lecture 9: externalities and public goods
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Lecture 9: Externalities and Public goods. Charit Tingsabadh M.Sc. Programme in Environmental and natural resource economics Semester 1/2005. outline. Concepts Specification Empirics. concept. Externality: By-products of consumptions and production may benefit or harm other people - PowerPoint PPT PresentationTRANSCRIPT
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Lecture 9: Externalities and Public goodsCharit Tingsabadh
M.Sc. Programme in Environmental and natural resource economics
Semester 1/2005
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concept
• Externality: By-products of consumptions and production may benefit or harm other people
• Definition:when a person’s well-being or a firm’s capability is directly affected by the actions of other consumers of firms rather than indirectly through changes in prices.
• Examples: any suggestion?
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Externalities: examples• Supply side: a wedge between private cost and social cost (can be +
or - )• Example:
– Polluting factory causes fish deaths in river– Building a road allows other people to travel more conveniently– Coal-burning power station emits SO2 which causes acid rain
• Demand side: wedge between (marginal) private benefit and (marginal) social benefit
• (+ or - )• Example:
– vaccination reduces health risk for all, not only the individual taking the jab;
– Network: the more people have telephone, the more benefit to each subscriber
– Forest conservation improves water supply and reduces greenhouse gas concentration
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More generally..
Private good Common pool/open access
Club good Public good
rivalry
high
low
excludabilityhigh low
Externality arises from low excludability
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Effect on the market:supply side• Negative externality raises social cost over private cost
price
quantity
D
D
M Private Cost
M Social cost
Result: price too low, too much is demanded and produced
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Effect on the market:demand side• Positive externality raises social benefit cost over private benefit
price
quantity
D
D
Cost
M Social benefit
Result: price too low, too little is demanded and produced
M private benefit
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conclusion
• Because of externalities• Market (private) prices do not reflect social prices• Wrong (inefficient) resource allocation• Would improve if external cost(benefit) can be
internalised.• Internalisation through property rights-give
ownership, but of what ? And to whom?• Institutional economics to the rescue..
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Public Good
• Extreme case of low rivalry and low excludability
• Pure public good: • no rivalry-if available to one consumer, is
avaliable to all consumers• No excludability-cannot exclude anybody
from consumption• So, if one consumes, all consume.
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Graphing public good
• Demand side:• Individual demand, normal downward
sloping demand curve• Market demand, vertical summation of
individual demand curves, because same amount is consumed. Samuelson condition.
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Description of market• Total demand is vertical sum of individual demand• Supply is shared in same quantity• Cost is more than individual benefit• Will there be market supply?• If one pays for supply, all others will have it also,• So wait for the “public” spirited person, free riding
by others• If not, no supply.• Clear case of market failure!!!!
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Correcting for externalities
• Pigouvian tax– How to set the tax rate?
• Property rights allocation (Coase theorem)– Whose rights-who pays?
• Rule-based control– To reduce transaction cost
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The Commons
• Commons: high rivalry, low excludability• Example: public park, roads, fishing• Capacity limits to use • Over-capacity use results in congestion• Demand-side management vs. supply
expansion• Fees, quota, controlling access, etc.