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