Macro Chapter 4

Presentation 2

Externality

• Some of the costs or benefits of a good are passed on to or “spill over” to a 3rd party that is external to the transaction

Negative Externalities

• Costs inflicted on a 3rd party without compensation

• Ex- environmental pollution: a chemical company dumps waste into the river, harming the fish and water supply

Negative Externalities cont’d

• When a firm avoids costs by polluting, its supply curve will be further to the right

• As a result the cost is too low and output too high for allocative efficiency

• ***this causes an overallocation of the use of resources for the good

Government Actions for Negative Externalities

• 1. Legislation- limit or eliminate the problem--- increases the cost of production through purification devices, exhaust systems etc.

• 2. Taxes- this would cause the firm to supply less of the good

Positive Externalities

• A positive benefit obtained without compensation by third parties

• Ex- immunization shots benefit society

• Schools also provide better educated people, less likely to commit crime or rely on government funding

Positive Externalities Cont’d

• A market failure exists here in the form of underallocation---- society would benefit from having more of the externality

Government Actions to Correct for Positive Externalities

• 1. Subsidize Consumers- increase the demand for the good/service (ex low int. loans for college)

• 2. Subsidize Suppliers- state $$ to colleges

• 3. Provide the goods- US Post Office, vaccines

Principal Agent Problem

The principals are the owners of the corporation that hire agents to run the business

The interests of the principals and agents often conflict

Ex- executives build expensive offices or buy corporate jets, which cuts into profits

Rivalry

• When one person buys a good/service, it is not available for purchase and consumption by someone else

Excludability

• Only buyers who are willing and able to pay for a G/S can obtain its benefit

Public Goods

• Everyone can simultaneously obtain the benefit from such a good

• Nonrivalry and Nonexcludability

• Ex- Public defense, street lights, environmental protection

Free-Rider Problem

• People receive benefits from a public good without contributing to its costs

• ***this makes the goods unprofitable to private firms

Quasi Public Goods

• A good/service where excludability could apply but has such a large positive externality the gov’t sponsors its production to prevent underallocation

• Libraries, museums, schools