1. Chapter 16 Public Goods, Externalities, and Information Asymmetries
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter Objectives Public goods vs. private goods
The optimal quantity of a public good
Cost-benefit analysis
Externalities
Information failures and government intervention
WHEN FREE MARKETS DON’T WORK!!!
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3. Public Goods Private goods Public goods Rivalry and excludability
Nonrivalry- eg. GPS
Nonexcludability eg Military Defense
Free-rider problem eg living in sight view of Yankee stadium field
No market demand in large part due to the first 3 above—market demand for a bridge?
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4. Optimal Quantity of a Public Good
Supplied by the government
Government estimates demand? How?
Compare marginal benefit to marginal cost (MB=Demand Curve, MC= Supply Curve)
Demand for a public good
Sum individual willingness to pay
Sum vertically
NEXT PAGE---THIS IS DIFFERENT THAN ARE USUAL MEANS OF SUMMING UP DEMAND
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5. Demand for Public Goods
Example: two individuals
(1)
Quantity
Of Public
Good
(2)
Adams’
Willingness
To Pay (Price)
(3)
Benson’s
Willingness
To Pay (Price)
(4)
Collective
Willingness
To Pay (Price) 1 2 3 4 5 $4 3 2 1 + $5 4 3 2 1 = $9 7 5 3 1
Graphically…
REMEMBER BOTH CAN USE THIS PRODUCT WITHOUT HARMING THE OTHERS USE
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6. Demand for Public Goods$9 7 5 3 1 P Q 2 4
Collective Demand S
Optimal
Quantity
$7 for 2 Items
$3 for 4 Items
Collective
Willingness
To Pay DC
Connect the Dots
Collective Demand and Supply $6 5 4 3 2 1 P Q
Benson’s Demand
$4 for 2 Items D2
$2 for 4 Items
Benson $6 5 4 3 2 1 P Q
Adams’ Demand
$3 for 2 Items
$1 for 4 Items D1
Adams
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7. Cost-Benefit Analysis
Provide a public good? Education? Defense? Health Care
How much should be provided? Pre-school?
Resources are limited
Marginal-cost-marginal-benefit rule
Allocate government resources to maximize net benefit
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8. Externalities Market failure Negative externality Positive externality
Requires government action
Negative externality
External cost
Overproduction
Positive externality
External benefit
Underproduction
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9. Externalities Negative Externalities? Such as? Positive Externalities?Q
Negative
Externalities St St
Positive
Externalities S Dt D D
Overallocation
Underallocation Qo Qe Qe Qo
Negative
Externalities? Such as?
Positive
Externalities?
Such as?
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10. Coase Theorem Externalities corrected by individual bargaining
Property ownership defined
Small number people
Bargaining costs negligible
Limitations
Liability rules and lawsuits
Example- neighbors wall is deteriorating, creating an eyesore
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11. Government Intervention
Correct negative externality
Direct controls- limits on production? Cap N Trade?
Specific taxes (fines?)
Correct positive externality
Subsidize buyers or producers
Government provision
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12. Market Based Approach Tragedy of the commons
Resource lacks defined ownership
Air, lakes, etc.
No incentive to maintain
Market for externality rights
Right to pollute
Can be bought and sold
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13. Boy, do I have Problems!
Average Bluefin tuna size and # have declined precipitously – how can we create sustainable fisheries?-What economic TERM leads to overfishing?
If health insurance companies are required to accept everyone why might that lead to fewer people having insurance?
What economic “term” does this deal with?
How can government ensure that inclusion doesn’t lead to fewer getting insurance?

14. MORAL HAZARD!!!
Why would getting homeowner’s insurance cause me to more recklessly take care of my property? What is the term in economics that deals with this issue? Have you ever taken more of a risk because you didn’t have to fully accept the loss?

15. Using economic analysis how should the Town determine whether to have a one public swimming pool? Two?
Why am I far more likely to buy a “certified” used BMW 325 IS car for $15,000 than the identical make/model/year/mileage from Bob Smith for $12,000?

16. Make an Economic Argument that Tort reform (limits on lawsuits) will lead to negative externalities.
Make an Economic Argument that Tort Reform will lead to positive externalities.

17. Market for Pollution Rights
Advantages
Real-world examples P Q
Price Per Pollution Right
Quantity of 1-Ton Pollution Rights
D2018
S=Supply of
Pollution
Rights
D2008
$200
$100
500
750
1000
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18. Optimal Externality Reduction
How much pollution abatement?
MC = MB (WHAT HAPPENS IF TOO MUCH ABATEMENT? MC
Socially
Optimal Amount
Of Pollution
Abatement
Cost of Pollution Abatement (Dollars)
Society’s Marginal Benefit and Marginal MB Q1
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19. Climate Change Earth has warmed over the last century
Human activity contributing factor
Carbon dioxide and greenhouse effect
Kyoto Protocol 1997
Climate change policies
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20. Climate Change
Carbon-Dioxide Emissions, Tons Per Capita, Selected Nations 2005
United States
Australia
Canada
Czech Republic
Germany
Japan
United Kingdom
Spain
Italy
France
Source: OECD Environmental Data
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21. Information Failures Asymmetric information
Inadequate buyer information
Gasoline market
Licensing of surgeons
Inadequate seller information
Moral hazard problem
Adverse selection problem
Workplace safety
Qualification
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22. Lojack: A Case of Positive Externalities
Crime reduction expenditures $300 billion
Some redistribute vs. reduce crime
Lojack car recoveries 95% vs. 60%
External benefits
Catch thieves
Locate and stop chop shops
MSB 15 times the MC
Underallocation
Policy to encourage use of Lojack?
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23. Key Terms private goods public goods free-rider problem
cost-benefit analysis
marginal-cost-marginal-benefit rule
externalities
Coase theorem
tragedy of the commons
market for externality rights
optimum reduction of an externality
cap-and-trade program
climate-change problem
asymmetric information
moral hazard problem
adverse selection problem
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24. Public Choice Theory and the Economics Of Taxation
Next Chapter Preview…
Public Choice Theory
and the Economics
Of Taxation
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