Public goods and Externalities Market Failures Public goods and Externalities

Market Failures in Competitive Markets Demand-Side Market Failures Impossible to Charge the right price Willingness Supply-Side Market Failures Not paying full cost of producing its output Pay capital costs but not for things like pollution

Efficiently Functioning Markets Consumer Surplus Benefit surplus received by a consumer Difference between max. willing price to actual price Max. price depends on alternative uses of money Producer Surplus Difference between price producer receives and the minimum acceptable price Minimum price often marginal price Positive relationship between equilibrium price and the producer surplus Efficiency Revisited Efficiency Losses (deadweight losses)

Efficiently Functioning Markets Efficiency Revisited Productive Efficiency- competition forces producers to use best technology and resources to minimize per unit cost Allocative Efficiency- correct quantity produced relative to other goods and services Efficiency Losses (deadweight losses) Reductions of combined consumer and producer surplus Result of both and under and overproduction

Public Goods Private goods characteristics Rivalry- a product bought and consumed is no longer available to another buyer Excludability- seller keeps people who don’t pay from obtaining the product or its benefits Public goods characteristics Nonrivalry-Everyone can simultaneously obtain the benefits of a public good Nonexcludability- no effective way of excluding individuals from the benefits of a good Free-rider problem Private firms don’t produce public goods Only government can finance through taxation

Public Goods Optimal Quantity of a public good Demand for Public goods Non determinable unless through surveys and public votes Demand for Public goods Willingness to pay schedule Survey Willingness to pay curve (demand curve)

Public Goods Comparing MB and MC Cost Benefit Analysis Marginal Benefit and Marginal Cost optimal quantity when MB=MC Cost Benefit Analysis Means in which to determine whether to provide a public good and how much to provide Resources towards public goods if the public good exceeds need for more private goods The benefit must exceed the cost to be economically justifiable Marginal-cost-marginal-benefit rule: Tells you the plan that provides society with the maximum net benefit

Public Goods Quasi-Public goods Reallocation Process Goods and services that could be produced and delivered in a way that exclusion would be possible Ex. Education, streets, highways, police, libraries, museums Government typically provides to avoid underallocation of resources Reallocation Process Government diverts purchasing power from private spenders to government, typically through taxes Frees resources from private use Tax proceeds then used to provide public good

Externalities Externality- the costs or the benefits of a good or service are passed onto or “spill over to” someone other than the immediate buyer or seller Negative Externalities Cause supply-side market failures Ex. Polluted air, Airport noise, foul smelling gas Cost exceeds total benefit Marginal cost lower than company paying for such a cost Positive Externalities

Externalities Positive Externalities Government Intervention Demand-side market failures Willingness to pay for third parties receiving the benefit Ex. vaccinations Government Intervention Government may step in if Externalities affect large numbers of people Pass legislation, ex. Clear Air Act of 1990 Taxes, Tax CFC manufacturing (Ozone depleting material) Subsidies to buyers Subsidies to producers Government provisions, Ex polio vacines

Society’s Optimal Amount of Externality Reduction MC,MB, and equilibrium Quantity Optimal reduction of an externality- MC=MB Shifts in Locations of the Curves Technology improvements, ex pollution control equipment Governments Role in the Economy Inefficiency may seep in due to incentive for officials