Chapter 10: Externalities Chapter 11: Public Goods and Common Resources

Transcription

1 Econ 23 Introduction to Economics: Micro Chapter : Externalities Chapter 11: Public Goods and Common Resources Instructor: Hiroki Watanabe Spring 213 Watanabe Econ 23 Externality & 11 Public Goods 1 / 59 1 Introduction 2 When Market Fails 3 Categorization 4 Pigouvian Tax 5 Summary Watanabe Econ 23 Externality & 11 Public Goods 2 / 59 1 Introduction Definition Instances Question 2 When Market Fails 3 Categorization 4 Pigouvian Tax 5 Summary Watanabe Econ 23 Externality & 11 Public Goods 3 / 59

2 Definition Definition 1.1 (Externality) is a cost or a benefit directly imposed upon someone by actions taken by others. "Directly"=Bypassing the market transaction. An externally imposed benefit is a positive externality. An externally imposed cost is a negative externality. Watanabe Econ 23 Externality & 11 Public Goods 4 / 59 Instances Examples of negative externalities: Air pollution. Water pollution. Traffic congestion. Second-hand cigarette smoke. Increased insurance premiums due to alcohol or tobacco consumption. Show tunes Tuesday. Watanabe Econ 23 Externality & 11 Public Goods 5 / 59 Instances Examples of positive externalities: Beekeepers and orchards. A well-maintained property next door that raises the market value of your property. A pleasant cologne or scent worn by the person seated next to you. Improved driving habits that reduce accident risks. Show tunes Tuesday. Watanabe Econ 23 Externality & 11 Public Goods 6 / 59

3 Instances Externality impacts a third party; i.e. somebody who is not a participant in the activity that creates the external cost or benefit. Watanabe Econ 23 Externality & 11 Public Goods 7 / 59 Question Question 1.2 (Cap and Trade) Listen to Marketplace Clip. Why do we use cap and trade scheme in the first place? How exactly does China benefit from avoiding carbon duties? Watanabe Econ 23 Externality & 11 Public Goods 8 / 59 1 Introduction 2 When Market Fails Blocking Sunlight Implications Fixes: Coase s Theorem Sunlight Permits 3 Categorization 4 Pigouvian Tax 5 Summary Watanabe Econ 23 Externality & 11 Public Goods 9 / 59

4 Blocking Sunlight Suppose Kenneth s neighbor Liz plans to build a -story apartment. Each floor brings in the net profit of $5 ($ to build and $15 from the rent payment for example). Kenneth incurs $ for reduced sunlight ( =# of floors). Watanabe Econ 23 Externality & 11 Public Goods / 59 Blocking Sunlight Marginal Cost to Kenneth 9 Marginal Profit to Liz MC, Marginal Profit [$] # of Floors Watanabe Econ 23 Externality & 11 Public Goods11 / 59 Blocking Sunlight Since there is no sunlight market, Liz builds his -story apartment as planned. Her total profit is then, π L ( = ) = 15 = 5. Thanks to Liz s apartment, reduced sunlight incurs total cost of π K ( = ) = ( ) = 55. Total surplus is π L ( = ) + π K ( = ) = 5 55 = 5. Watanabe Econ 23 Externality & 11 Public Goods12 / 59

5 Blocking Sunlight = is not efficient. If Liz chooses = 9 instead, then, π L ( = 9) = = 45. π K ( = 9) = ( ) = 45. TS = = (> 5). Since there is no market for sunlight, Liz can reduce sunlight without compensating the neighbors. Liz imposes negative externality. Watanabe Econ 23 Externality & 11 Public Goods13 / 59 Implications First Theorem fails to hold because of the presence of negative externality. Externalities cause efficiency loss; typically 1 too much scarce resource is allocated to an activity which causes a negative externality 2 too little resource is allocated to an activity which causes a positive externality. What would be the most ideal result (i.e. the most efficient outcome)? Not building anything ( = ) so that we wouldn t incur any cost to Kenneth? Watanabe Econ 23 Externality & 11 Public Goods14 / 59 Fixes: Coase s Theorem The answer is = 5 (or 4). π L ( = 5) = = 25. π K ( = 5) = ( ) = 15. TS = =. If = 5, Liz is willing to pay at most $5 to add 5th floor. If = 5, Kenneth is willing to allow 5th floor as long as he recieves $5 or more in compensation. If =, Liz is willing to pay at most $5 to add th floor. If =, Kenneth is willing to allow 1st floor as long as he receives $1 or more in compensation. Watanabe Econ 23 Externality & 11 Public Goods15 / 59

