Public Goods and Common Resources

Chapter

 

• The marginal social cost of pollution is the additional cost imposed on society as a whole by an additional unit of pollution.
• The marginal social benefit of pollution is the additional gain to society as a whole from an additional unit of pollution.
• The socially optimal quantity of pollution is the quantity of pollution that society would choose if all the costs and benefits of pollution were fully accounted for.

 

 

• An external cost is an uncompensated cost that an individual or firm imposes on others.
• An external benefit is a benefit that an individual or firm confers on others without receiving compensation.

 

Pollution is an example of an external cost, or negative externality; in contrast, some activities can give rise to external benefits, or positive externalities. External costs and benefits are known as externalities.

Left to itself, a market economy will typically generate too much pollution because polluters have no incentive to take into account the costs they impose on others.

 

• In an influential 1960 article, the economist Ronald Coase pointed out that, in an ideal world, the private sector could indeed deal with all externalities.
• According to the Coase theorem, even in the presence of externalities an economy can always reach an efficient solution provided that the transaction costs—the costs to individuals of making a deal—are sufficiently low.
• The costs of making a deal are known as transaction costs.

 

• The implication of Coase’s analysis is that externalities need not lead to inefficiency because individuals have an incentive to find a way to make mutually beneficial deals that lead them to take externalities into account when making decisions.
• When individuals do take externalities into account, economists say that they internalize the externality.

• Transaction costs prevent individuals from making efficient deals.

 

Examples of transaction costs include the following:

• The costs of communication among the interested parties—costs that may be very high if many people are involved.
• The costs of making legally binding agreements that may be high if doing so requires the employment of expensive legal services.
• Costly delays involved in bargaining—even if there is a potentially beneficial deal, both sides may hold out in an effort to extract more favorable terms, leading to increased effort and forgone utility.

 

Policies Toward Pollution:

• Environmental standards are rules that protect the environment by specifying actions by producers and consumers. Generally such standards are inefficient because they are inflexible.
• An emissions tax is a tax that depends on the amount of pollution a firm produces.
• Tradable emissions permits are licenses to emit limited quantities of pollutants that can be bought and sold by polluters.
• Taxes designed to reduce external costs are known as Pigouvian taxes.

 

 

• When the quantity of pollution emitted can be directly observed and controlled, environmental goals can be achieved efficiently in two ways: emissions taxes and tradable emissions permits.
• These methods are efficient because they are flexible, allocating more pollution reduction to those who can do it more cheaply.
• An emissions tax is a form of Pigouvian tax, a tax designed to reduce external costs.
• The optimal Pigouvian tax is equal to the marginal social cost of pollution at the socially optimal quantity of pollution.

 

• When there are external costs, the marginal social cost of a good or activity exceeds the industry’s marginal cost of producing the good.
• In the absence of government intervention, the industry typically produces too much of the good.
• The socially optimal quantity can be achieved by an optimal Pigouvian tax, equal to the marginal external cost, or by a system of tradable production permits.

 

 

The marginal social benefit of a good or activity is equal to the marginal benefit that accrues to consumers plus its marginal external benefit.

• A Pigouvian subsidy is a payment designed to encourage activities that yield external benefits.
• A technology spillover is an external benefit that results when knowledge spreads among individuals and firms. The socially optimal quantity can be achieved by an optimal Pigouvian subsidy equal to the marginal external benefit.
• An industrial policy is a policy that supports industries believed to yield positive externalities.
• The marginal social cost of a good or activity is equal to the marginal cost of production plus its marginal external cost.

 

 

 

• A good is subject to a network externality when the value of the good to an individual is greater when a large number of other people also use the good.
• Any way in which other people’s consumption of a good increases your own marginal benefit from consumption of that good can give rise to network effects.
• A good is subject to positive feedback when success breeds greater success and failure breeds failure.

 

Chapter 18

Characteristics of Goods

A good is excludable if the supplier of that good can prevent people who do not pay from consuming it.

 

A good is a rival in consumption if the same unit of the good cannot be con- sumed by more than one person at the same time.

 

A good that is both excludable and rival in consumption is a private good.

 

When a good is non excludable, the supplier cannot prevent consumption by people who do not pay for it.

 

A good is nonrival in consumption if more than one person can consume the same unit of the good at the same time.

