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Page 1: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Page 2: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

An externality is an unintended consequence of a choice

that falls on someone other than the decision-maker.

Externalities may be positive or negative

Externalities may arise in consumption or production

Page 3: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Production externalities drive a wedge between the

marginal private cost (MC) that is borne by the producer,

and the marginal social cost (MSC) that is the total cost

to society.

MSC = MC + marginal external cost

The marginal external cost is the cost of producing one

more unit of a good or service that falls on people other

than the producer.

Production Externalities

Page 4: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Negative Production Externalities

Page 5: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Production and Pollution: How Much?

In the market for a good with an externality that is

unregulated, the amount of pollution created depends on

the equilibrium quantity of the good produced.

Negative Production Externalities:

Pollution

Page 6: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Figure 16.2 shows the

equilibrium in an

unregulated market with

an external cost.

The quantity produced is

where marginal private

cost equals marginal

social benefit.

Negative Externalities: Pollution

Page 7: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

At the market equilibrium,

MSB is less than MSC,

so the market produces

an inefficient quantity.

At the efficient quantity,

marginal social cost equals

marginal social benefit.

With no regulation, the

market overproduces and

creates a deadweight loss.

Negative Externalities: Pollution

Page 8: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Consumption externalities drive a wedge between the

marginal private benefit (MB) that is borne by the

producer, and the marginal social benefit (MSB) that is

the total cost to society.

MSB = MB + marginal external benefit

The marginal external benefit is the benefit from

consuming one more unit of a good or service that falls on

people other than the consumer.

Consumption Externalities

Page 9: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

The marginal external

benefit is the vertical distance

between the MB and MSB

curves.

Positive Consumption Externalities:

Knowledge

Page 10: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

A private market will

underproduce an item

that generates an

external benefit

and creates a

deadweight loss.

Positive Externalities: Knowledge

Page 11: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Property Rights

Property rights are legally established titles to the

ownership, use, and disposal of factors of production and

goods and services that are enforceable in the courts.

One way to look at the market failure that arises in the

presence of externalities is that it comes about because of

the absence of property rights.

Externalities and property rights

Page 12: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

The Coase Theorem

The Coase theorem is a proposition that if property rights

exist, only a small number of parties are involved, and

transactions costs (defined below) are low, then private

transactions are efficient.

There are no externalities because all parties take into

account the externalities involved. The outcome is

independent of who has the property rights.

To see this, take the example of “the barking dog”.

Externalities and property rights

Page 13: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Barking dog example

D owns a dog that barks

J is bothered by the dog barking

What is the efficient allocation?

Depends on value of benefit to D of keeping dog compared

to cost to J of barking.

Page 14: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Benefit to D from owning dog: $500

Cost to J of barking dog: -$800

Total surplus if D keeps dog : -$300

Total surplus if D gets rid of the dog : $ 0

Efficient outcome: J pays D to get rid of the dog

Scenario 1 Suppose D owns the “property right” to let the

dog bark. J can offer to pay him to get rid of the dog.

She will offer P<$800; he will accept P>500. So he gets

rid of the dog - outcome is efficient.

Scenario 2 Suppose J owns the “property right” to quiet. D

can offer to pay her not to complain about the dog. D

will offer P<500; J will accept P>500. No deal. She

complains, the dog is removed. The outcome is efficient.

Page 15: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

This example illustrates the Coase theorem:

(1) if property rights exist, only a small number of parties

are involved, and transactions costs (defined below) are

low, then private transactions are efficient; and

(2) the outcome is independent of who has the property

rights.

Easy to see (2) in our example. In both scenarios, the dog

is not allowed to bark. Does not depend on who has

property right.

However, the distribution of surplus depends on the

property right. When D has the property right, J gets

less surplus and D gets more surplus (J pays D to get rid

of dog).

Page 16: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

This example illustrates the Coase theorem:

(1) if property rights exist, only a small number of parties

are involved, and transactions costs (defined below) are

low, then private transactions are efficient; and

(2) the outcome is independent of who has the property

rights.

What about the first proposition?

Page 17: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

The Coase solution works only if transaction costs are low.