6 Fixes: Coase s Theorem How do we achieve the efficient allocations? This is called internalization of externality. What if we create a market for sunlight? Watanabe Econ 23 Externality & 11 Public Goods16 / 59 Fixes: Coase s Theorem Ronald Coase s insight is that most externality problems are due to an inadequate specification of property rights and, consequently, an absence of markets in which trade can be used to internalize external costs or benefits. Causing a producer of an externality to bear the full external cost or to enjoy the full external benefit is called internalizing the externality. Watanabe Econ 23 Externality & 11 Public Goods17 / 59 Fixes: Coase s Theorem Theorem 2.1 (Coase s Theorem) When there is no cost associated with negotiations, the efficient level of the externality-generating commodity is produced through negotiation (transaction) no matter which agent is assigned the property right. Watanabe Econ 23 Externality & 11 Public Goods18 / 59

7 Sunlight Permits Can Liz and Kenneth autonomically achieve = 5? Following Coase s theorem, create a market for sunlight by issuing sunlight permits. Coase s theorem implies: 1 Efficient level of production ( = 5) will be achieved with permits. 2 The outcome does not depend on the issuer. Two scenarios: 1 Kenneth is the issuer. 2 Liz is the issuer. Watanabe Econ 23 Externality & 11 Public Goods19 / 59 Sunlight Permits 1 Suppose Kenneth owns the permits. 1 1st permit: Kenneth charges $5, Liz buys it ( = 1). 2 2nd permit: Kenneth charges $5, Liz buys it. 3 3rd permit: Kenneth charges $5, Liz buys it. 4 4th permit: Kenneth charges $5, Liz buys it. 5 5th permit: Kenneth charges $5, Liz buys it. 6 6th permit: Kenneth charges $6 or more, Liz doesn t buy it. π L ( = 5) = =. π K ( = 5) = 5 5 ( ) =. TS = + = (= TS ). Watanabe Econ 23 Externality & 11 Public Goods2 / 59 Sunlight Permits 2 Suppose Liz owns the permits. 1 1st permit: Liz charges $, Kenneth buys it ( = 9). 2 2nd permit: Liz charges $9, Kenneth buys it. 3 3rd permit: Liz charges $8, Kenneth buys it. 4 4th permit: Liz charges $7, Kenneth buys it. 5 5th permit: Liz charges $6, Kenneth buys it. 6 6th permit: Liz charges $5, Kenneth doesn t buy it. π L ( = 5) = ( ) = 65 π K ( = 5) = ( ) ( ) = 55. TS = = (= TS ). Watanabe Econ 23 Externality & 11 Public Goods21 / 59

8 Sunlight Permits Regime Issuer π L π K TS DWL Laissez-Faire Complete Ban - - Coase 5 Liz Coase 5 Kenneth Watanabe Econ 23 Externality & 11 Public Goods22 / 59 1 Introduction 2 When Market Fails 3 Categorization Four Types of Goods Free-Rider s Problem 4 Pigouvian Tax 5 Summary Watanabe Econ 23 Externality & 11 Public Goods23 / 59 Four Types of Goods Free goods (goods without market) pose a special challenge for economic analysis. Most goods in our economy are allocated in markets. And markets usually do a good job: No deadweight loss in equilibrium (c.f. Ch 4): p E = RP(y E ) = MWTP(y E ). Watanabe Econ 23 Externality & 11 Public Goods24 / 59

9 Four Types of Goods When goods are available free of charge, the market forces that normally allocate resources in our economy are absent. When a good does not have an associated price, private markets cannot ensure that the good is produced and consumed in the proper amounts. Watanabe Econ 23 Externality & 11 Public Goods25 / 59 Four Types of Goods In such cases, government policy can potentially remedy the market failure and raise economic well-being. It is useful to group goods according to two characteristics: Supply Is the good excludable? (Can I give a cheesecake to Liz without giving it to Kenneth?) Excludability. Demand If Liz ate a cheesecake, can Kenneth still have the same one? Rivalry. Watanabe Econ 23 Externality & 11 Public Goods26 / 59 Four Types of Goods Definition 3.1 (Four Types of Goods) Rivalry in consumption Shared consumption Excludable Private Goods: Club Goods: in supply Cheesecakes Fire Protection TV set Cable TV Congested toll roads Uncongested toll roads Universal Common Resources: Pure Public Goods: in supply Fish in the ocean Tornado siren Congested nontoll roads Uncongested nontoll roads National defence Smoke concentration Watanabe Econ 23 Externality & 11 Public Goods27 / 59

