Upcoming in Class Group Quiz Thursday Homework #2 Due Next Thursday Writing Assignment Due Oct. 28th

Market for Electricity with Externalities Price of Good Marginal Social Cost Marginal Private Cost P* P Ps2 Demand Quantity of Good Q1 Q2

Coase Theorem If property rights are well-defined, and no significant transaction costs exist, an efficient allocation of resources will result even with externalities. The theorem states that when trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights.

Coase Example .Two pieces of land that are adjacent. Farmer McDonald grows crops worth $6,000. Farmer Brown’s land is on a swamp. Farmer Brown drains the swamp and can grow crops on his land worth $2,000. As a result McDonald’s land flood and destroys his crop. Example of not clear who pays is the swamp exampleTwo ways to resolve 1) M can pay B $4,000 not to drain the swamp. 2) Can pass a law against draining swamps without the agreement of any affected parties, which gives M the right to determine flood control upstream. Suppose the government invents a new crop so that Bs crop is worth $10,000. Now B should pay M $8000 for the right to drawn the swamp.

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

Tragedy of the Commons When a resource is non-excludable, individuals act independently and rationally consume with their own self-interest in mind. Ultimately, this will deplete the resource.

Public Goods Private Goods Common Goods Club Goods Rivalrous Fish, hunting game, grazing land Food, clothing, toys, cars Non-Excludable Excludable Satellite television, Golf courses, Cinemas National defense, lighthouses, clean air, information goods Public Goods Club Goods Non-Rivalrous

Common Good - Problem Model the benefit from hunting. TB increase but eventually decreases because it takes so much effort to kill just one buffalo.

Public Goods Non-excludable and non-rivalrous (indivisble) Biological diversity Genetic diversity Charming landscapes Intellectual property? What is the efficient level of a public good? Marginal cost = marginal benefits. Problem of two individuals their demand curve… summing up the benefits. Free rider - Typically, the pricing system requires charging a different price to each consumer. Consumers may not choose to reveal the strength of their preferences. Due to non-excludability consumers still receive the benefits, giving them more reason to not reveal their preferences. This diminishes the incentive to contribute

Public Goods Problem Suppose there are two people in a community who benefit from river preservation and the biodiversity created by it. Individual A Individual B Total Benefit 10 P=10-2q P=8-2q 8 Problem of two individuals their demand curve… summing up the benefits. Free rider - Typically, the pricing system requires charging a different price to each consumer. Consumers may not choose to reveal the strength of their preferences. Due to non-excludability consumers still receive the benefits, giving them more reason to not reveal their preferences. This diminishes the incentive to contribute 5 4

Tragedy of the Commons Typically, the pricing system requires charging a different price to each consumer. Consumers may not choose to reveal the strength of their preferences. Due to non-excludability consumers still receive the benefits, giving them more reason to not reveal their preferences. This diminishes the incentive to contribute.

Public Goods Problem What are the community’s total benefits from river preservation? Suppose the marginal cost of river preservation is MC=2q. What is the socially optimal level of river preservation? How much would each individual pay? Why might river preservation be difficult to implement? Social optimum is 3. Individual A pays $6 per mile and Individual B pays $2 per mile. River preservation is difficult because 1) need to know each individuals WTP curve exactly 2) Perhaps individual A gets upset about having to pay more than B. Free rider - Typically, the pricing system requires charging a different price to each consumer. Consumers may not choose to reveal the strength of their preferences. Due to non-excludability consumers still receive the benefits, giving them more reason to not reveal their preferences. This diminishes the incentive to contribute

Public Goods Typically the market undersupplies public goods. Why? Free-riders –someone who derives benefits from a commodity without contributing to its supply. Free rider - Typically, the pricing system requires charging a different price to each consumer. Consumers may not choose to reveal the strength of their preferences. Due to non-excludability consumers still receive the benefits, giving them more reason to not reveal their preferences. This diminishes the incentive to contribute. I free ride on NPR and This American Life. Anyone else free-ride?

Public Goods Problem How much would be produced if individual A were to pay for the river preservation? Would individual B, then pay also for any river preservation? Individual A would supply 2.5 miles of river preservation. River preservation is difficult because 1) need to know each individuals WTP curve exactly 2) Perhaps individual A gets upset about having to pay more than B. Free rider - Typically, the pricing system requires charging a different price to each consumer. Consumers may not choose to reveal the strength of their preferences. Due to non-excludability consumers still receive the benefits, giving them more reason to not reveal their preferences. This diminishes the incentive to contribute

Upcoming in Class Group Quiz Next Thursday Writing Assignment Due Oct. 28th