Transactions costs are the cost of conducting a

transaction.

In our example, the transactions cost would involve

negotiating a price between J and D.

When a large number of people are involved in an

externality and transactions costs are high, the Coase

solution of establishing property rights doesn’t work and

governments try to deal with the externality.

Page 18: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Government Actions in the Face of External Costs

There are three main methods that the government uses

to cope with external costs:

Taxes

Emission charges

Marketable permits

Negative Externalities: Pollution

Page 19: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Taxes

The government can set a tax equal to marginal external

cost.

The effect of such a tax is to make marginal private cost

plus the tax equal to marginal social cost,

MC + tax = MSC.

This tax is called Pigovian tax, in honor of the British

economist Arthur Pigou, who first proposed dealing with

externalities in this fashion.

Negative Externalities: Pollution

Page 20: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

A pollution tax equal to

the marginal external cost

can achieve an efficient

outcome because

MSC = MSB.

The government collects a

tax revenue.

Negative Externalities: Pollution

Page 21: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Marketable Permits

Each firm is assigned a permitted amount of pollution per

period and firms trade permits.

The market price of a permit confronts polluters with the

marginal social cost of their actions and leads to an

efficient outcome.

Negative Externalities: Pollution

Page 22: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Government Action in the Face of External Benefits

Four devices that the government can use to achieve a

more efficient allocation of resources in the presence of

external benefits are

Public provision

Private subsidies

Vouchers

Patents and copyrights

Positive Externalities: Knowledge

Page 23: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Public Provision

Under public provision,

a public authority that

receives payment from

the government produces

the good or service.

Figure 16.7(a) shows how

public provision can

achieve an efficient

outcome.

Positive Externalities: Knowledge

Page 24: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Private Subsidies

A subsidy is a payment by the government to private

producers.

If the government pays the producer an amount equal to

the marginal external benefit for each unit produced, the

quantity produced is efficient.

Positive Externalities: Knowledge

Page 25: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Figure 16.7(b) shows

how a subsidy can

achieve an efficient

outcome.

Positive Externalities: Knowledge

Page 26: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Vouchers

A voucher is a token that

the government provides

to households, which they

can use to buy specified

goods or services.

Figure 16.8 shows how

vouchers can achieve a

more efficient outcome.

Positive Externalities: Knowledge

Page 27: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Patents and Copyrights

Intellectual property rights give the creator of knowledge

the property right to the use of that knowledge.

The legal device for establishing an intellectual property

right is the patent or a copyright.

A patent or copyright is a government-sanctioned

exclusive right given to an inventor of a good, service or

productive process to use to produce, use and sell the

invention for a given number of years.

Positive Externalities: Knowledge

Page 28: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Page 29: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

What is the essential difference between:

A city police department and Brinks security

Fish in the Atlantic Ocean and fish in a fish farm

A live concert and a concert on television

These and all goods and services can be classified

according to whether they are excludable or

nonexcludable and rival or nonrival.

Classifying Goods and Resources

Page 30: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Excludable

A good is excludable if only the people who pay for it are able to enjoy its benefits.

Brinks’s security services, Cooke Aquaculture’s fish, and a U2 concert are examples.

Nonexcludable

A good is nonexcludable if everyone can benefit from it regardless of whether they pay for it.

The services of the Calgary police, fish in the Atlantic Ocean, and a concert on network television are examples.

Classifying Goods and Resources

Page 31: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Rival

A good is rival if one person’s use of it decreases the

quantity available for someone else.

A Brinks’s truck can’t deliver cash to two banks at the

same time. A fish can be consumed only once.

Nonrival

A good is nonrival if one person’s use of it does not

decrease the quantity available for someone else.

The services of the Calgary police and a concert on

network television are nonrival.

Classifying Goods and Resources

Page 32: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

A Four-Fold Classification

Private Goods

A private good is both rival and excludable.

A can of Coke and a fish on Cooke’s Aquaculture farm are examples of private goods.

Public goods

A public good is both nonrival and nonexcludable. A public good can be consumed simultaneously by everyone, and no one can be excluded from its benefits.