10 Free-Rider s Problem A perfectly competitive market is a market where the following conditions are met: 1 product homogeneity (product differentiation) 2 small agents (industrial organization) 3 free mobility (urban economics) 4 perfect knowledge (information economics) 5 exclusion (public finance) 6 rivalry (public finance) 7 free entry (industrial organization) The First Theorem applies. Watanabe Econ 23 Externality & 11 Public Goods28 / 59 Free-Rider s Problem Market does not allocate non-excludable goods well. Definition 3.2 (Free Rider) is a person who receives the benefit of a good but avoids paying for it. If the private firm is to supply fish in the ocean or tornado siren, it will go bankrupt. Fishermen or residents can receive the service without paying for it. And they don t pay for it (free-riders problem). Watanabe Econ 23 Externality & 11 Public Goods29 / 59 1 Introduction 2 When Market Fails 3 Categorization 4 Pigouvian Tax Landscape Detecting Externality on I-35 Why Shouldn t Liz Be on I-35? Tragedy of Commons Fixes Example 5 Summary Watanabe Econ 23 Externality & 11 Public Goods3 / 59

11 Landscape Consider commuters from Superior to Duluth this morning. 1 There are cars on the highway. -th driver s marginal willingness to pay for the trip is MWTP( ). MWTP is the opportunity cost of driving. Alternatives: commuter rail, bus etc. 1 C.f. Brueckner [?] Chpt 5. Watanabe Econ 23 Externality & 11 Public Goods31 / 59 Landscape MWTP, Trip Cost [$] Trip Cost t(x) Car (x) Watanabe Econ 23 Externality & 11 Public Goods32 / 59 Landscape Definition 4.1 (Trip Cost Function) Trip cost function t( ) measures Liz s cost of making a trip when there are cars on the road (or equivalently, when she is -th car on the road). It is not flat all the way through. Watanabe Econ 23 Externality & 11 Public Goods33 / 59

12 Landscape Flat at the beginning Increasing in the end Watanabe Econ 23 Externality & 11 Public Goods34 / 59 Detecting Externality on I-35 How does Liz make her decision? 1 MWTP( ) > t( ) commute. 2 MWTP( ) < t( ) use alternative modes of transportation. How many cars will there be then? Watanabe Econ 23 Externality & 11 Public Goods35 / 59 Detecting Externality on I-35 Is E (equilibrium traffic volume) efficient? E -th commuter s (private) surplus is CS P ( E ) = MWTP( E ) t( E ). Watanabe Econ 23 Externality & 11 Public Goods36 / 59

13 Detecting Externality on I MWTP, Trip Cost, SMC [$] CS 2 1 Trip Cost t(x) SMC(x) Car (x) Watanabe Econ 23 Externality & 11 Public Goods37 / 59 Detecting Externality on I-35 Let s say Liz is the E -th car on the road. Her MWTP(8) = 6 and the cost of trip is t(8) = 6 as well. Does Liz consider that her entrance drags everybody else s speed down? Her entrance effect over the existing cars are not priced. Externality at work. Watanabe Econ 23 Externality & 11 Public Goods38 / 59 Why Shouldn t Liz Be on I-35? What is the Pareto optimal number of cars then? Need to take the externality into consideration. Definition 4.2 (Social Total Cost) The social total cost of having cars on I-55 (the total cost on the society as a whole) is STC( ) = Watanabe Econ 23 Externality & 11 Public Goods39 / 59

14 Why Shouldn t Liz Be on I-35? Adding Liz costs the society on the whole by: 2 ΔSTC( ) Δ = t( ) }{{} her own cost Δt( ) + } Δ }{{}. {{ } # of cars everyone has to slow down 2 Recall the product rule: (STC( )) = t( ) + t ( ). Watanabe Econ 23 Externality & 11 Public Goods4 / 59 Why Shouldn t Liz Be on I-35? Additional increase in social total cost (which is not just t( )) is called social marginal cost. SMC( ) is larger than trip cost t( ). t( ) just returns the trip cost for each level and does not count additional burden that -th car imposes on the society. -th commuter s social surplus is CS S ( ) = MWTP( ) SMC( ). Watanabe Econ 23 Externality & 11 Public Goods41 / 59 Why Shouldn t Liz Be on I-35? 9 Trip Cost t(x) 8 SMC(x) MWTP, Trip Cost [$] Car (x) Watanabe Econ 23 Externality & 11 Public Goods42 / 59