 

Because goods can be either excludable or nonexcludable, rival or nonrival in con- sumption, there are four types of goods, illustrated by the matrix in Figure:

 

 

Public Goods

A public good is both nonexcludable and nonrival in consumption.

 

Here are some other examples of public goods:

 

■ Disease prevention. When doctors act to stamp out the beginnings of an epidemic before it can spread, they protect people around the world.

■ National defense. A strong military protects all citizens.

■ Scientific research. More knowledge benefits everyone.

 

Figure 18-2 illustrates the efficient provision of a public good, showing three marginal benefit curves.

 

 

 

Cost-Benefit Analysis

 

Governments engage in cost-benefit analysis when they estimate the social costs and social benefits of providing a public good.

 

Common Resources

A common resource is nonexcludable and rival in consumption: you can’t stop me from consuming the good, and more consumption by me means less of the good available for you.

 

The Problem of Overuse

 

Common resources left to the market suffer from overuse: individuals ignore the fact that their use depletes the amount of the resource remaining for others.

 

 

Artificially Scarce Goods

An artificially scarce good is exclud- able but nonrival in consumption.

 

 

Chapter 19

 

Special Considerations

 

While it is true that the government is rarely the most cost-effective agent to deliver a program, it is also true that the government is the only organization that can potentially care for all its citizens without being driven to do so as part of another agenda. Running a welfare state is fraught with difficulties, but it is also difficult to run a nation where large swaths of the population struggle to get the food, education, and care needed to better their personal situation.

 

 

Chapter 20

 

Physical capital – consist of manufactured productive resources such as equipment, buildings, tools, and machines.

Human capital is the improvement in labour created by education and knowledge that is embodied in the workforce.

The factor distribution of income is the division of total income among labor, land, and capital.

 In a perfectly competitive market economy, the price of the good multiplied by the marginal product labor is equal to the value of the marginal product of labor: VMPL = P × MPL. A profit-maximizing producer hires labor up to the point at which the value of the marginal product of labor is equal to the wage rate: VMPL = W. The value of the marginal product of labor curve slopes downward due to diminish- ing returns to labor in production.

The value of the marginal product of a factor is the value of the additional output generated by employing one more unit of that factor.

The value of the marginal product curve of a factor shows how the value of the marginal product of that factor depends on the quantity of the factor employed.

 

The market demand curve for labor is the horizontal sum of all the individual demand curves of producers in that market.

There are three main aspects that causes factor demand curves to shift:

1) Changes in prices of goods

2) Changes in supply of other factors

3) Changes in technology

As in the case of labor, producers will employ land or capital until the point at which its value of the marginal product is equal to its rental rate. According to the marginal productivity theory of income distribution, in a perfectly competitive economy each factor of production is paid its equilibrium value of the marginal product.

The equilibrium value of the marginal product of a factor is the additional value produced by the last unit of that factor employed in the factor market as a whole.

The rental rate of either land or capital is the cost, explicit or implicit, of using a unit of that asset for a given period of time.

 

Existing large disparities in wages both among individuals and across groups lead some to question the marginal productivity theory of income distribution.

Compensating differentials, as well as differences in the values of the marginal products of workers that arise from differences in talent, job experience, and human capital, account for some wage disparities.

Market power, in the form of unions or collective action by employers, as well as the efficiency-wage model, also explain how some wage disparities arise.

Discrimination has historically been a major factor in wage disparities. Market competition tends to work against discrimination.

The choice of how much labor to supply is a problem of time allocation: a choice between work and leisure.

A rise in the wage rate causes both an income and a substitution effect on an individual's labor supply. The substitution effect of a higher wage rate induces longer work hours, other things equal. This is countered by the income effect: higher income leads to a higher demand for leisure, a normal good. If the income effect dominates, a rise in the wage rate can actually cause the individual labor supply curve to 66 slope the "wrong" way: downward.

 The market labor supply curve is the horizontal sum of the individual labor supply curves of all workers in that market. It shifts for four main reasons: changes in prefer ences and social norms, changes in population, changes in opportuni ties, and changes in wealth.

