2. Public goods and externalities: two more “market failures” another market failure (discussed in the previous lecture) is due to “monopoly power” these three market failures plus income distribution are the main rationales for government intervention in a market economy

3. Public Goods Two Key properties non-rivalry in consumption –if I consume more, others do not need to consume less non-excludability –you cannot prevent people from consuming the good –free rider problem

4. National Defense

5. Fire Protection

6. Police

7. Lighthouse?

8. How much of a public good should be produced? Mimic the market: –produce up to the point where marginal benefit equals marginal cost examples: –number of police on the street –size of national defense force

9. Cost-Benefit Analysis when the choice is to produce or not produce Because benefits come in the future they must be discounted

10. Numerical Example: Should PAPD buy a new computer?

11. Present Discounted Value of Benefits PDV = 500/(1+i) + 600/(1+i) 2 if i =.05 then PDV = 500/(1.05) + 600/(1.05) 2 = 476 + 544 = 1020 –thus the PAPD should make the investment in the computer

12. Higher discount rates mean that fewer projects will meet cost-benefit test. Thus discounting enters political debate.

13. Externalities Definition: When the costs of producing or the benefits of consuming spill over to other people. Negative externalities Positive externalities

14. A Negative Externality: Pollution

15. Positive Externalities Education Innovative ideas Research

16. The Economic Impact of Negative Externalities

17. The Economic Impact of Positive Externalities

18. What are the possible remedies for externalities? Private Remedies Let the individuals work it out themselves –Need to define property rights –But transaction costs and free rider problem might prevent the private remedy

19. Command and control A common form of “social regulation” used by EPA –scrubbers –CAFÉ standards Usually not very flexible or efficient

20. Using Taxes or subsidies make them feel the pain or the gain more flexible than command and control but can’t be sure about the total amount

21. The Tax Remedy for a Negative Externality

22. The Subsidy Remedy for a Positive Externality

23. Why don’t you draw it by hand?

24. Tradable Permits Examples –SO 2 (acid rain) – CO 2 (global warming) Permit allows each firm to emit a certain amount of pollutants Total number of permits issued equals emission limit for the region each year Firms that are better at reducing emissions sell permits to firms that are worse at it.

25. End of Lecture