Chapter 5 Externalities environmental policy and public goods Externality a benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service Negative externality possibility of bearing a cost even though they were not involved in the buying or selling Market may produce a quantity of the good that is greater than the Too much of the good or service will be produced at market efficient amount equilibrium Positive externality people who are not directly involved in producing the good or service or paying for it can benefit The market may produce a quantity that is less than the efficient Too little of the good or service will be produced at market amount equilibrium When there are externalities government intervention may actually increase economic efficiency and enhance the well being of society Public goods goods that may not be produced at all unless the government produces them Interfere with the economic efficiency of a market equilibrium Causes a difference between the private cost of production and the social cost or the private benefit from consumption and the social benefit o Private cost cost borne by the producer of a good or service o Social cost total cost of producing a good or service SC PC any external cost Unless there is an externality SC PC o Private benefit benefit received by the consumer of a good or service o Social benefit total benefit from consuming a good or service SB PB any external cost Unless there is an externality PB SB Market failure situations in which the market fails to produce the efficient level of output Property rights the rights individuals or businesses have to the exclusive use of their property including the right o buy or sell it Externalities and market failures result from incomplete property rights or from the difficulty of enforcing property rights in certain situations If marginal benefit of reducing is greater than the marginal cost further reductions will make society better off If the marginal cost of reducing is greater than the marginal benefit reducing will actually make society worse off Transaction costs the costs in time and other resources that parties incur in the process of agreeing to and carrying out an exchange of goods or services Coase theorem if transaction costs are low private bargaining will result in an efficient solution to the problem of externalities Private solutions to the problem of externalities will occur only if all parties to the agreement have full information about the costs and benefits associated with the externality All parties must be willing to accept a reasonable agreement Pigovian taxes and subsidies government taxes and subsidies intended to bring about an efficient level of output in the presence of externalities Eliminates deadweight loss Improves economic efficiency Command and control approach involves government imposing quantitative limits on the amount of pollution firms are allowed to emit or requiring firms to install specific pollution control devices Central lessons of economics resources are scarce and trade offs exist Four categories of goods goods differ on the basis of whether their consumption is rival and excludable Rivalry when one person s consuming a unit of a good means no one else can consume it Excludability anyone who does not pay for a good cannot consume it 1 Private goods a A good that is both rival and excludable i Food clothing haircuts ii One person s consuming a unit of these goods precludes other people from consuming that unit iii No one can consume these goods without buying them 2 Public goods a Both nonrival and nonexcludable i Often supplied by a government ii National defense iii You cannot be excluded from consuming it whether you pay for it or not iv Everyone can consume without paying for it v Free riding benefiting from a good without paying for it 3 Quasi public goods a Some goods are excludable but not rival b Cable television c People who do not pay do not receive but one person s consumption doesn t affect other s 4 Common resources a A good that is rival but not excludable b Forest land in poor countries c d But if no one has a property right to the forest no one can be excluded If one person cuts down a tree no one else can use the tree from using it Rival Nonrival Excludable Nonexcludable Private goods Common resources Quasi Public goods Public goods Demand for a public good Market demand curve for a good or service sum of the quantity of the good demanded by each consumer at each price Optimal quantity of a public good Sum of consumer surplus and producer surplus is maximized Common resources Tragedy of the commons the tendency for a common resource to be overused