Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show Government And Market Failure 30 C H A P T E R

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show Rivalry & Excludability (Chapter 5) Private Goods Divisibility Demand Curve is Horizontal Summation Public Goods Indivisibility PUBLIC GOODS

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show Problems of Revealing Preferences Quantity Adams’ Willingness to pay (price) Benson’s Willingness to pay (price) Collective Willingness to pay (price) 1 DEMAND FOR A PUBLIC GOOD Exclusion Principle does not apply

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show Problems of Revealing Preferences Quantity Adams’ Willingness to pay (price) Benson’s Willingness to pay (price) Collective Willingness to pay (price) 1$4$5$9+= DEMAND FOR A PUBLIC GOOD

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show Problems of Revealing Preferences Quantity Adams’ Willingness to pay (price) Benson’s Willingness to pay (price) Collective Willingness to pay (price) 1212 $4 3 $5 4 $ ==== DEMAND FOR A PUBLIC GOOD

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show Problems of Revealing Preferences Quantity Adams’ Willingness to pay (price) Benson’s Willingness to pay (price) Collective Willingness to pay (price) $4 3 2 $5 4 3 $ ====== DEMAND FOR A PUBLIC GOOD

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show Problems of Revealing Preferences Quantity Adams’ Willingness to pay (price) Benson’s Willingness to pay (price) Collective Willingness to pay (price) $ $ $ ======== DEMAND FOR A PUBLIC GOOD

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show Problems of Revealing Preferences Quantity Adams’ Willingness to pay (price) Benson’s Willingness to pay (price) Collective Willingness to pay (price) $ $ $ ========== DEMAND FOR A PUBLIC GOOD

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show P Q $ OPTIMAL AMOUNT OF A PUBLIC GOOD Adams’ willingness to pay D1D1

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show P Q $ OPTIMAL AMOUNT OF A PUBLIC GOOD Benson’s willingness to pay D2D2 D1D1

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show P Q $ DCDC OPTIMAL AMOUNT OF A PUBLIC GOOD When vertically added equals collective willingness to pay D2D2 D1D1

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show P Q $ The public good’s marginal cost as shown by S DCDC S OPTIMAL AMOUNT OF A PUBLIC GOOD

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show P Q $ DCDC S OPTIMAL AMOUNT OF A PUBLIC GOOD Yields the optimum amount of the public good MB = MC

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show COST-BENEFIT ANALYSIS Marginal Cost = Marginal Benefit Rule Spillover Costs Overallocation Spillover Benefits Underallocation Externalities

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show P Q SPILLOVER COSTS AND BENEFITS D 0 Spillover costs StSt S Overallocation Q0Q0 QeQe

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show P Q SPILLOVER COSTS AND BENEFITS 0 QeQe Q0Q0 D DtDt Spillover Benefits StSt Underallocation

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show Liability Rules and Lawsuits Government Intervention Direct Controls Specific Taxes Individual Bargaining – Coase Theorem SPILLOVER COSTS AND BENEFITS Subsidies and Government Provision

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show P Q CORRECTING SPILLOVER COSTS D 0 Spillover costs StSt S TAX Overallocation Corrected Q0Q0 QeQe

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show P Q CORRECTING SPILLOVER BENFITS 0 Q0Q0 QeQe D S DtDt Spillover Benefits Underallocation

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show P Q CORRECTING SPILLOVER BENFITS 0 Q0Q0 QeQe D S DtDt Subsidy to consumer increases demand Underallocation Corrected Correcting by Subsidy to Consumers

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show P Q D 0 Subsidy to producers increases supply StSt S’ t Underallocation Corrected QeQe Q0Q0 Correcting by Subsidy to Producers CORRECTING SPILLOVER BENFITS

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show A MARKET-BASED APPROACH TO SPILLOVER COSTS The Tragedy of the Commons A Market for Externality Rights Operation of the Market Advantages S = Supply of pollution rights D 2012 Price per pollution right Quantity of pollution rights $200 $100 D 2004

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show SOCIETY’S OPTIMAL AMOUNT OF EXTERNALITY REDUCTION Application of MC = MB Rule MC, MB Equilibrium Optimal Reduction of an Externality Shifts in the Curves Graphically…

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show SOCIETY’S OPTIMAL AMOUNT OF EXTERNALITY REDUCTION MC MB Socially optimum amount of pollution abatement 0 Society’s marginal benefit and marginal cost of pollution abatement Amount of pollution abatement Q1Q1

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show Market for Recyclable Inputs Policy Demand Incentives Supply Incentives Global Warming Theory RECYCLING

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show Information Failures Inadequate information … about sellers about buyers Moral Hazard Problem Adverse Selection Problem Workplace Safety Asymmetric Information RECYCLING

cost-benefit analysis marginal-cost – marginal-benefit rule externalities Coase theorem tragedy of the commons market for externality rights optimal reduction of an externality asymmetric information moral hazard problem adverse selection problem ENDBACK Copyright McGraw-Hill/Irwin, 2005

Copyright McGraw-Hill/Irwin, 2005 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Recycling Key Terms Previous Slide Next Slide End Show Next: Public Choice Theory And The Economics of Taxation Chapter 31