1. REGULATION, PUBLIC GOODS, & BENEFIT-COST ANALYSIS Chapter 11 slide 1 Competitive Markets Provide the “Right” amounts of Goods and Services that People Want and at Least Cost. Government Regulation is intended to remedy several kinds of Market Failure: 1.Monopoly 2.Externalities, and 3.Imperfect Information Perfectly Competitive Markets do not require regulation. Recall the message of Chapter 7:

2. Market Failure due to Monopoly 11.2 Output Price Industry Demand Unit Cost E QCQC PCPC QMQM PMPM  M M C. S. DWL M By raising price and limiting output, monopoly generates a deadweight loss (relative to the social optimum of perfect competition).

3. Market Failure due to Monopoly 11.3 Antitrust measures are intended to prevent the emergence of monopoly and restore competition to a monopolistic industry. 1. Breaking Up Monopolies 2. Preventing Monopolies from Arising 3. Preventing Mergers that Reduce Competition 4. Preventing Price Fixing

4. 0 2 4 8 10 12 $9 8 7 6 5 4 3 2 1 0 INDUSTRY DEMAND MTC MC ExternalCost of Pollution: $1 Market Failure due to Externalities 11.4 An externality is a side effect (good or bad) caused by one economic agent and incurred by other agents. For a “dirty” industry, the full marginal cost of production includes the cost of the externality.

5. Pollution Cleaned Up 0% 100% Marginal Benefit of Clean Up Marginal Cost of Clean Up 11.5 Market Failure due to Externalities The ideal remedy is to tax a negative externality. The tax should equal the marginal harm due to the externality. The tax provides the appropriate incentive for the firm to reduce the externality. The optimal amount of cleanup balances the resulting MB versus the MC of cleanup. P* Tax t* induces the optimal amount of cleanup P*. t*

6. PUBLIC GOODS 11.6 A Pure Public Good is non-rival and non-exclusive. Practical Issues: 1. Estimating Benefits/Costs from reported preferences. 2. Public Financing. 3. “Politics” and Voting. A public good’s optimal scale is determined by weighing MBs and MC (where MBs are summed vertically). Highway Length (miles) MB (drivers) MB (truckers) MB Total = MB D + MB T $MB, $MC MC of Highway expansion H* The optimal length of this highway is H* miles (where MB Total = MC).

7. 11.7 BENEFIT-COST ANALYSIS A program should be undertaken if and only if: Net Benefit = Total Benefit – Total Cost > 0. Steps: 1. Indentify benefits and costs to all affected parties. 2. Measure dollar values for benefits and costs (using market values or imputed values). 3. Compute total net benefit (possibly considering distribution effects on gainers and losers).

8. BUILDING A PUBLIC BRIDGE 11.8 1. Ferry (status quo) CS = $5 million/year  = $5 million. NPV @4% = $250 million. Trips (millions) Price Trip demand P = 4 -.4Q B 105 P F = $2  F = $5 million CS = $5 million F AC = $1 $3 $4 0 2. Bridge (P = $0) CS = $20 million/year  = -$5 million, Cap Cost = $85 m. NPV @4% = $290 million. 3. Ferry (Regulated @ P = $1) CS = $11.5 million/year  = $0 million. NPV @4% = $281.25 million. 7.5