Externalities, Commons and Public Goods

Perloff Chapter 18

Externalities

• When a person’s well being or a firm’s production capacity is affected directly by another’s actions.

• Negative– Chemical plant dumping waste into a lake.

• Positive– A firm installing shrubs and sculpture benefits

its neighbours

Marginal cost with and Externality

• Marginal Private Cost– The additional cost incurred when an additional

unit of output is produced.

• Marginal Social Cost– The full cost incurred by all of society in

producing another unit of output.– MCs=MCp+MCg

Welfare Effects of Pollution

Demand

MC p MC g

MC g

MCs = MCp + MC g

450

ps = 282

pc = 240

30

84

198

Qc = 105Qs = 84 2250

ec

e

A

B

F

C D

E

H

G

Q, Tons of paper per day

MC p

Pric

e of

pap

er,

p,$

per

ton

` Social Private Change

CS A A+B+C+D B+C+D

PSp B+C+F+G F+G+H H-B-C

Cg C+G C+D+E+G+H D+E+H

PSp-Cg B+F F-C-D-E -B-C-D-E

Cs+PSs A+B+F A+B+F-E -E=DWL

s

Emissions Standard

• Regulate pollution (or output) in order to achieve the social optimum.

• In the paper example constrain output to 84 units per day. Need to know:– Demand curve– Marginal social cost curve– Relationship between paper production and

pollution.

• Enforcement is costly.

Emissions Fee• Tax the pollution

that is produced.• Tax output

(assuming a fixed relationship with pollution)

• Either:– vary tax with

output (t(Q))

– fixed tax (t)Demand

MCp

MCg

MCs = MC p + t (Q)

MCp + t

t = 84

450

p s =

282

MC

p =

198

MC

g =

84

Qs = 84 2250

es

Q, Tons of paper per day

Pric

e o

f p

ap

er,

p,

$ p

er

ton

Cost benefit Analysis

• Compares the costs and benefits of a movement away from the market equilibrium.

• Costs:– Reduced output of paper– Consumer surplus reduced– Producer surplus reduced

• Benefits– Reduced costs of polution

CBA of polution

Cost: less paper

Benefit: less gunk

Maximumnetbenefit

84 631050

84105

G, Units of gunk per day

Q, Tons of paper per day

G, Units of gunk per day

Q, Tons of paper per day

(a) Cost and Benefit

(b) Marginal Cost and Marginal Benefit

4,000

2,000

105

84

0

MC

MB

Ben

efit,

Cos

t, $

Mar

gina

l ben

efit,

Mar

gina

l cos

t, $

Externality With Monopoly

DemandMR

MC p

MC g

MC s = MC p + MC g

450

330310

282

240

30

84 105 22570600

em

ec

es

et

A B CDP

rice

of p

aper

, p,

$ p

er t

on

Regulation of a Monopoly with an Externality

• It may be that the monopoly is preferable to competition if regulation is not possible.

• Charging a tax equal to the MC of pollution may reduce welfare if monopoly output is below social optimum.

• Achieving the social optimum may entail subsidisation of a monopoly.

Property rights

• An exclusive right to use an asset

• Private ownership of asset

• Right to be free of noise pollution– Courts could be used to enforce the right– You could sell the right to someone who wants

to be noisy.

• In many cases the rights are not assigned.

0 1 2

0

1

2

Coase Theorem: No property Rights

$0$0

$10$0

$15$0

$0$14

$10$10

$15$2

$0$15

$10$5

$15-$3

Chemical firm: tonnes dumped per day.

Boat firm: Boats rented per day

If property rights are with boat owner:

Minimum price per unit of pollution is $5

Maximum price is $10

If property rights are with chem. firm:

Minimum price per unit of pollution is $5

Maximum price is $7.50

0 1 2

0

1

2

$14$0

$0

$3$7

$1$14

$0

$3$17

$1$16

$0$15

$3$12

$1$11

Coase theorem: Property rights with boat firm

Chemical firm: tonnes dumped per day.

Boat firm: Boats rented per day

Pollution priced at $7 per tonne

0 1 2

0

1

2

$2$12

-$12

$16-$6

$15$0

$12

$16$4

$15$2

$12$3

$16-$1

$15-$3

Coase theorem: property rights with chemical firm

Chemical firm: tonnes dumped per day.

Boat firm: Boats rented per day

Pollution priced at $6 per tonne

Coase Therorem: Summary

• Assigning property rights results in the efficient outcome.

• Efficiency is achieved regardless of who has the property rights.

• The distribution of welfare in the efficient outcome is dependent on the initial allocation of property rights.

Common Property

• Unlike private property people cannot be excluded.

• When deciding how much to use, people ignore the impacts on others so the resource is overused.

• Common pool, water, gas, oil.• Internet• Roads• Fisheries

Public Goods

• Non-Excludability– People cannot be prevented from consuming a good.

• Non rivalry– The good is not used up when one person uses it.

Markets for public goods• Only exist for excludable goods.• Demand curve is the vertical summation of individual willingness-to-

pay or demand curves

Guards per hour

Supply, MC

25

18

13

10

87

32

5 7 940

ep es

D 1

D

D 2

Pric

e of

gua

rd s

ervi

ce,

$ pe

r ho

ur

Free riding

Voting for the provision of a public good