1. 11 CHAPTERS 16 AND 17 LECTURE - PUBLIC CHOICES, PUBLIC GOODS AND ECONOMICS OF THE ENVIRONMENT

2. 22 Public Choices A public choice is a decision that has consequences for many people and perhaps for an entire society. Why Governments Exist Governments exist for three reasons. They 1.Establish and maintain property rights. 2.Provide nonmarket mechanisms for allocating scare resources. 3.Implement arrangements that redistribute income and wealth. Replacing markets with government resource allocation decisions is no simple matter. Government failure is a situation in which government actions lead to inefficiency. Government failure can lead to overprovision or under provision.

3. 3 Public Choices Four groups of decision makers are:  Voters  Firms  Politicians  Bureaucrats Political Marketplace Voters express their demand via votes. Voters and firms express their demand for policies via campaign contributions. Politicians express their supply of policies with proposals which they hope will attract votes.

4. 44 Public Choices Bureaucrats try to get the biggest possible budget for their departments and provide public goods and services. Political Equilibrium In a political equilibrium the choices of voters, firms, politicians, and bureaucrats are compatible and no group can see a way of improving its position by making a different choice.

5. 55 What Is a Public Good? What is the essential difference between:  A city police department and Brink’s security?  Fish in the Atlantic Ocean and fish in a fish farm?  A live concert and a concert on television? These and all goods and services can be classified according to whether they are excludable or nonexcludable and rival or nonrival. Public Choices

6. 66 Excludable A good is excludable if only the people who pay for it are able to enjoy its benefits. Brink’s security services, East Point Seafood’s fish, and a Coldplay concert are examples. Nonexcludable A good is nonexcludable if it is impossible (or extremely costly) to prevent anyone from benefiting from it. The services of the LAPD, fish in the Pacific Ocean, and a concert on network television are examples. Public Choices

7. 77 Rival A good is rival if one person’s use of it decreases the quantity available for someone else. A Brink’s truck can’t deliver cash to two banks at the same time. A fish can be consumed only once. Nonrival A good is nonrival if one person’s use of it does not decrease the quantity available for someone else. The services of the LAPD and a concert on network television are nonrival. Public Choices

8. 88 Four-fold Classification of Goods and Services.

9. 99 Public Choices Mixed Goods and Externalities Mixed goods don’t fit neatly into the four-fold classification. A mixed good is a private good the production or consumption of which creates an externality. An externality is a cost (external cost) or a benefit (external benefit) that arises from the production or consumption of a private good and that falls on someone other than its producer or consumer. Mixed Goods with External Benefits These goods include health care and education. Mixed Goods with External Costs These goods include electricity and road, rail, and air transportation produced by burning hydrocarbon fuels (coal, oil, and natural gas).

10. 10 Public Choices Inefficiencies that Require Public Choices Public choices must be made to  Provide public good and mixed goods  Conserve common resources  Regulate natural monopoly The Free-Rider Problem A free rider enjoys the benefits of a good or service without paying for it. Because no one can be excluded from the benefits of a public good, everyone has an incentive to free ride. Public goods create a free-rider problem—the absence of an incentive for people to pay for what they consume

11. 11 The value of a private good is the maximum amount that a person is willing to pay for one more unit of it. The value of a public good is the maximum amount that all the people are willing to pay for one more unit of it. To calculate the value placed on a public good, we use the concepts of total benefit and marginal benefit. Marginal Social Benefit from a Public Good Total benefit is the dollar value that a person places on a given quantity of a good. The greater the quantity of a good, the larger is a person’s total benefit. Marginal benefit is the increase in total benefit that results from a one-unit increase in the quantity of a good. The marginal benefit of a public good diminishes with the quantity of the good provided. Providing Public Goods

12. 12 The figure shows that the marginal social benefit of a public good is the sum of marginal benefits of everyone at each quantity of the good provided. Part (a) shows Lisa’s marginal benefit. Part (b) shows Max’s marginal benefit. Providing Public Goods

13. 13 The economy’s marginal social benefit of a public good is the sum of the marginal benefits of all individuals at each quantity of the good provided. The economy’s marginal social benefit curve for a public good is the vertical sum of all individual marginal benefit curves. Providing Public Goods

14. 14 The Marginal Social Cost of a Public Good The marginal social cost of a public good is determined in the same way as that of a private good. The Efficient Quantity of a Public Good The efficient quantity of a public good is the quantity at which marginal social benefit equals marginal social cost. Providing Public Goods

15. 15 The figure below illustrates the efficient quantity of a public good. With fewer than 3 airplanes, MSB exceeds MSC. Resources can be used more efficiently by increasing the quantity.

