Lecture 12: Externalities and Public Goods

Transcription

1 Lecture 12: Externalities and Public Goods November 20, 2018

2 Overview Course Administration Defining Positive and Negative Externalities Fixing Externalities Defining Public Goods Optimal Level of Public Goods Provision Equilibrium Provision of Public Goods Public Provision of Public Goods

3 Course Administration 1. Problem Set 11 is posted 2. Problem Set 9 answers posted 3. One more lecture after this one and before exam 4. Any outstanding issues?

4 Examples of Positive Economic Profits that (may) Disappear Kosher restaurants that serve meat in DC currently there is only one, Char Bar but there are 276,000 Jews in DC Snapchat earned positive economic profits for a while Facebook wanted to buy it but Snapchat refused now Facebook makes a stories feature that does about the same thing Consultants for LEED Certification for buildings when rating system was relatively new, there were few consultants prices were very high but then many more consultants got credentials credentials and prices dropped

5 Ripped from the Headlines Next Week Afternoon Finder Presenter Julia Greenberg David Neu Marius Ghincea Evening Finder Presenter Michael Harris John Jacobs

6 Defining Externalities

7 Externality Definition Externality cost or benefit accruing to party not involved in economic transaction

8 Externality Definition Externality cost or benefit accruing to party not involved in economic transaction Positive externality benefit accruing to party not involved in economic transaction

9 Externality Definition Externality cost or benefit accruing to party not involved in economic transaction Positive externality benefit accruing to party not involved in economic transaction Negative externality cost accruing to party not involved in economic transaction

10 Externality Definition Externality cost or benefit accruing to party not involved in economic transaction Positive externality benefit accruing to party not involved in economic transaction Negative externality cost accruing to party not involved in economic transaction Examples, please.

11 In a World Without Externalities Demand measures private marginal benefit equal to social marginal benefit Supply measures private marginal cost equal to social marginal cost

12 In a Market Without Externalities P D Q S If private demand = private marginal benefit = social marginal benefit And Private supply = private marginal cost = social marginal cost Then market equilibrium maximizes social welfare, which is total surplus Provides goods to consumer at lowest possible cost

13 In a Market With Externalities Assume a negative externality = Social marginal cost private marginal cost = Social marginal cost = private marginal cost + external marginal cost

14 In a Market With Externalities Assume a negative externality = Social marginal cost private marginal cost = Social marginal cost = private marginal cost + external marginal cost Assume a positive externality = Social marginal benefit private marginal benefit = Social marginal benefit = private marginal benefit + external marginal benefit

15 In a Market With Externalities Assume a negative externality = Social marginal cost private marginal cost = Social marginal cost = private marginal cost + external marginal cost Assume a positive externality = Social marginal benefit private marginal benefit = Social marginal benefit = private marginal benefit + external marginal benefit What does this mean for the relationship between market equilibrium P MKT and Q MKT and socially optimal P SOC and Q SOC?

16 What Does a Negative Externality Do to Market Supply? Where Are the Private Market P and Q? P S = MC D Q

17 What Does a Negative Externality Do to Market Supply? Where is the Social Marginal Cost? P P MKT S = MC D Q MKT Q

18 What Does a Negative Externality Do to Market Supply? What are the Socially Optimal P and Q? P S = MC + EMC P MKT S = MC D Q MKT Q

19 What Does a Negative Externality Do to Market Supply? What is the Vertical Distance Between the Supply Curves? P S = MC + EMC P SOC P MKT S = MC D Q SOC Q MKT Q

20 What Does a Negative Externality Do to Market Supply? Where is the Deadweight Loss? P S = MC + EMC P SOC P MKT EMC S = MC D Q SOC Q MKT Q

21 What Does a Negative Externality Do to Market Supply? Too Much Production, at Too Low a Price P P SOC P MKT DWL EMC S = MC + EMC S = MC Q SOC Q MKT D Q

22 Positive Externalities Where Are Market Equilibrium P and Q? P S D= PMB Q

23 Positive Externalities Where is the Social Marginal Benefit Curve? P S P MKT Q MKT D= PMB Q

24 Positive Externalities What are the Socially Optimal P and Q? P S P MKT D = PMB + EMB Q MKT D= PMB Q

25 Positive Externalities What is the Vertical Difference Between the Demand Curves? P S P SOC P MKT D = PMB + EMB Q MKT Q SOC D= PMB Q