National defence is the best example of a public good.

Classifying Goods and Resources

Page 33: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Common Resources

A common resource is rival and nonexcludable.

A unit of a common resource can be used only once, but no one can be prevented from using what is available. Ocean fish are a common resource.

They are rival because a fish taken by one person isn’t available for anyone else.

They are nonexcludable because it is difficult to prevent people from catching them.

Classifying Goods and Resources

Page 34: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Natural Monopolies (don’t focus on this)

In a natural monopoly, economies of scale exist over the

entire range of output for which there is a demand.

A special case of natural monopoly arises when the good

or service can be produced at zero marginal cost. Such a

good is nonrival. If it is also excludable, it is produced by a

natural monopoly.

The Internet and cable television are examples.

Classifying Goods and Resources

Page 35: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Figure 17.1

shows this four-

fold classification

of goods and

services.

Classifying Goods and Resources

Page 36: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

The Free-Rider Problem

A free rider enjoys the benefits of a good or service without

paying for it.

Because no one can be excluded from the benefits is a

public good, everyone has an incentive to free ride.

Public goods create a free-rider problem—the absence of

an incentive for people to pay for what they consume.

Public Goods

Page 37: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

The value of a private good is the maximum amount that a

person is willing to pay for one more unit of it.

The value of a public good is the maximum amount that all

the people are willing to pay for one more unit of it.

To calculate the value placed on a public good, we use the

concepts of total benefit and marginal benefit.

Public Goods

Page 38: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Marginal Social Benefit of a Public Good

Total benefit is the dollar value that a person places on a

given quantity of a good.

The greater the quantity of a good, the larger is a person’s

total benefit.

Marginal benefit is the increase in total benefit that results

from a one-unit increase in the quantity of a good.

The marginal benefit of a public good diminishes with the

quantity of the good provided.

Public Goods

Page 39: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Figure 17.2 shows that the

marginal social benefit of a

public good is the sum of

marginal benefits of

everyone at each quantity

of the good provided.

Part (a) shows Lisa’s

marginal benefit.

Part (b) shows Max’s

marginal benefit.

Public Goods

Page 40: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

The economy’s marginal

social benefit of a public

good is the sum of the

marginal benefits of all

individuals at each quantity

of the good provided.

The economy’s marginal

social benefit curve for a

public good is the vertical

sum of all individual

marginal benefit curves.

Public Goods

Page 41: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

The marginal social benefit

curve for a public good

contrasts with the demand

curve for a private good,

which is the horizontal sum

of the individual demand

curves at each price.

Public Goods

Page 42: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

The Marginal Social Cost of a Public Good

The marginal social cost of a public good is determined

in the same way as that of a private good.

The Efficient Quantity of a Public Good

The efficient quantity of a public good is the quantity that

at which marginal social benefit equals marginal social

cost.

Public Goods

Page 43: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Figure 17.3 illustrates

the efficient quantity of

a public good.

With fewer than

2 satellites,

MSB exceeds MSC.

Resources a can be

used more efficiently by

increasing the quantity.

Public Goods

Page 44: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

With more than

2 satellites,

MSC exceeds MSB.

Resources can be used

more efficiently if fewer

satellites are provided.

So the quantity at which

MSB = MSC, resources

are used efficiently.

Private production would

produce 0 satellites.

Public Goods

Page 45: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Efficient Public Provision

Because the government can tax all the consumers of the

public good and force everyone to pay for its provision,

public provision overcomes the free-rider problem.

If two political parties compete, each is driven to propose

the efficient quantity of a public good.

A party that proposes either too much or too little can be

beaten by one that proposes the efficient amount because

more people vote for an increase in net benefit.

Public Goods

Page 46: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

The Tragedy of the Commons

The tragedy of the commons is the absence of incentives to prevent the overuse and depletion of a commonly owned resource.

Examples include the Atlantic Ocean cod stocks, South Pacific whales, and the quality of the earth’s atmosphere.

The traditional example from which the term derives is the common grazing land surrounding middle-age villages.

Common Resources

Page 47: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Sustainable Production

Sustainable production is the rate of production that can be maintained indefinitely.

