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# McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Market Failures: Public Goods and Externalities 4.

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Presentation on theme: "# McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Market Failures: Public Goods and Externalities 4."— Presentation transcript:

1 # McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Market Failures: Public Goods and Externalities 4

2 4-2 Market Failures Market fails to produce the right amount of the product Resources may be Overallocated Underallocated LO1

3 4-3 Demand-Side Failures Impossible to charge consumers what they are willing to pay for the product Some can enjoy benefits without paying LO1

4 4-4 Supply-Side Failures Occurs when a firm does not pay the full cost of producing its output External costs of producing the good are not reflected in supply LO1

5 4-5 Efficiently Functioning Markets Demand curve must reflect the consumers, full willingness to pay Supply curve must reflect all the costs of production LO1

6 4-6 Consumer Surplus Difference between what a consumer is willing to pay for a good and what the consumer actually pays Extra benefit from paying less than the maximum price LO2

7 4-7 Consumer Surplus LO2 Consumer Surplus (1) Person (2) Maximum Price Willing to Pay (3) Actual Price (Equilibrium Price) (4) Consumer Surplus Bob$13$8$5 (= $13 - $8) Barb128 4 (= $12 - $8) Bill118 3 (= $11 - $8) Bart108 2 (= $10 - $8) Brent98 1 (= $9 - $8) Betty88 0 (= $8 - $8)

8 4-8 Consumer Surplus LO2 Price (per bag) Quantity (bags) D Q1Q1 P1P1 Consumer Surplus Equilibrium Price

9 4-9 Producer Surplus Difference between the actual price a producer receives and the minimum price the producer would accept Extra benefit from receiving a higher price LO2

10 4-10 Producer Surplus LO2 Producer Surplus (1) Person (2) Minimum Acceptable Price (3) Actual Price (Equilibrium Price) (4) Producer Surplus Carlos$3$8$5 (= $8 - $3) Courtney48 4 (= $8 - $4) Chuck58 3 (= $8 - $5) Cindy68 2 (= $8 -$6) Craig78 1 (= $8 -$7) Chad88 0 (= $8 - $8)

11 4-11 Producer Surplus LO2 Price (per bag) Quantity (bags) S Q1Q1 P1P1 Equilibrium price Producer surplus

12 4-12 Efficiency Revisited LO2 Price (per bag) Quantity (bags) S Q1Q1 P1P1 D Consumer surplus Producer surplus

13 4-13 Quantity (bags) Price (per bag) Efficiency Losses LO2 c S Q1Q1 Q2Q2 D b d a e Efficiency loss from underproduction

14 4-14 Efficiency Losses LO2 c S Q1Q1 Q3Q3 D b f a g Quantity (bags) Price (per bag) Efficiency loss from overproduction

15 4-15 Private Goods Characteristics Produced in the market by firms Offered for sale Characteristics Rivalry Excludability LO3

16 4-16 Public Goods Characteristics Provided by government Offered for free Characteristics Nonrivalry Nonexcludability Free-rider problem LO3

17 4-17 Measuring Demand LO3 Optimal Quantity for a Public Good, Two Individuals (1) Quantity of Public Good (2) Adams Willingness to Pay (Price) (3) Bensons Willingness to Pay (Price) (4) Collective Willingness to Pay (Price) 1$4+$5=$9 23+4=7 32+3=5 41+2=3 50+1=1

18 4-18 Cost-Benefit Analysis Cost Resources diverted from private good production Private goods that will not be produced Benefit The extra satisfaction from the output of more public goods LO3

19 4-19 Cost-Benefit Analysis LO3 Cost-Benefit Analysis for a National Highway Construction Project (in Billions) (1) Plan (2) Total Cost of Project (3) Marginal Cost (4) Total Benefit (5) Marginal Benefit (6) Net Benefit (4) – (2) No new construction $0 A: Widen existing highways 4$45$51 B: New 2-lane highways C: New 4-lane highways D: New 6-lane highways

20 4-20 Externalities A cost or benefit accruing to a third party external to the transaction Positive externalities Too little is produced Demand-side market failures Negative externalities Too much is produced Supply-side market failures LO4

21 4-21 Externalities LO4 (a) Negative externalities (b) Positive externalities 0 D S StSt Overallocation Negative Externalities StSt Underallocation Positive Externalities QoQo QoQo QeQe QeQe P P 0 QQ D DtDt a c z x b y

22 4-22 Government Intervention Correct negative externalities Direct controls Specific taxes Correct positive externalities Subsidies and government provision LO4

23 4-23 Government Intervention LO4 (a) Negative Externalities D S StSt Overallocation Negative Externalities QoQo QeQe P 0 Q a c b (b) Correcting the overallocation of resources via direct controls or via a tax D S StSt QoQo QeQe P 0 Q a T

24 4-24 Government Intervention LO4 (a) Positive externalities 0 StSt Underallocation Positive externalities QoQo QeQe D DtDt z x y (b) Correcting via a subsidy to consumers 0 StSt QoQo QeQe D DtDt (c) Correcting via a subsidy to producers 0 S' t QoQo QeQe D Subsidy StSt U

25 4-25 Government Intervention LO4 Methods for Dealing with Externalities Problem Resource Allocation OutcomeWays to Correct Negative externalities (spillover costs) Overproduction of output and therefore overallocation of resources 1.Private bargaining 2.Liability rules and lawsuits 3.Tax on producers 4.Direct controls 5.Market for externality rights Positive externalities (spillover benefits) Underproduction of output and therefore underallocation of resources 1.Private bargaining 2.Subsidy to consumers 3.Subsidy to producers 4.Government provision

26 4-26 Societys Optimal Amounts LO5 0 Societys Marginal Benefit and Marginal Cost of Pollution Abatement (Dollars) Q1Q1 MB MC Socially Optimal Amount of Pollution Abatement

27 4-27 Governments Role in the Economy Government can have a role in correcting externalities Officials must correctly identify the existence and cause Has to be done in the context of politics LO5


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