t intervention.
Ronald H. Coase
It used to be,“Would you likea smoke”?
Then it became, “Do you mind if I smoke”?
Property rights of smoking have changed over the years.
Then it became, “Thank you for not smoking.”
Finally, an outright ban on smoking.
Negative Externality
Government intervention:1. Tax – could pay for fixing extra cost
– or at least decrease Q2. Q Restriction – establish a law to
force correction3. Price Control – establish an effective
price floor4. Permits – i.e.. pollution permits that
can be bought and sold among polluters
Possible Solutions:
Pass out Negative Externalities Homework
& do example together
Pass Out
& do example together
P
Q
MPC
MSB
Pm
Qm
ABC Plastics is polluting the ground water surrounding it’s factory. The Gov’t decides to tax their product and use the $ to treat the area. Graph the externality including the tax.
1. Start with a base S/D graph, except
- label supply MPC and demand MSB
- Label P&Q - Pm & Qm
ABC Plastics is polluting the ground water surrounding it’s factory. The Gov’t decides to tax their product and use the $ to treat the area. Graph the externality including the tax.
2. Add the externalityP
Q
MPC
MSB
Pm
Qm
Pso
Qso
- Draw social equilibrium lines and labels Pso & Qso
- Add arrow to show direction of change in cost lines, P’s and Q’s
MSC
- Add in the social cost (MSC) line
P
Q
MPC
MSB
Pm
Qm
Pso
Qso
MSC
TAX
ABC Plastics is polluting the ground water surrounding it’s factory. The Gov’t decides to tax their product and use the $ to treat the area. Graph the externality including the tax.
You have drawn the Externality, now add the tax
4. Shade in the area of the tax and label it
You can either write it inside the shaded area or outside with an arrow
When Markets Don’t WorkMarket FailurePositive Externality (or spillover)
Example:Getting a vaccine for a contagious
disease
The rest of the population benefits from the protect,
but doesn’t pay for it.
Positive Externality
Example: Vaccinations
There is an UNDERALLOCATION (making too little) of the good at too high a price
Qm
P
Q
Marginal Social Cost (MSC)
Marginal Private Benefit (MPB)
Pmarket
MSB > MPBMarginal Social Benefit (MSB)
Qso
Psocial
Positive Externality
Why is this bad? Deadweight loss
Qm
P
Q
MSC
MPB
MSB
Qso
Pm
Pso
TO FIND THE AREA OF THE DEADWEIGHT LOSS FOLLOW THE MARKET Q UP TO THE MSC CURVE. IT’S THE AREA BETWEEN MSC, MSB AND QMARKET
Positive Externality
Why is this bad? Deadweight loss
Qm
P
Q
MSC
MPB
MSB
Qso
Pm
Pso
TO FIND THE AREA OF THE DEADWEIGHT LOSS FOLLOW THE MARKET Q UP TO THE MSC CURVE. IT’S THE AREA BETWEEN MSC, MSB AND QMARKET
Why does this happen?
When the accessible and desirable nature of public goods inclines
people to use these goods, sometimes without paying for the
privilege
Public vs. Private Goods
Private goods1. Exclusionary – owner can exclude those who don’t pay for it
2. Rival – consuming it prevents others from doing the same
Example: Can of soda
1. Non-exclusionary – owner cannot exclude those who don’t pay for it
2. Nonrival – consuming it doesn’t prevent others from doing the same
Public vs. Private Goods
Public goods
Public vs. Private Goods
Public goodsExamples:
Lighthouses All the captains use it to keep from crashing, but they don’t
pay for it and there isn’t a good way to make them
Public vs. Private Goods
Public goods
Anyone walking by benefits from the light, but does not have to pay for the benefit
Street Light Systems
Examples:
Public vs. Private Goods
Public goodsThe market will not provide optimum amounts of these good, or provide them at all because there is no way to make a profit from them.
The production of public goods results in positive externalities which are not paid for, so there is less incentive to produce it.
In a family of four, there are two cops and tworobbers. Who are the “free” riders and why?
What’s Wrong with this picture?
It wouldn’t work because Sunsets are a non-excludable good, in that non-payers can't be prevented from enjoying them.
Possible Solutions:
Positive Externality
1. Government Production: have the gov’t produce the good using tax dollars
Examples:
National Defense
Interstate Highway System
Why do governments pay for mosquito sprayingof neighborhoods? Why isn’t this privatized?
Possible Solutions:
Positive Externality
1. Government Production: have the gov’t produce the good using tax dollars
2. Subsidy: to either producer or consumer of the product
3. Legal Mandate: legally require consumption or production of the good
Possible Solutions:
Positive Externality
Example:
The more education a person has, the less likely they are commit crimes & the more likely they are to solve problems, help people….contribute to society
Education – all 3 are used
Possible Solutions:
Positive Externality
Education produces a positive externality
It is under produced or underallocated at too high a price
Example: Education – all 3 are used
Possible Solutions:
Positive Externality
Example:1. The gov’t produces it
(public schools)
2. They subsidize consumers (low cost student loans & scholarships) They subsidize producers (fed grants)
3. Require it 5-18yrs olds
Education – all 3 are used
Pass out Negative Externalities Homework
& do example together
Pass Out
& do example together
P
Q
MSC
MPB
Pm
Qm
The government decides to subsidize consumers for tuberculosis vaccinations by issuing discount coupons to parents of school children. Graph the externality including the subsidy.
1. Start with a base S/D graph, except
- label supply MSC and demand MPB
- Label P&Q - Pm & Qm
2. Add the externality
Qm
P
Q
MSC - Add in the social
benefit (MSB) line
MSB
Pm- Draw social
equilibrium lines and labels Pso & Qso
Qso
Pso
- Add arrow to show direction of change in lines, P’s and Q’s
The government decides to subsidize consumers for tuberculosis vaccinations by issuing discount coupons to parents of school children. Graph the externality including the subsidy.
Qm
P
Q
MSC
MSB
Pm
Qso
Pso
You have drawn the Externality, now add the subsidy
4. Shade in the area of the subsidy and label it
You can either write it inside the shaded area or outside with an arrow
SUBSID
Y
The government decides to subsidize consumers for tuberculosis vaccinations by issuing discount coupons to parents of school children. Graph the externality including the subsidy.
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