Upcoming in Class Homework #1 Due Today 1st Group Quiz - Monday Sept. 10th Writing Assignment Due Oct. 24th

HW1 – Problem 1 What is the difference between a common good, a public good, and an open-access good? Give examples.

HW1 –Problem 2 What is willingness-to-pay? What is your WTP for a dozen eggs from Meijer? What is your WTP for a dozen farm fresh eggs from organically raised free-range chickens? Explain why they are different.

HW1 – Problem 3 Assume a change in the quality of a good results in an increase in consumers’ WTP. Assume also that the supply of the good is unchanged. Illustrate this situation graphically and identify the change in net benefits attributable to the change in quality.

Max. Net Benefit Price of Good Marginal Cost Equilibrium Price Marginal Benefit Quantity of Good Equilibrium Quantity

Static Model Dynamic Model Time does not matter Cost/Benefit Analysis – cutting down trees Benefit > Cost => support action Cost > Benefit => oppose action Dynamic Model Account for time Cost/Benefit Analysis accounting for time Max [B0, B1, B2] Present Value – $1 invested today at 10% interested yields $1.10 a year from now. Present Value (PV) of X one year from now is X/(1+r)2 r is the interest rate (discount rate) PV[Bn]=Bn/(1+r)n

Market Equilibrium Price of Good Supply Equilibrium Price Demand Quantity of Good Equilibrium Quantity

Consumer Surplus Price of Good Supply Equilibrium Price Demand Quantity of Good Equilibrium Quantity

Producer Surplus Price of Good Supply Equilibrium Price Demand Quantity of Good Equilibrium Quantity

Total Welfare Price of Good Supply Equilibrium Price Demand Quantity of Good Equilibrium Quantity

Well-Defined Property Rights Exclusivity – All benefits and costs accrued as a result of owning and using the resources should accrue to the owner, and only the owner, either directly or indirectly by sale to others Transferability – All property rights should be transferable from one owner to another in a voluntary exchange Enforceability – Property rights should be secure from involuntary seizure or encroachment by others (ie. eminent domain) Examples of poorly defined rights- Exclusivity: Pollution, Transferability: Snickers Bar example Rafting Demand Enforcement: Libya Civil War En Elephants - http://www.colby.edu/personal/t/thtieten/end-bots.html http://www.perc.org/articles/article1407.php Note – Eminent domain is the inherent power of the state to seize a citizen's private property, expropriate property, or seize a citizen's rights in property with due monetary compensation, but without the owner's consent. Example, Haiti & Dominican Republic

A Note on Rights Efficient Property Rights => Net Benefits are Maximized Consumer Surplus – area under the demand curve minus the area representing cost Producer Surplus – area under the price line that lies over the marginal cost curve Net Benefits = CS + PS

Externalities as a Source of Market Failure Exclusivity – when the owner bears all of the consequences of his actions Externality – when the welfare of some agent (individual, household, or firm) depends on the activities under control of some other agent. Negative externalities (external diseconomy) Positive externalities (external economy) Externality – what you do affects me. Negative Externalities – Pollution Second hand smoke Over-fishing Positive Externalities – Donations to save the Rain forest Vegetarians

Market for Electricity Price of Good Supply Equilibrium Price Demand Quantity of Good Equilibrium Quantity

Market for Electricity with Externalities Price of Good Marginal Social Cost Marginal Private Cost P* Market Price Consumer Surplus with externality Producer Surplus with externality Max possible benefits Total external costs = total cost of pollution Socially efficient level of output. Demand Quantity of Good Q* Market Quantity

HW 1 – Problem 4 Consider the following supply and demand schedule for steel:   Price 20 40 60 80 100 120 140 160 180 Qd 200 Qs 220 260 300 340

HW 1 – Problem 4 Pollution from steel production is estimated to create an external cost of sixty dollars per ton. Show the external cost, market equilibrium, and social optimum on a graph.  

HW 1 – Problem 4 What kinds of policies might help to achieve the social optimum? How would this policy affect consumers? How would this policy affect producers? What effect would the policy have on market equilibrium price and quantity? 

Dealing with Externalities The Pursuit of Efficiency Legislative and Executive Regulation Direct Control – Quota Cap and Trade Pigovian Tax – “polluter pays principle” Not always clear who pays

How would you graph a positive externality? Example, when Duncan Hines produces brownie mix, it pollutes a small amount of cocoa powder into the air. This makes the air smell like brownies, and increase the MSB from the production of brownies. Brownie Smells - http://www.thisamericanlife.org/radio-archives/episode/307/in-the-shadow-of-the-city

Pigovian Tax Problem Suppose the demand function for gasoline is Pd = 6.5 - 0.5 Q where Q represents billions of gallons of gasoline. Suppose the supply function for gasoline is based on the firms’ marginal private costs and equals Ps=Q What is the market equilibrium level of output and price?

Pigovian Tax Problem Suppose the government’s EPA determines the socially optimal amount of gasoline use is actually 3 billion gallons of gasoline. To reach this socially optimal quantity, the government is going to implement a per unit tax on the consumption of gasoline. The tax revenue from which will go to protecting the environment as determined by the EPA. What should the tax amount be? What price will the consumers pay? What price will the sellers receive? How much money will go to protecting the environment?

Coase Theorem If property rights are well-defined, and no significant transaction costs exist, an efficient allocation of resources will result even with externalities.

Market for Electricity with Externalities Price of Good Marginal Social Cost Marginal Private Cost P* Market Price How you can save the world is to find the MSC. Demand Quantity of Good Q* Market Quantity

Coase Theorem Problem A chemical factory is situated next to a farm. Airborne emissions from the chemical factory damage crops on the farm. The marginal benefits of emissions to the factory and the marginal costs of damage to the farmer are as follows MB= 360 – 0.4 Q and MC=90+0.2Q From an economic viewpoint, what is the best solution to this environmental conflict of interest? How might this solution be achieved? Optimal q=450 of the pollutant and MC=MB=180. If the farmer has the right to say how much to pollute, the company can offer up to $180 per unit of pollution to allow 450 units of pollution. The farmer also benefits from the first 450 units of pollution and receives $180 for each. Company pays B+C but gains A+B+C. Net profit is area A. If the company has the right to pollute, the would pollute 900 units. But the farmer could pay the company not to pollute paying up to $180 per unit for 450 units (area D+E). The farmer still incurs the cost of area C. The company’s net gain is A+B+C+D+E. Scenario 1) Farmer gains = B Company gains= A. Scenario 2) Farmer pays= D+E and suffers C. Company gains= A+B+C+D+E Both Scenarios) Net gain to society is $60,750

Upcoming in Class Homework #1 Due Thursday Group Quiz Next Thursday Writing Assignment Due Oct. 27th