Econ 4001.01 1st Edition Lecture 24Outline of Last Lecture II. How Can Firms Avoid Adverse Selection Problems?III. SignalingIV. The Traditional Mortgage Market ExampleOutline of Current Lecture V. Types of Market FailuresVI. ExternalitiesVII. What do Externalities do to Markets?VIII. Government Corrections for ExternalitiesIX. Public Policies Toward Negative ExternalitiesX. Introduction to Public GoodsXI.Non-excludable Goods and Degree of RivalryCurrent LectureExternalities and Public Goods- Types of Market Failureso Externalitieso Public Goodso Moral Hazard and Adverse Selectiono Today we’ll discuss the first two- Externalitieso Externality- uncompensated impact of a market participant on an uninvolved partyo Negative Externality Examples: Pollution: health of people nearby, dry cleaner next door to the factory, environmental effects Drug dealing in a neighborhood Noise from an airport: disrupts people living nearby, nearby recording studioso Positive Externality Examples: Police station next to business Perfume or Bakery on route to work Network effects: E-bay, Facebook, etc. (the more people/the more positive effects)These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute. Knowledge Externalities - What do Externalities do to Markets?o Demand curve traces out the value to buyers- maximum willingness to pay, elasticityo Demand= private value/Supply= private costo Negative externality on a graph: raises supply curve (or shifts it left) The optimal quantity is less and price is highero With a positive externality, benefit to a third party is not taken into account by the sellero Typically, a seller earns no revenue from a positive externalityo Since the social benefit is greater than the private benefit, equilibrium quantity istoo lowo Social benefit curve lies above the market demand curve Example: education as a positive externality: by obtaining an education, we receive knowledge that will allow us to get better jobs, earn more incomeo Positive externality on a graph: demand curve raises (or shifts it right)- Can Government Help Correct Externalities?o Positive externality: government provides a subsidy for the company/government can provide the service directly/find a way to change the behavior of the entity producing the externality (the buyer)o Negative externality: government can tax or regulate- Public Policies toward negative externalitieso Command and Control Responses Ban the offending behavior Enact regulations to limit offending behavioro Market-based Responses Provide incentives so that the markets work optimally (example: create a market for the offending good, i.e. buying or selling the right to pollute at certain levels) Levy corrective (Pigovian) taxes on sellers Assign property rights and compel compensation Create market for offending “good”o Example for a Corrective Tax= Gasoline Driving automobiles causes externalities (pollution, congestion, traffic, accidents, injuries, etc.) Gasoline tax- if it is set properly (high enough)- Less traffic and congestion- Less impact on the environment- No dead weight loss- Final Word on Public Policy for Externalitieso Two market friendly methods for governments: Tradeable Permits Corrective Taxeso Problem with it is a moral objection: permits make pollution seem like a normal good, suggests pollution is okayo Another problem is practical objection: government may not set the correct price(for a tax) or quantity (for permits)- Introduction to Public Goodso Goods can be divided into categories based on: Rivalry: degree to which consumption by one person reduces the amount available for others Excludability: degree to which people can be prevented from consuming agood if they don’t pay for ito Purely Private Goods Rival and Excludable (Automobiles, Clothing, Restaurant meals)o Club Goods Excludable and Non-Rival (Sam’s Club/Cable Television)o Common Resources Non-excludable and Rival (fish in the ocean, highways at rush hour) Most often depleted Tragedy of the Commonso Public Goods Non-excludable and non-rival (National defense, knowledge, large city park)- Non-excludable good and degree of rivalryo For non-excludable goods, then the social impact depends on degree of rivalryo If the goods are non-rival, there is no limit on the number of consumerso Since people benefit from using this good, the optimal quantity is largeo Supply of private goods depends on price vs. costo With non-excludable goods, consumers don’t have to pay so ability to set a profitable price in limitedo As a result, the quantity supplied of public goods is below the socially optimal levelo For partly rival goods, congestion limits the benefito The “free rider problem” A free rider is a consumer who receives the benefit of the good without paying for it This problem prevents the private market from supplying public goods, and reduces the supply of congestion goods Government uses its power of taxation to fund these public