26 Positive Externalities Where is the Deadweight Loss? P EMB S P SOC P MKT D = PMB + EMB Q MKT Q SOC D= PMB Q

27 Positive Externalities Too Little Production, at Too High a Price P EMB DWL S P SOC P MKT D = PMB + EMB Q MKT Q SOC D= PMB Q

28 Try It Yourself: Negative Externalities Suppose that leather is sold in a perfectly competitive industry. The industry short-run supply curve (marginal cost curve) is P = MC = 3Q, where Q is measured in millions of hides per year. The demand for leather hides is given by Q = 60/7 P/7. 1. Find the equilibrium market price and quantity. 2. Suppose that the leather tanning releases bad stuff into waterways. The external marginal cost is $4/hide. Calculate the socially optimal level of output and price for the tanning industry.

29 Fixing Externalities

30 What is the Right Level of Production with Negative Externalities? Efficient level of production level of production necessary to produce the efficient quantity of the good tied to the externality Assume that there is a social marginal cost of production (= private cost + external cost) Assume that there is a social marginal benefit of production (= marginal cost of abatement) What level of production is optimal?

31 Optimal Provision of a Good with a Negative Externality Why is POLL 0?

32 Getting to the Socially Optimal P and Q Three methods 1. Change prices 2. Change quantities 3. Tradeable permits

33 1. Using Taxes and Subsidies to Return to the Efficient Point Suppose we know the external marginal cost Charge a tax equal to the external marginal cost This returns us to the socially optimal equilibrium outcome Called a Pigouvian tax Requires that you (the policymaker) know the cost exactly Can redistribute tax revenues to those harmed by policy Policy relevant? See Citizens Climate Lobby s proposal for a carbon fee.

34 To Be Clear Before tax private marginal cost = MC social marginal cost = MC + EMC

35 To Be Clear Before tax private marginal cost = MC social marginal cost = MC + EMC After tax, T = EMC private marginal cost = MC + T social marginal cost = MC + EMC

36 1a. Correcting for a Negative Externality Private and Social Supply Before a Tax P S = MC + EMC P SOC P MKT EMC S = MC D Q SOC Q MKT Q

37 1a. Correcting for a Negative Externality After the Tax, Private Supply = Social Supply P S = MC + EMC = MC + T P SOC P MKT EMC = T S = MC D Q SOC Q MKT Q

38 1b. Correcting for a Positive Externality Private and Social Demand Before a Subsidy P EMB S P SOC P MKT D = PMB + EMB Q MKT Q SOC D= PMB Q

39 1b. Correcting for a Positive Externality After the Subsidy, Private Demand = Social Demand P EMB = Sub S P SOC P MKT D = PMB + EMB = PMB + Sub Q MKT Q SOC D= PMB Q

40 2. Using a Quota to Get to Efficient Point Private and Social Supply Before a Quota P S = MC + EMC P SOC P MKT EMC S = MC D Q SOC Q MKT Q

41 2. Using a Quota to Get to Efficient Point With a Quota P S = MC w/ quota S = MC + EMC P SOC P MKT EMC S = MC D Q SOC Q MKT Q

42 The Trouble with Using Quotas

43 The Trouble with Using Quotas 1. May be hard to know optimal market output level 2. Even if you know the optimal market output, policy must assign quotas by firm. Ideally, you d assign quotas by cost of reduction, but you d need to know firm-specific costs. 3. All costs and benefits are borne by market participants; no tax revenues to redistribute

44 3. Tradeable Permits The government decides how much negative activity (or positive activity) to allow It makes permits to allow that much activity It distributes permits to anybody (firms, you) The choice of distribution method determines winners and losers! Permits trade

45 3. Tradeable Permits The government decides how much negative activity (or positive activity) to allow It makes permits to allow that much activity It distributes permits to anybody (firms, you) The choice of distribution method determines winners and losers! Permits trade Why is this superior in terms of getting to the equilibrium outcome?

46 3. Tradeable Permits The government decides how much negative activity (or positive activity) to allow It makes permits to allow that much activity It distributes permits to anybody (firms, you) The choice of distribution method determines winners and losers! Permits trade Why is this superior in terms of getting to the equilibrium outcome? Government doesn t need to know anything about firms cost structures Firms with lowest cost of reducing activity will undertake it

47 Defining Public Goods

48 Defining Public Goods Public goods are both non-rival and non-excludable Non-rival goods where your consumption does not impact my consumption Non-excludable goods from which consumption cannot be excluded

49 Defining Public Goods Public goods are both non-rival and non-excludable Non-rival goods where your consumption does not impact my consumption Non-excludable goods from which consumption cannot be excluded Pure public goods are rare:

50 Defining Public Goods Public goods are both non-rival and non-excludable Non-rival goods where your consumption does not impact my consumption Non-excludable goods from which consumption cannot be excluded Pure public goods are rare: national defense, perhaps air for breathing.

