Presentation on theme: "Externalities and Public Goods"— Presentation transcript:
1 Externalities and Public Goods From free-riding to theCoase theorem
2 Externalities and Public Goods Up until now we have made several implicit assumptions when analysing “agents”Agents are independent : their welfare depends only on their own consumption / production decisionsBut maybe people’s satisfaction/welfare depends indirectly on what other people decide?Does this influence the market outcome? How?How can these effects be taken into account?
3 Externalities and Public Goods The characteristics of goods are “well behaved”Goods and services are always clearly defined, dividable into measurable units and exchangeable on a specified marketBut what about goods or services that can’t be divided, valued (priced), or exchanged on a market?What does economics have to say about these kinds of goods?
4 Externalities and Public Goods Public goods and free ridingExternalities and inefficiencyThe Coase theorem
5 Public goods and free riding Goods can be classified according to two fundamental, intrinsic properties :Rivalry : Two agents cannot simultaneously benefit from the consumption of a given unit of a goodExclusion (through price): an agent can only dispose of a given unit of a good once he has paid its price. This concept is closely linked to the existence of property rights.
6 Public goods and free riding Typology of goodsExclusion Possible?YesNoRival?Private GoodCar, medical drugsImpure Public goodCongested road14th July FireworksClub GoodPay per view TV, PatentsPublic GoodPublic lightsDefence
7 Public goods and free riding A “pure” public good satisfies three conditions:1. Impossibility of exclusion (possibility of freeriding)One cannot restrict the use of the good to specific agents (i.e. To those who pay)Examples:Public lighting? Defence? Fireworks display? Motorway? Lighthouse? Rule of Law?
8 Public goods and free riding A “pure” public good satisfies three conditions:2. Non-congestion (Non-rivalry)The satisfaction obtained from the good does not depend on the number of usersExamples:Public lighting? Defence? Fireworks display? Motorway? Lighthouse? Rule of Law?
9 Public goods and free riding A “pure” public good satisfies three conditions:3. Compulsory consumptionThe agent cannot decide not to consume the good (has no choice in the matter)Examples:Public lighting? Defence? Fireworks display? Motorway? Lighthouse? Rule of Law?
10 Public goods and free riding As a result, for public goods, the coordination of agents cannot happen on the marketEverybody is a consumer whether they want it or not.A supplier of the public good cannot exclude people who refuse to pay the good (free riders)This supplier has not way of recuperating his costsThere is a market failure on public goods: they will not be provided on a free market
11 Public goods and free riding The central aspect of this was shown by Ronald CoaseFree-riding and externalities occur when property rights are either:Not defined: who owns light of a lighthouse or the security provided by a police force?Not enforceable: there is a lack of institutions to enforce the property rights (example: “free” internet downloads)As a result, there is no market to extract compensation from freeriders
12 Externalities and Public Goods Public goods and free ridingExternalities and inefficiencyThe Coase theorem
13 Externalities and inefficiency An externality is a possible cause of market failures.It corresponds to the direct (non-market) impact of an agents decision on another agent’s welfareExternal economies, external effects, externalitiesIn production (the bees and orchard example)In consumption (internet or telephone)This impact can be negative or positiveNegative : leads to over-investmentPositive : leads to under-investment
14 Externalities and inefficiency Definition of a negative externalityThe Marginal social cost (msC) is larger that the marginal private cost (mpC)msC > mpCIn other words, I do not bear all the costs of my production/consumption decisions,Some costs “leak” out and are borne by other agents
15 Externalities and inefficiency msCCmpCThe polluter pays principle internalises the externality by making the polluter carry the negative externalityp*q*q1Marginal external costq
16 Externalities and inefficiency Example of negative production externalitiesThe effect of oil spills on local fishermenMy neighbour's trees shading my garden from the sunExamples of negative consumption externalitiesSmokers in restaurantsNeighbours playing techno very loudly at 3am!
17 Externalities and inefficiency What policies can be used to remove the inefficiency ?Regulation (emission standards, smoking bans)Taxation (problem: what is the optimal level of taxes what is the size of the externality?)Importantly, in terms of policy there is an optimal level of pollution !!It is not socially desirable to reduce it to zero.
18 Externalities and inefficiency Definition of a positive externalityThe Marginal social benefit (msB) is larger that the marginal private benefit (mpB)msB > mpBIn other words, I do not reap all the benefits of my production/consumption decisions,some benefits “leak” out and benefit other agents
19 Externalities and inefficiency BmpBExample : intellectual property rights attempt to increase the marginal private benefit by capturing the externalitymsBp*Marginal external benefitq1q*q
20 Externalities and inefficiency Example of positive production externalitiesThe classical bees/orchard exampleTechnological innovations (spillovers)Examples of positive consumption externalitiesNetwork goods (internet, telephone)HomeownershipEducationVaccination
21 Externalities and inefficiency What policies can be used to remove the inefficiency ?Subsidies (tax deductions on mortgages, public network infrastructure investment)Intellectual property rights (IPR)RegulationsAs for the optimal level of pollution, there is an optimal level of intellectual protection!It is not socially desirable to reduce IPR to zero
22 Externalities and Public Goods Public goods and free ridingExternalities and inefficiencyThe Coase theorem
23 The Coase theorem Named after Ronald Coase (Nobel 1991) No state intervention is required to correct externalities if:There are defined property rights (remember what was said above)There are no transaction costs between agentsIn this ideal case, all the state has to do is define some property rights, and the market will internalise the externality
24 The Coase theorem Coase’s initial work: Radio stations Initially, no frequency bands are defined: radio stations can interfereNegative production externalityThe state needs to create frequency bandsenforceable property rightsInteractions between agents produce :The allocation of these bands between the various radio stationsThe compensation of externalities is carried out by transactions between stations
25 The Coase theorem In real life, however, transaction costs exist Asymmetric/imperfect information about the externalityProving the existence of an externality can take a lot of time and effort (see Erin Brockovich vs Pacific Gas),Asymmetric relations between agentsImagine a litigation between a big chemical consortium and a local association on pollution.What is the likelihood of the association making its case with no external help ?
26 The Coase theoremIn that case, a 2nd role appears for the state: Reduce transactions costs between agentsEncourage the creation of consumers rights associations (increase coordination between agents)Create environmental watchdogs with a monitoring mission (reduces the information asymmetries)Reinforce legal / mediation /dispute resolution institutions (reduces the transaction costs)
27 The Coase theoremThis decentralised approach to reducing externalities is becoming increasingly popularIn theory it is cheaper: Taxes on pollution do provide an income, but monitoring costs are usually higherIn theory it is also more efficient: The state doesn’t need to figure out what the size of the externality is, which is a problem with taxation or regulationRecent example: the market for Carbon dioxide