15 Why Shouldn t Liz Be on I-35? What does efficient outcome satisfy? 1 MWTP( ) > SMC( ): A gain from additional car (MWTP) is still larger than the additional burden imposed on the society. 2 MWTP( ) < SMC( ): Adding one car does more harm (SMC) than does good (MWTP). 3 Once you deviate from MWTP( ) = SMC( ), somebody can be better off. Efficient outcome satisfies: = 6(< E = 8). = SMC(x). Watanabe Econ 23 Externality & 11 Public Goods43 / 59 Why Shouldn t Liz Be on I-35? Liz: drives as long as MWTP( ) t(x). Society: drive as long as MWTP( ) SMC(x). = 6(< E = 8). Watanabe Econ 23 Externality & 11 Public Goods44 / 59 Why Shouldn t Liz Be on I-35? 12 MWTP, Trip Cost, SMC [$] CS 2 1 Trip Cost t(x) SMC(x) Car (x) Watanabe Econ 23 Externality & 11 Public Goods45 / 59

16 Why Shouldn t Liz Be on I-35? 12 MWTP, Trip Cost, SMC [$] CS 2 1 Trip Cost t(x) SMC(x) Car (x) Watanabe Econ 23 Externality & 11 Public Goods46 / 59 Why Shouldn t Liz Be on I-35? 12 MWTP, Trip Cost [$], SMC DWL 3 Offset 2 1 Trip Cost t(x) SMC(x) Car (x) Watanabe Econ 23 Externality & 11 Public Goods47 / 59 Tragedy of Commons Laissez-faire scheme fails to achieve the optimal number of cars. A discrepancy between trip cost t( ) (the cost an individual driver perceives) and the social marginal cost SMC( ) (the additional cost the society as a whole faces). Individual drivers take no account of the cost inflicted upon the rest of the drivers. Called tragedy of commons. Watanabe Econ 23 Externality & 11 Public Goods48 / 59

17 Tragedy of Commons Note E actually creates deadweight loss, whereas maximizes the total surplus. Watanabe Econ 23 Externality & 11 Public Goods49 / 59 Fixes To realize = 6, you can impose tax (toll) on drivers. By how much? Pigouvian tax δ := SMC(6) t(6) = 6. Watanabe Econ 23 Externality & 11 Public Goods5 / 59 Fixes 12 MWTP, Trip Cost, SMC [$] Trip Cost t(x) SMC(x) t(x) Car (x) Watanabe Econ 23 Externality & 11 Public Goods51 / 59

18 Fixes 12 MWTP, Trip Cost, SMC [$] CS Tax Revenue 3 2 Trip Cost t(x) 1 SMC(x) t(x) Car (x) Watanabe Econ 23 Externality & 11 Public Goods52 / 59 Example Exercise 4.3 (Pigouvian Tax) The following represents the highway use pattern on I What is the current traffic volume? 2 What is the optimal traffic volume? 3 What is the deadweight loss? 4 How much should the Pigouvian tax be? 5 t(x) SMC(x) Trip Cost, MWTP, SMC / Traffic Volume x (in ) Watanabe Econ 23 Externality & 11 Public Goods53 / 59 Example 5 t(x) SMC(x) Trip Cost, MWTP, SMC / Traffic Volume x (in ) Watanabe Econ 23 Externality & 11 Public Goods54 / 59

19 Example 5 t(x) SMC(x) Trip Cost, MWTP, SMC / Traffic Volume x (in ) Watanabe Econ 23 Externality & 11 Public Goods55 / 59 1 Introduction 2 When Market Fails 3 Categorization 4 Pigouvian Tax 5 Summary Watanabe Econ 23 Externality & 11 Public Goods56 / 59 Externality Coase s theorem 4 categories Pigouvian tax Watanabe Econ 23 Externality & 11 Public Goods57 / 59

20 Intro Market Failure Categorization Pigouvian Tax Airline du Jour Today s color theme is provided by courtesy of Watanabe Intro S7 Econ 23 Externality & 11 Public Goods 58 / 59 Market Failure Categorization Pigouvian Tax Index cap and trade, 8 club goods, 27 Coase s theorem, 18 common resources, 27 commuter s private surplus, 36 commuter s social surplus, 41 CSP ( ), see commuter s private surplus CSS ( ), see commuter s social surplus deadweight loss, 49 δ, see Pigouvian tax equilibrium traffic volume, 36 excludability, 26, 27 externality, 4, 38 negative, 4, 5 positive, 4, 6 free rider, 29 free-riders problem, 29 internalization, 16 Watanabe marginal willingness to pay, 31 MWTP( ), see marginal willingness to pay opportunity cost, 31 Pareto optimal, 39 Pigouvian tax, 5 private goods, 27 property rights, 17 pure public goods, 27 rivalry, 26, 27 SMC( ), see social marginal cost social marginal cost, 41 social total cost, 39 STC( ), see social total cost t( ), see trip cost function tragedy of commons, 48 trip cost function, 33 E, see equilibrium traffic volume Econ 23 Externality & 11 Public Goods 59 / 59