16. 16 Inefficient Private Provision If a private firm tried to produce and sell a public good, almost no one would buy it. The free-rider problem results in too little of the good being produced by a private firm. Efficient Public Provision Because the government can tax all the consumers of the public good and force everyone to pay for its provision, public provision overcomes the free-rider problem. If two political parties compete, each is driven to propose the efficient quantity of a public good. A party that proposes either too much or too little can be beaten by one that proposes the efficient amount because more people vote for an increase in net benefit. Providing Public Goods

17. 17 Externalities Automobile pollution and congestion Noisy neighbors Cigarette smoke Fire prevention Inoculation to prevent contagious disease Education Home improvement Negative Externalities Positive Externalities Why are externalities a problem? u They cause overproduction of goods displaying negative externalities and underproduction of goods displaying positive externalities. u They also lead to market inefficiencies.

18. 18 Social Costs Social cost: the total social cost of a transaction is the private cost plus the external cost. If all of the costs of a transaction are borne by the participants in the transaction, the private costs and the social costs are the same. Let MPC = Marginal Private Cost Let Marginal External Cost (MEC) be the cost of the externality Thus Marginal Social Cost (MSC) = MPC plus MEC

19. 19 Negative Externalities With a negative externality, the supply curve does not reflect the true cost of the good. As a result, the supply that is provided is greater than it would be if suppliers had to pay all the costs (including the external cost). S is the supply provided, whereas S t is the supply as it would be if the suppliers had to pay the external cost. S t = MSC = MPC + MEC = MPC

20. 20 Negative Externality: Pollution as an Example At the market equilibrium, MSB is less than MSC, so the market produces an inefficient quantity of the good. At the efficient quantity of the good, MSC = MSB. With no regulation, the market produces too much of the good and creates a deadweight loss.

21. 21 Negative Externality: Pollution Property Rights Sometimes externalities arise because of the absence of property rights. Property rights are legally established titles to the ownership, use, and disposal of factors of production and goods and services that are enforceable in the courts.

22. 22 The figure illustrates how the establishment of property rights achieves an efficient outcome. The producer of the good bears all the costs. The market outcome is efficient because at the quantity of the good produced MSC equals MSB. Negative Externality: Pollution

23. 23 Negative Externality: Pollution The Coase Theorem The Coase theorem is a proposition that if property rights exist, only a small number of parties are involved, and transactions costs (defined below) are low, then private transactions are efficient. There are no externalities because all parties take into account the externalities involved. The outcome is independent of who has the property rights.

24. 24 Negative Externality: Pollution The Coase solution works only if transactions costs are low. Transactions costs are the cost of conducting a transaction. An example is the transactions costs of buying a home include fees for a realtor, a mortgage loan advisor, and legal assistance. When a large number of people are involved in an externality and transactions costs are high, the Coase solution of establishing property rights doesn’t work and governments try to deal with the externality.

25. 25 Internalizing an Externality Methods for Dealing with Externalities

26. 26 Negative Externalities: Pollution Taxes The government can set a tax equal marginal external cost. The effect of such a tax is to make marginal private cost plus the tax equal to marginal social cost, MC + tax = MSC. This tax is called Pigovian tax, in honor of the British economist Arthur Cecil Pigou, who first proposed dealing with externalities in this fashion.

27. 27 The figure shows how a pollution tax equal to the marginal external cost can achieve an efficient outcome. At the quantity of the good produced MSC = MSB. The government collect a tax revenue. Negative Externalities: Pollution

28. 28 Negative Externality: Pollution Emissions Charges The government sets a price per unit of pollution, so that the more a firm pollutes, the higher are its emissions charges. For the emissions charge to induce the firm to generate the efficient level of pollution, the government would need a lot of information that is usually unavailable.

29. 29 Negative Externality: Pollution Cap-and-Trade Each firm is assigned a permitted amount of pollution per period and firms trade permits. The market price of a permit confronts polluters with the social marginal cost of their actions and leads to an efficient outcome. This method was used successfully to decrease lead pollution in the United States.

30. 30 The Tragedy of the Commons The tragedy of the commons is the overuse of a common resource that arises when its users have no incentive to conserve it and use it sustainably. Examples include the overfishing of Atlantic Ocean cod and South Pacific whales. The traditional example from which the term derives is the common grazing land surrounding middle-age British villages.

31. 31 The Tragedy of the Commons Sustainable Use of a Renewable Resource Renewable resource is one that replenishes itself by birth and growth of new members of the population. Sustainable catch is the quantity of fish that can be caught year after year without depleting the stock. If the stock is small, the quantity of new fish born is small, so the sustainable catch is small. If the stock is large, many fish are born but they must to complete for food…. so only a small number survive to reproduce and grow large enough for fishers to catch.

32. 32 With a positive externality, the demand curve does not reflect all the benefits of the good. As a result, the demand that is given is D which is less than it would be if demanders received all the benefits (including the external one). D t is the demand as it would be if the demanders received the external benefit. D t = MSB = MPB + MEB Positive Externalities (Internalizing) Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.