51 Defining Public Goods Public goods are both non-rival and non-excludable Non-rival goods where your consumption does not impact my consumption Non-excludable goods from which consumption cannot be excluded Pure public goods are rare: national defense, perhaps air for breathing. Public goods are not necessarily publicly provided goods.

52 Key Aspects in Defining Public Goods Everyone consumes the same quantity, but everyone need not equally value the good Classification as a public good depends on market conditions and technology Some goods may be non-rival but not excludable and vice versa Things that aren t products have public good aspects Public provision Public provision = public good = public production How do public goods from podcasts fit in this?

53 Three Public (?) Goods to Ponder 1. Education 2. Public transportation 3. Trustworthy communication

54 Optimal Provision of Public Goods

55 Optimal Provision of Private Goods

56 Using Algebra To Do This Suppose we have two demand curves Q Joe = P Q Jack = P This is a piece-wise linear function. What are the pieces? At P > $52, Jack doesn t want any more At P > $100, Joe doesn t want any more We write this as Q M = { P if 0 < P < P if P > 52 Why doesn t this work for public goods?

57 Optimal Provision of Public Goods? How Much Are Mr. 1 and Mr. 2 Willing to Pay for Fireworks? P P 1 Q P 2 Q 2

58 Optimal Provision of Public Goods? How Much Are Mr. 1 and Mr. 2 Willing to Pay for Fireworks? P P 1 Q P 2 Q 2 P 1 + P 2

59 Optimal Provision of Public Goods? How Much Are Mr. 1 and Mr. 2 Willing to Pay for Fireworks? P P 1 Q P 2 Q 2 P 1 + P 2

60 Optimal Provision of Public Goods? How Much Are Mr. 1 and Mr. 2 Willing to Pay for Fireworks? P P 1 Q P 2 Q 2 P 1 + P 2 Q

61 Optimal Provision of Public Goods? How Much Are Mr. 1 and Mr. 2 Willing to Pay for Fireworks? P P 1 Q P 2 Q 2 P 1 + P 2 Q 2

62 Adding Market Demand for Public Goods in Math For public goods, we add up P at a given quantity, Q For 300 fireworks, how much is everyone willing to pay? Mechanically, add P = g(q) Note that this may have a kink(s) where after quantities where people drop out of the market

63 Equilibrium Provision of Public Goods

64 If Public Goods Are Provided Privately If you care only about your own consumption too little market provision of public goods

65 If Public Goods Are Provided Privately If you care only about your own consumption too little market provision of public goods Furthermore, suppose Mr. 1 likes 6 units of the public good Mr. 2 likes 5 units of the public good Mr. 1 purchases 6 units What is Mr. 2 s best response?

66 If Public Goods Are Provided Privately If you care only about your own consumption too little market provision of public goods Furthermore, suppose Mr. 1 likes 6 units of the public good Mr. 2 likes 5 units of the public good Mr. 1 purchases 6 units What is Mr. 2 s best response? This is known as the free rider problem failure to contribute to public good = in general, private markets underprovide public goods Even goods that a whole group wants and is willing to pay for may not be provided.

67 When Does Private Market Provide Some Public Goods? The smaller the group, the more likely the provision When one, or a few, members care a lot Altruism Warm glow

68 Can the Government Do Better? Due to the failure in the private market, one solution is for government to provide public goods.

69 Can the Government Do Better? Due to the failure in the private market, one solution is for government to provide public goods. What do you think the problems are with this? Free-rider problem again: optimal amount of public goods is sum of P given Q Consumers might not know their demand (do you know your demand for missiles?) And consumers have an incentive to underestimate

70 Can the Government Do Better? Due to the failure in the private market, one solution is for government to provide public goods. What do you think the problems are with this? Free-rider problem again: optimal amount of public goods is sum of P given Q Consumers might not know their demand (do you know your demand for missiles?) And consumers have an incentive to underestimate Government provision crowds out private provision Before the government firework show, you might have bought some of your own. Now you do not. Other examples? Costs and benefits hard for government to measure

71 Recap of Today Externalities Definitions, positive and negative Possible corrections Public goods Definition Optimal market provision Equilibrium market provision

72 Next Class Turn in Problem Set 11 Social insurance Gruber Chapter 12