1. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 1 SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE Government and Market Failure

2. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 2 In this chapter you will learn 17.1 To distinguish between a public and private good 17.2 The nature of externalities and the ways of dealing with them 17.3 About the economics of solid- waste disposal, and recycling 17.4 About information failures and ways of rectifying them

3. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 3 Chapter 17 Topics 17.1 Public Goods 17.2 Externalities Revisited 17.3 The Economics of Solid-waste Disposal and Recycling 17.4 Information Failures

4. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 4 Private Goods n rivalry n excludability n demand curve is horizontal summation of individual demand curves

5. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 5 Public Goods n non-rivalry n non-excludability n free-rider problem ð government must provide

6. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 6 Demand for Public Goods Quantity Adams’willingness to pay (price) Benson’swillingness 1 1 $4 Table 17-1

7. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 7 Demand for Public Goods Quantity Adams’willingness to pay (price) Benson’swillingness 1 1 $4 $5 + + Table 17-1

8. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 8 Demand for Public Goods Quantity Adams’willingness to pay (price) Benson’swillingness Collectivewillingness 1 1 $4 $5 $9 + + = = Table 17-1

9. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 9 Demand for Public Goods Quantity Adams’willingness to pay (price) Benson’swillingness Collectivewillingness 1212 1212 $4 3 $4 3 $5 4 $5 4 $9 7 $9 7 ++++ ++++ ==== ==== Table 17-1

10. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 10 Demand for Public Goods Quantity Adams’willingness to pay (price) Benson’swillingness Collectivewillingness 1234512345 1234512345 $4 3 2 1 0 $4 3 2 1 0 $5 4 3 2 1 $5 4 3 2 1 $9 7 5 3 1 $9 7 5 3 1 ++++++++++ ++++++++++ ========== ========== Table 17-1

11. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 11 P Q $ 9 7 5 3 1 0 1 2 3 4 5 Optimal Amount of a Public Good Adams’s willingness to pay Adams’s willingness to pay Figure 17-1

12. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 12 P Q $ 9 7 5 3 1 0 1 2 3 4 5 Optimal Amount of a Public Good Benson’s willingness to pay Benson’s willingness to pay Figure 17-1

13. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 13 P Q $ 9 7 5 3 1 0 1 2 3 4 5 Optimal Amount of a Public Good When vertically added equals collective willingness to pay When vertically added equals collective willingness to pay DCDCDCDC Figure 17-1

14. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 14 P Q $ 9 7 5 3 1 0 1 2 3 4 5 Optimal Amount of a Public Good The good’s marginal cost as shown by S DCDCDCDC S Figure 17-1

15. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 15 P Q $ 9 7 5 3 1 0 1 2 3 4 5 Optimal Amount of a Public Good Yields the optimum amount of the public good Yields the optimum amount of the public good DCDCDCDC S Figure 17-1 MB = MC

16. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 16 Cost-Benefit Analysis n rule for deciding whether to provide a public good, & how much to provide: MB=MCillustrated…

17. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 17 Cost-Benefit Analysis Plan Total Cost MC Total Benefit MB Net Benefit No new construction 000 A: Widen existing highways 451 B: Two-lane 10133 C: Four-lane 18235 D: Six-lane 2826-2 4 6810 5810 3 not justifiable

18. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 18 Cost-Benefit Analysis Plan Total Cost MC Total Benefit MB Net Benefit No new construction 000 A: Widen existing highways 451 B: Two-lane 10133 C: Four-lane 18235 D: Six-lane 2826-2 4 6810 5810 3 what level of activity is optimal?

19. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 19 Cost-Benefit Analysis Plan Total Cost MC Total Benefit MB Net Benefit No new construction 000 A: Widen existing highways 451 B: Two-lane 10133 C: Four-lane 18235 D: Six-lane 2826-2 4 6810 5810 3 yesyes yesyes yesyes nono is MB > MC?

20. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 20 Cost-Benefit Analysis Plan Total Cost MC Total Benefit MB Net Benefit No new construction 000 A: Widen existing highways 451 B: Two-lane 10133 C: Four-lane 18235 D: Six-lane 2826-2 4 6810 5810 3 Plan C is optimal

21. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 21 Chapter 17 Topics 17.1 Public Goods 17.2 Externalities Revisited 17.3 The Economics of Solid-waste Disposal and Recycling 17.4 Information Failures

22. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 22 Externalities Revisited n a spillover is a cost or benefit accruing to an individual or group that is external to a market transaction n e.g., pollution, immunization illustrated…

23. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 23 P Q Figure 17-2 D 0 S Spillovercosts StStStSt Overallocation Q0Q0Q0Q0 QeQeQeQe too much is produced

24. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 24 P Q D S 0 DtDtDtDt SpilloverBenefits Underallocation Q0Q0Q0Q0 QeQeQeQe Figure 17-2 too little is produced

25. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 25 Externalities n Individual Bargaining: Coase Theorem –example: forest land –limitations n Liability Rules & Lawsuits

26. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 26 Externalities n Government Intervention –Direct Controls

27. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 27 P Q Figure 17-3 D 0 S Spillovercosts StStStSt Overallocation Q0Q0Q0Q0 QeQeQeQe direct controls shift S left

28. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 28 P Q Figure 17-3 D 0 StStStStOverallocationcorrected Q0Q0Q0Q0 QeQeQeQe

29. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 29 Externalities n Government Intervention –Direct Controls –Specific Taxes

30. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 30 P Q Figure 17-3 D 0 S Spillovercosts StStStStOverallocation Q0Q0 QeQe imposing a tax shifts S left TAX

31. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 31 P Q Figure 17-3 D 0 StStStStOverallocationcorrected Q0Q0Q0Q0 QeQeQeQe

32. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 32 Externalities n Government Intervention –Direct Controls –Specific Taxes –Subsidies & Government Provision usubsidies to buyers

33. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 33 P Q D S 0 Underallocation Q0Q0Q0Q0 QeQeQeQe Figure 17-4 DtDtDtDt Subsidy to Buyers subsidizing buyers shifts D right

34. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 34 P Q S 0 DtDtDtDt Underallocationcorrected Q0Q0Q0Q0 QeQeQeQe Figure 17-4

35. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 35 Externalities n Government Intervention –Direct Controls –Specific Taxes –Subsidies & Government Provision usubsidies to buyers usubsidies to producers

36. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 36 P Q D S 0 DtDtDtDt Underallocation Q0Q0Q0Q0 QeQeQeQe Figure 17-4 subsidizing producers shifts S right StStStSt

37. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 37 P Q D 0 DtDtDtDt Underallocationcorrected Q0Q0Q0Q0 QeQeQeQe Figure 17-4 StStStSt

38. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 38 Externalities n Government Intervention –Direct Controls –Specific Taxes –Subsidies & Government Provision usubsidies to buyers usubsidies to producers ugovernment provision

39. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 39 Externalities n A Market-based Approach to Spillover Costs –The Tragedy of the Commons –A Market for Externality Rights –Operation of the Market

40. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 40 Market for Pollution Rights S D 2004 5007501000 Price per pollution right Quantity of pollution rights Figure 17-5 $100 supply is set by government

41. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 41 Market for Pollution Rights D 2004 5007501000 Price per pollution right Quantity of pollution rights Figure 17-5 $100 a price of $100 reduces pollution from 750 tonnes to 500 tonnes S

42. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 42 Market for Pollution Rights D 2004 D 2014 5007501000 Price per pollution right Quantity of pollution rights Figure 17-5 $100 $200 market for pollution rights limits pollution as population expands S

43. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 43 Externalities n Market-based Approach Advantages –reduces society’s costs –polluters have a monetary incentive not to pollute –conservation groups can buy up pollution rights –growing revenue can be devoted to environment –rising price should stimulate innovation

44. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 44 Externalities n Society’s Optimal Amount of Externality Reduction –MC, MB & Equilibrium Quantity

45. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 45 Q 0 Society’s marginal benefit and marginal cost of pollution abatement Amount of pollution abatement Recall the MB = MC rule? Figure 17-6

46. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 46 Q 0 MC Society’s marginal benefit and marginal cost of pollution abatement Amount of pollution abatement Figure 17-6

47. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 47 Q 0 MC MB Society’s marginal benefit and marginal cost of pollution abatement Amount of pollution abatement Figure 17-6

48. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 48 Q 0 MC MB Socially optimal amount of pollutionabatement Society’s marginal benefit and marginal cost of pollution abatement Amount of pollution abatement some pollution may be economically efficient Figure 17-6

49. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 49 Q 0 MC MB Socially optimal amount of pollutionabatement Society’s marginal benefit and marginal cost of pollution abatement Amount of pollution abatement MC & MB curves may shift over time Figure 17-6

50. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 50 Chapter 17 Topics 17.1 Public Goods 17.2 Externalities Revisited 17.3 The Economics of Solid-waste Disposal and Recycling 17.4 Information Failures

51. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 51 Recycling n millions of tonnes of garbage must be disposed of annually –Market For Recyclable Inputs –Policy udemand incentives usupply incentives illustrated…

52. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 52 Figure 17-7 amount of recycling price Q1Q1Q1Q1 S1S1S1S1 D1D1D1D1 P Q P1P1P1P1 equilibrium price & quantity

53. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 53 Figure 17-7 amount of recycling price Q1Q1Q1Q1 S1S1S1S1 D1D1D1D1 P Q P1P1P1P1 incentives for producers shift D right D2D2D2D2 Q2Q2Q2Q2 P2P2P2P2

54. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 54 Figure 17-7 amount of recycling price Q1Q1Q1Q1 S1S1S1S1 D1D1D1D1 P Q P1P1P1P1 incentives for households shift S right Q3Q3Q3Q3 P3P3P3P3 S2S2S2S2

55. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 55 Global Warming n progress in pollution reduction n global warming  climate change predictions n Kyoto Protocol 1997 n costs vs benefits n transition costs n U.S. has refused to sign

56. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 56 GLOBAL PERSPECTIVE 17.1

57. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 57 Chapter 17 Topics 17.1 Public Goods 17.2 Externalities Revisited 17.3 The Economics of Solid-waste Disposal and Recycling 17.4 Information Failures

58. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 58 Information Failures n asymmetric information n inadequate information about sellers –example: gasoline market –example: licensing of surgeons

59. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 59 Information Failures n inadequate information about buyers –moral hazard problem uCanada’s health care system & “excess” demand –adverse selection problem –workplace safety n qualification

60. © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 17 60 Chapter 17 Topics 17.1 Public Goods 17.2 Externalities Revisited 17.3 The Economics of Solid-waste Disposal and Recycling 17.4 Information Failures