1. 16 - 1 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures Unit 5 Market Failures

2. 16 - 2 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures Private Goods Divisible Excludable Demand Curve is Horizontal Summation Public Goods Indivisible Not Excludable Demand Curve is Vertical Summation PUBLIC GOODS

3. 16 - 3 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures Problems of Revealing Preferences Quantity Adams’ Willingness to pay (price) Benson’s Willingness to pay (price) Collective Willingness to pay (price) 1234512345 $4 3 2 1 0 $5 4 3 2 1 $9 7 5 3 1 ++++++++++ ========== DEMAND FOR A PUBLIC GOOD Adam is a Free Rider

4. 16 - 4 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures P Q $ 9 7 5 3 1 0 1 2 3 4 5 D = MSB S = MSC OPTIMAL AMOUNT OF A PUBLIC GOOD Yields the optimum amount of the public good MSB = MSC

5. 16 - 5 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures Externalities Market failure –Requires government action Negative externality –External (spillover) cost –Overproduction Positive externality –External (spillover) benefit –Underproduction

6. 16 - 6 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures Externalities Correcting Externalities Individual Bargaining – Coase Theorem Liability Rules and Lawsuits Government Intervention –Direct Control –Taxes –Subsidies

7. 16 - 7 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures P Q CORRECTING NEGATIVE EXTERNALITIES D = MSB 0 Spillover costs S = MSC S = MPC TAX Overallocation Corrected Q0Q0 QeQe

8. 16 - 8 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures P Q D = MSB 0 Subsidy to producers increases supply S = MPC S = MSC Underallocation Corrected QeQe Q0Q0 Correcting by Subsidy to Producers CORRECTING POSITIVE EXTERNALITIES

9. 16 - 9 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures A MARKET-BASED APPROACH A Market for Externality Rights S = Supply of pollution rights D 2012 Price per pollution right Quantity of pollution rights 500 750 1000 $200 $100 D 2004

10. 16 - 10 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures Market Failures Tragedy of the Commons Asymmetric (Unequal) Information –about sellers Licensing Weights & Measures –about buyers Moral Hazard Problem Adverse Selection

11. 16 - 11 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures TAX STRUCTURES Who pays the tax? Benefits-Received Principle Ability-to-Pay Principle Tax as a percentage of income: Progressive Tax Regressive Tax Proportional Tax

12. 16 - 12 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures TAX APPLICATIONS: Personal Income Tax Progressive Sales Tax Regressive Corporate Income Tax Proportional Payroll Taxes Regressive Property Taxes Regressive Estate & Gift Taxes Progressive Identify whether progressive, regressive, or proportional

13. 16 - 13 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures Revisiting Deadweight Loss Role of Elasticity (E D & E S ) Qualifications Redistributive Goals Reducing Negative Externalities TAX INCIDENCE AND EFFICIENCY LOSS

14. 16 - 14 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures How a Tax Effects Welfare A F B D C E Quantity 0 Price Demand Supply = PBPB Q2Q2 = PSPS Price buyers pay Price sellers receive = P1P1 Q1Q1 Price without tax

15. 16 - 15 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures 20 40 60 80 100 100 80 60 40 20 0 Percent of Families Percent of Income Perfect Equality Complete Inequality Lorenz Curve (actual distribution) Area between the lines shows the degree of income inequality THE LORENZ CURVE

16. 16 - 16 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures 20 40 60 80 100 100 80 60 40 20 0 Percent of Families Percent of Income Perfect Equality Complete Inequality Lorenz Curve (actual distribution) Area between the lines shows the degree of income inequality THE LORENZ CURVE Gini Ratio Numerical Measure of Overall Dispersion of Income Area Between Lorenz Curve and Diagonal Total Area Below the Diagonal Gini Ratio =

17. 16 - 17 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures BIG BANANA BAD

18. 16 - 18 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures Ability Differences Education and Training Discrimination Preferences and Risks Unequal Distribution of Wealth Market Power Luck, Connections, and Misfortune CAUSES OF INCOME INEQUALITY

19. 16 - 19 Public Goods Demand for a Public Good Optimal Amount of a Public Good Cost-Benefit Analysis Spillover Costs and Benefits Market-Based Approach to Spillover Rights Society’s Optimal Amount of Externality Reduction Information Failures Sample Exam Work on the following questions from Unit 5: 15, 29, 30, 44, 45 & 60