Presentation on theme: "PART 10 Market Failures Markets may fail to generate efficient results due to Monopoly Externalities Public Goods Open Access Markets may also have informational."— Presentation transcript:
1 PART 10 Market FailuresMarkets may fail to generate efficient results due toMonopolyExternalitiesPublic GoodsOpen AccessMarkets may also have informational problems—adverse selection and moral hazard
2 ExternalitiesAn externality is a cost or a benefit that is not reflected in market demand or supply curvesAn effect external to the marketEnvironmental pollution, congestion in cities, etcMSC$S (MC)D (MB)Q*Q’Output
3 Pollution and Abatement Pollution imposes costsAbatement of pollution is also costly“Optimal” amount of pollution is where MC of pollution is equal to its MBMarginal benefit of pollution is the abatement cost savedCan also think of this as the MC and MB of abatement
4 Pollution and Abatement Optimal quantity of pollution$MCMBP*P’PollutionIf the affected parties cannot negotiatethe market will produce P’ pollution
5 Pollution and Abatement Optimal quantity of abatement$MCMBA*AbatementIf the affected parties cannot negotiatethe market would produce no abatement.
6 Externalities and Transactions Costs Externalities can be thought of a being caused by a lack of property rights or high transactions costs (costs of negotiation or litigation)The Coase TheoremImportant point is that the world is a world of positive transactions costs, so that externalities are common
7 Externalities and Transactions Costs Example: A lake which can be used for recreation (by a fishing club) or waste discharge by a firmWe can think of the costs and benefits of the abatement of pollutionThe costs are the costs of reducing waste discharge, the benefits are the better fishing
8 Externalities and Transactions Costs $MCMBA*A’Abatement0 = no abatementA’ = complete abatementA* = optimal level of abatement
9 Externalities and Transactions Costs If the firm and the fishing club could negotiate without cost then regardless of who has the property right they would negotiate to A*If there are high costs to negotiating and the fishing club has the property right end up at A’ (MC>MB of abatement)If there are high costs to negotiating and the firm has the property right end up at 0 (MB>MC of abatement)Transactions costs are usually high, so the market results in inefficient allocation of resources
10 Policy Towards Externalities Regulation by standardsIf the standard to be achieved is the same for all firms this can result in inefficiency$MB2MB1PollutionStandard
11 Policy Toward Externalities Charges – Polluter pays a per unit charge$MB2MB1UnitchargePollution
12 Policy Toward Externalities Tradable Permits: Set total pollution level and let firms trade$PMB1+MB2Pollution$$PMB2MB1Pollution 1Pollution 2
13 Policy Toward Externalities Optimal (Pigovian) TaxesSet tax equal to excess of the marginal social cost over the marginal private cost$MSCMC+ TaxMCMBQQ*
14 Public GoodsA public good is a good that has to be provided to everyone or to no oneNational defense, clean air, lighthouses, public healthPure public goods characterized by non-rival consumption and non-excludable use
15 Public Goods Rivalry and excludability Rival Non-rival Artificially scarce goodsExcludableMost goodsNon-excludableOpen accessPublic goodsArtificially scarce goods often have close tozero MC of production. Private producers haveto find ways of limiting distribution to thosewho pay. Examples include computer software,downloadable music, pay per view TV. Someinefficiency in private provision.
16 Public Goods Public goods and the free rider problem If provided the good will be provided even to those who do not payLack of incentive to pay—people will try to free rideProvision by voluntary contributionProvision by government
17 Benefits of a Public Good One person’s consumption of a unit of a public good does not exclude othersMarginal willingness to pay (MB) for the first unit of a public good is the vertical sum of the marginal willingness to pay of all individualsIf I am willing to pay $100 for a one unit improvement in air quality and you are willing to pay $50 for a one unit improvement in air quality the MB of that improvement is $150
18 Optimal Provision of a Public Good The optimal level of provision for a public good is where MB=MC (economic efficiency)If left to the market the good will be under-provided (cannot capture people’s willingness to pay)Public provision—will government provide the optimal amounts of a public good?
19 Open Access Common property resources Problem of free entry and overuse of the resource“Tragedy of the Commons”Regulation, tax, assign some form of property right to individuals or groupsSystem of tradable licensesExample of fisheries
20 Open Access Optimal level of effort Yield TC TR Effort Open access Max sustainable yieldMax Econ Yield