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Externalities and Public Goods DERYA GÜLTEKİN-KARAKAŞ

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Presentation on theme: "Externalities and Public Goods DERYA GÜLTEKİN-KARAKAŞ"— Presentation transcript:

1 Externalities and Public Goods DERYA GÜLTEKİN-KARAKAŞ
Chapter 18 Externalities and Public Goods DERYA GÜLTEKİN-KARAKAŞ 1

2 Topics to be Discussed Externalities Public Goods Chapter 18 2

3 Externalities Negative Positive
Action by one party imposes a cost on another party Positive Action by one party benefits another party Chapter 18 4

4 External Cost Scenario Steel plant dumping waste in a river
The entire steel market effluent can be reduced by lowering output (fixed proportions production function) Chapter 18 5

5 External Cost Scenario
Marginal External Cost (MEC) is the cost imposed on fishermen downstream for each level of production. Marginal Social Cost (MSC) is MC plus MEC. Chapter 18 6

6 External Costs Firmaların MC eğrilerinin P1 q1 Q1 MSC MSCI MEC MECI q*
When there are negative externalities, the marginal social cost MSC is higher than the marginal cost. MEC MECI The differences is the marginal external cost MEC. q* P* Q* The industry competitive output is Q1 while the efficient level is Q*. The profit maximizing firm produces at q1 while the efficient output level is q*. Price Price MC S = MCI D P1 Aggregate social cost of negative externality Firm output Industry output Firmaların MC eğrilerinin 16

7 External Cost Negative Externalities encourage inefficient firms to remain in the industry and create excessive production in the long run. Chapter 18 17

8 Externalities Positive Externalities and Inefficiency
Externalities can also result in too little production, as can be shown in an example of home repair and landscaping. Chapter 18 18

9 External Benefits Value MSB D P1 MC P* MEB Repair Level q* q1
When there are positive externalities (the benefits of repairs to neighbors), marginal social benefits MSB are higher than marginal benefits D. q* P* A self-interested home owner invests q1 in repairs. The efficient level of repairs q* is higher. The higher price P1 discourages repair. D MC P1 q1 Is research and development discouraged by positive externalities? Repair Level Chapter 18 25

10 Public Goods Question When should government replace firms as the producer of goods and services? Chapter 18 100

11 Public Goods Public Good Characteristics Nonrival
For any given level of production the marginal cost of providing it to an additional consumer is zero. Nonexclusive People cannot be excluded from consuming the good. Chapter 18 101

12 Public Goods Not all government produced goods are public goods
Some are rival and exclusive Education Parks Chapter 18 102

13 Efficient Public Good Provision
Benefits (dollars) D1 D2 D When a good is nonrival, the social marginal benefit of consumption (D) , is determined by vertically summing the individual demand curves for the good. $7.00 $5.50 Marginal Cost $1.50 Efficient output occurs where MC = MB at 2 units of output. MB is $ $4.00 or $5.50. $4.00 Output 1 2 3 4 5 6 7 8 9 10 Chapter 18 105

14 Public Goods Public Goods and Market Failure
How much national defense did you consume last week? Chapter 18 106

15 Public Goods Free Riders
There 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. Chapter 18 107

16 Public Goods Establishing a mosquito abatement company
How do you measure output? Who do you charge? A mosquito meter? Chapter 18 108

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