This production rate depends on the existing stock of fish and the number of boats that go fishing.

For a given fish stock, as more boats go fishing, the quantity of fish caught increases.

But with too many boats fishing, the quantity of fish caught decreases.

Common Resources

Page 48: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Table 17.1 illustrates the number of boats and the quantity if fish caught.

As the number of fishing boats increases, the quantity of fish caught increases to some maximum.

Overfishing occurs when the maximum sustainable catch decreases.

Common Resources

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© 2010 Pearson Education Canada

Table 17.1 also shows the average and marginal catch depends on the number of boats that go fishing.

As the number of fishing boats increases:

The average quantity of fish caught decreases.

The marginal catch decreases.

Common Resources

Page 50: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Figure 17.6 illustrates the sustainable production of fish.

As the number of fishing boats increases, the quantity of fish caught increases to some maximum.

Overfishing occurs when the maximum sustainable catch decreases.

Common Resources

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© 2010 Pearson Education Canada

An Overfishing Equilibrium

Figure 17.7 shows why

overfishing occurs.

Marginal private benefit, MB,

is the average catch per

boat.

Marginal private benefit

decreases as the number of

boats increases.

The marginal cost per boat

is MC (assumed constant).

Common Resources

Page 52: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

The Efficient Use of the Commons

The quantity of fish caught by each boat decreases as the

number of boats increases.

But no one has an incentive to take this fact into account

when deciding whether to fish.

The efficient use of a common resource requires marginal

social cost to equal marginal social benefit.

Common Resources

Page 53: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Marginal Social Benefit

Marginal social benefit is the increase in the total fish

catch that results from an additional boat.

Marginal social benefit equals the marginal catch of a

boat, not the average catch per boat.

Common Resources

Page 54: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Efficient Use

Figure 17.8 shows the marginal private benefit curve, MB, and the marginal social benefit curve, MSB.

With no external costs, the marginal social cost MSCequals marginal cost MC.

Resources are used efficiently when MSB equals MSC.

Common Resources

Page 55: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Achieving an Efficient Outcome

It is harder to achieve an efficient use of a common

resource than to define the conditions under which it

occurs.

Three methods that might be used are

Property rights

Production quotas

Individual transferable quotas (ITQs)

Common Resources

Page 56: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Property Rights

By assigning property rights, common property becomes

private property.

When someone owns a resource, the owner is

confronted with the full consequences of her/his actions

in using that resources.

The social benefits become the private benefits.

But assigning property rights is not always feasible.

Common Resources

Page 57: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Production Quotas

By setting a production quota at the efficient quantity, a common resource might remain in common use but be used efficiently.

Figure 17.9 shows this situation.

It is hard to make a production quota work.

Common Resources

Page 58: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Individual Transferable Quotas

An individual transferable quota (ITQ) is a production limit that is assigned to an individual who is free to transfer (sell) the quota to someone else.

A market in ITQs emerges.

If the efficient quantity of ITQs is assigned, the market price of an ITQ confronts resource users with a marginal cost of MC + price of ITQ.

With MC + price of ITQ equal to MSB, the quantity produced is efficient.

Common Resources

Page 59: © 2010 Pearson Education Canada - SFU.ca - Simon Fraser …friesen/ECON103_lecture9.pdf · 2009. 11. 10. · © 2010 Pearson Education Canada An externality is an unintended consequence

© 2010 Pearson Education Canada

Figure 17.10 shows the

situation with an efficient

number of ITQs.

The market price of an

ITQ increases the

marginal cost to

MC0 + price of ITQ.

Users of the resource

make MB equal

MC0 + price of ITQ, and

the outcome is efficient.

Common Resources

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Public Choice and Political Equilibrium

It is easy for economists to agree that ITQs make it

possible to achieve an efficient use of a common

resource.

It is difficult to get the political marketplace to deliver that

outcome.

In 1996, Congress killed an attempt to use ITQs in the

Gulf of Mexico and the Northern Pacific Ocean.

Self-interest and capture of the political process

sometimes beats the social interest.

Common Resources