 

Chapter

 

• The marginal social cost of pollution is the additional cost imposed on society as a whole by an additional unit of pollution.
• The marginal social benefit of pollution is the additional gain to society as a whole from an additional unit of pollution.
• The socially optimal quantity of pollution is the quantity of pollution that society would choose if all the costs and benefits of pollution were fully accounted for.

 

 

• An external cost is an uncompensated cost that an individual or firm imposes on others.
• An external benefit is a benefit that an individual or firm confers on others without receiving compensation.

 

Pollution is an example of an external cost, or negative externality; in contrast, some activities can give rise to external benefits, or positive externalities. External costs and benefits are known as externalities.

Left to itself, a market economy will typically generate too much pollution because polluters have no incentive to take into account the costs they impose on others.

 

• In an influential 1960 article, the economist Ronald Coase pointed out that, in an ideal world, the private sector could indeed deal with all externalities.
• According to the Coase theorem, even in the presence of externalities an economy can always reach an efficient solution provided that the transaction costs—the costs to individuals of making a deal—are sufficiently low.
• The costs of making a deal are known as transaction costs.

 

• The implication of Coase’s analysis is that externalities need not lead to inefficiency because individuals have an incentive to find a way to make mutually beneficial deals that lead them to take externalities into account when making decisions.
• When individuals do take externalities into account, economists say that they internalize the externality.

• Transaction costs prevent individuals from making efficient deals.

 

Examples of transaction costs include the following:

• The costs of communication among the interested parties—costs that may be very high if many people are involved.
• The costs of making legally binding agreements that may be high if doing so requires the employment of expensive legal services.
• Costly delays involved in bargaining—even if there is a potentially beneficial deal, both sides may hold out in an effort to extract more favorable terms, leading to increased effort and forgone utility.

 

Policies Toward Pollution:

• Environmental standards are rules that protect the environment by specifying actions by producers and consumers. Generally such standards are inefficient because they are inflexible.
• An emissions tax is a tax that depends on the amount of pollution a firm produces.
• Tradable emissions permits are licenses to emit limited quantities of pollutants that can be bought and sold by polluters.
• Taxes designed to reduce external costs are known as Pigouvian taxes.

 

 

• When the quantity of pollution emitted can be directly observed and controlled, environmental goals can be achieved efficiently in two ways: emissions taxes and tradable emissions permits.
• These methods are efficient because they are flexible, allocating more pollution reduction to those who can do it more cheaply.
• An emissions tax is a form of Pigouvian tax, a tax designed to reduce external costs.
• The optimal Pigouvian tax is equal to the marginal social cost of pollution at the socially optimal quantity of pollution.

 

• When there are external costs, the marginal social cost of a good or activity exceeds the industry’s marginal cost of producing the good.
• In the absence of government intervention, the industry typically produces too much of the good.
• The socially optimal quantity can be achieved by an optimal Pigouvian tax, equal to the marginal external cost, or by a system of tradable production permits.

 

 

The marginal social benefit of a good or activity is equal to the marginal benefit that accrues to consumers plus its marginal external benefit.

• A Pigouvian subsidy is a payment designed to encourage activities that yield external benefits.
• A technology spillover is an external benefit that results when knowledge spreads among individuals and firms. The socially optimal quantity can be achieved by an optimal Pigouvian subsidy equal to the marginal external benefit.
• An industrial policy is a policy that supports industries believed to yield positive externalities.
• The marginal social cost of a good or activity is equal to the marginal cost of production plus its marginal external cost.

 

 

 

• A good is subject to a network externality when the value of the good to an individual is greater when a large number of other people also use the good.
• Any way in which other people’s consumption of a good increases your own marginal benefit from consumption of that good can give rise to network effects.
• A good is subject to positive feedback when success breeds greater success and failure breeds failure.

 

Chapter 18

Public Goods and Common Resources

Characteristics of Goods

A good is excludable if the supplier of that good can prevent people who do not pay from consuming it.

 

A good is a rival in consumption if the same unit of the good cannot be con- sumed by more than one person at the same time.

 

A good that is both excludable and rival in consumption is a private good.

 

When a good is non excludable, the supplier cannot prevent consumption by people who do not pay for it.

 

A good is nonrival in consumption if more than one person can consume the same unit of the good at the same time.

 

Because goods can be either excludable or nonexcludable, rival or nonrival in con- sumption, there are four types of goods, illustrated by the matrix in Figure: