1 Lecture 9: Externalities and Public goods Charit Tingsabadh M.Sc. Programme in Environmental and natural resource economics Semester 1/2005

2 outline Concepts Specification Empirics

3 concept Externality: By-products of consumptions and production may benefit or harm other people Definition:when a person’s well-being or a firm’s capability is directly affected by the actions of other consumers of firms rather than indirectly through changes in prices. Examples: any suggestion?

4 Externalities: examples Supply side: a wedge between private cost and social cost (can be + or - ) Example: –Polluting factory causes fish deaths in river –Building a road allows other people to travel more conveniently –Coal-burning power station emits SO2 which causes acid rain Demand side: wedge between (marginal) private benefit and (marginal) social benefit (+ or - ) Example: –vaccination reduces health risk for all, not only the individual taking the jab; –Network: the more people have telephone, the more benefit to each subscriber –Forest conservation improves water supply and reduces greenhouse gas concentration

5 More generally.. Private goodCommon pool/open access Club goodPublic good rivalry high low excludability high low Externality arises from low excludability

6 Effect on the market:supply side Negative externality raises social cost over private cost price quantity D D M Private Cost M Social cost Result: price too low, too much is demanded and produced

7 Effect on the market:demand side Positive externality raises social benefit cost over private benefit price quantity D D Cost M Social benefit Result: price too low, too little is demanded and produced M private benefit

8 conclusion Because of externalities Market (private) prices do not reflect social prices Wrong (inefficient) resource allocation Would improve if external cost(benefit) can be internalised. Internalisation through property rights-give ownership, but of what ? And to whom? Institutional economics to the rescue..

9 Public Good Extreme case of low rivalry and low excludability Pure public good: no rivalry-if available to one consumer, is avaliable to all consumers No excludability-cannot exclude anybody from consumption So, if one consumes, all consume.

10 Graphing public good Demand side: Individual demand, normal downward sloping demand curve Market demand, vertical summation of individual demand curves, because same amount is consumed. Samuelson condition.

11 Market for public good Total demand D2 D1 S Price quantity

12 Description of market Total demand is vertical sum of individual demand Supply is shared in same quantity Cost is more than individual benefit Will there be market supply? If one pays for supply, all others will have it also, So wait for the “public” spirited person, free riding by others If not, no supply. Clear case of market failure!!!!

13 Correcting for externalities Pigouvian tax –How to set the tax rate? Property rights allocation (Coase theorem) –Whose rights-who pays? Rule-based control –To reduce transaction cost

14 The Commons Commons: high rivalry, low excludability Example: public park, roads, fishing Capacity limits to use Over-capacity use results in congestion Demand-side management vs. supply expansion Fees, quota, controlling access, etc.

15 Chapter 18 Externalities, Commons, and Public Goods

16 Figure 18.1 Welfare Effects of Pollution in a Competitive Market

Table 18.1 Industrial CO 2 Emissions, 1998

18 Figure 18.2 Taxes to Control Pollution

Figure 18.3 Cost- Benefit Analysis of Pollution

Application (Page 634) Emissions Standards for Ozone

21 Figure 18.4 Monopoly, Competition, and Social Optimum with Polution

22 Table 18.2 Property Rights and Bargaining

23 Table 18.2a Property Rights and Bargaining

24 Table 18.2b Property Rights and Bargaining

25 Table 18.2c Property Rights and Bargaining

26 Table 18.3 Rivalry and Exclusion

27 Figure 18.5 Inadequate Provision of a Public Good

28 Table 18.4 Private Payments for a Public Good

29 Table 18.5 Voting on $300 Traffic Signals

Cross-Chapter Analysis (Page 657) Emissions Fees Versus Standards Under Uncertainty