2 Overview Externalities and Property Rights Common Property Resources RecyclingCommon Property ResourcesPublic Goods & Private Preferences for Public GoodsBenefit-cost AnalysisPublic Choice Process2
3 The Efficient Amount of Recycling CostWith a refundable deposit,MC increases andMC = MSC = MCR.MC + per unit refundMCm1Without market interventionthe level of scrap will be at m1and m1 > m*.Households can dispose of glass and other garbage at very low cost. The low cost of disposal creates a divergence between the private and the social cost of disposal. S0, raising MC is a move in the right direction.MCRMSCm*Refund is like a tax for non-compliance, but no tax if there is complianceScrap4812Extent of recycling75
4 With refunds Sr increases to S’r and S increases to S’. Refundable DepositsS’rS’P’M*With refunds Sr increasesto S’r and S increases to S’.SvSrSThe supply of glass S isthe horizontal sum of theSupply of virgin glass (Sv)and the supply of recycledglass (Sr).$M1PWithout refunds theprice of glass is P andSr is M1.DPrice falls to P’ andthe amount ofrecycled glassincreases to M*.Amount of Glass80
5 Externalities and Property Rights Legal rules describing what people or firms may do with their propertyFor exampleIf residents downstream owned the river (clean water) they control upstream emissions.Bargaining and Economic EfficiencyEconomic efficiency can be achieved without government intervention when the externality affects relatively few parties and when property rights are well specified.81
6 PRIVATE SOLUTION TO EXTERNALITIES Coase Thorem: Economic agents can arrive at an efficient solution (i.e., an optimum assignment of property rights)irrespective of initial assignment of property rights,provided they can bargain free of cost (i.e., w/o transaction costs), andthere is no wealth effect to thwart the bargaining process.Coase Theorem at Work: Negotiating an Efficient Solution New York garbage spill (200 tons) littered the New Jersey beachesThe potential cost of litigation resulted in a solution that was mutually beneficial to both parties.
7 Coase Theorem MC of pollution abatement by factory MC of pollution to fisheriesOE is optimal quantity of pollution and O’E is the corresponding optimal quantity of abatementAt E, the marginal costs of pollution and abatement are equal, and the sum of the total costs i.e. triangle OXO’ is the leastAt A, MC of abatement exceeds MC of pollution, so it is cheaper to compensate the fishermen AB than to abate the pollution ACCLDemand price forabatement nowhigher to facilitatepollution reductionXDemand pricefor abatementfalls shortBOO’AEFPollutionAbatement
8 Common Property Resources Everyone has free access.Likely to be over-utilizedExamplesAir and waterFish and animal populationsMineralsSolutionPrivate ownershipQuestionWouldn’t private ownership be impractical?94
9 Common Property Resources Private CostFCWithout control the numberof fish/month is FC wherePC = MB (marginal benefit).Benefits,Costs($ perfish)However, private costsunderestimate true cost.The efficient level offish/month is F* whereMSC = MB (D)Marginal Social CostF*DemandFish per Month98
10 Crawfish Fishing in Lousiana Finding the Efficient Crawfish CatchF = crawfish catch in millions of pounds/yrC = cost in dollars/poundDemandC = = FMSCC = FPCC = FEfficient Catch9.2 million poundsD = MSC
11 Crawfish as a Common Property Resource Cost(dollars/pound)Marginal Social CostPrivate Cost22.214.171.124.325DemandCrawfish Catch(millions of pounds)98
12 Public Goods Public Good Characteristics Non-rivalFor any given level of production the marginal cost of providing it to an additional consumer is zero.Non-exclusivePeople cannot be excluded from consuming the good.Not all government produced goods are public goodsSome are rival and non-exclusive (more like a common property resource)Education101
13 Common Property Resource Typology of GoodsCharacteris-ticsExcludableNon-excludableRivalPrivate GoodCommon Property ResourceNon-rivalClub GoodPublic Good
14 Efficient Public Good Provision Benefits(dollars)D1D2DWhen a good is non-rival, the social marginalbenefit of consumption (D) , is determined byvertically summing the individual demandcurves for the good.$7.00$5.50Marginal Cost$1.50Efficient output occurswhere MC = MB at 2units of output. MB is$ $4.00 or $5.50.$4.00Horizontal sum of demand curvesWhat if this is the MC curve?Output12345678910105
15 Problem with Public Goods Free RidersThere is no way to provide some goods and services without benefiting everyone.Households do not have the incentive to pay what the item is worth to them.Free riders understate the value of a good or service so that they can enjoy its benefit without paying for it.Clean Air is a public goodNon-exclusive and non-rivalWhat is the price of clean air?107
16 How to know Private Preferences for Public Goods? Government production of a public good is advantageous because the government can assess taxes or fees to pay for it.Determining how much of a public good to provide when free riders exist is however extremely difficult.114
17 The Demand for Clean Air DollarsLow IncomeMiddle IncomeHigh Income30002500200015001000500Nitrogen Oxides(pphm)12345678910112
18 Findings on Demand for Clean Air Amount people are willing to pay for clean air increases substantially as pollution increases.Higher income earners are willing to pay more (the gap between the demand curves widen)National Academy of Sciences found that a 10% reduction in auto emissions yielded a benefit of $2 billion---somewhat greater than the cost.113
19 Exercise 7, p.653: Willingness to pay for different quantities of the public good Time G-1 G-2 G-3 V.Sum
20 Exercise 7, p.653: Willingness to demand the private good at different prices Price G-1 G-2 G-3 H.Sum
21 Benefit-cost Analysis Compares present value of benefits to present value of costs of a government project, which is mostly in the nature of public goodsHelps ranking projects in terms of benefit-cost ratio (must be >1) until available limited resources are exhaustedDifficulties in BC ratio estimation:Correctly estimating benefits & costs in the future, especially their opportunity costsMany benefits and costs - often in the nature of intangibles - are not quantifiableChoice of interest rate for discounting poses a very serious problem & hence sensitivity analysis is performed to choose across different alternative ratesHence, BC analysis still a subjective art rather than an objective science
22 Public Choice Process Broad groups Major characteristics 1. Voters Voting for policies favoring their interestsGenerally less informed about political decisions than their market decisions – referred to as ‘rational ignorance’- less need to gather information as elected leaders are empowered to take decisions on their behalf- very expensive to gather information on public choice- voters have less influence on and lesser affected by public choice as compared to market choice2. Politicians As counterpart of firm entrepreneurs/managers, seek to maximize chance of re-electionOften responds to desires of small, well-organized, well-informed, well-funded, passionate & vocal interest groups at the cost of mostly silent and uninformed majority
23 Public Choice Process Broad groups Major characteristics 3. Interest groups Organize lobbies and support politicians willing to serve their interests, although laws & regulations are invariably rationalized in terms of national interest4. Bureaucrats Often implements policies under monopoly conditions w/o caring for efficiency, unless there is pressure of competition to compete and coordinateOften non-neutral and non-passive, actively trying to influence policy & its implementationHence as a special interest group within government contributes to size & growth of the bureau
24 Some Institutional Changes Suggested to prevent ‘Government Failure’ Informing, educating & organizing votersContracting out government services not entirely public good in natureEncouraging inter-agency competitionReferendum & thus frequently reverting to direct democracySpecify total amount of funds to be allocated across competing uses.
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