1. Copyright 2008 The McGraw-Hill Companies 28-1 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Unit 7 The Role of Government

2. Copyright 2008 The McGraw-Hill Companies 28-2 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Objectives Market Failure & Government Failure How Public Goods are Distinguished from Private Goods Review of Cost-Benefit Analysis About Externalities (Spillover Costs and Benefits) and the Methods to Remedy Them How Information Failures Can Justify Government Interventions in Some Markets Lorenz Curve & Gini Coefficient Tariff Graph

3. Copyright 2008 The McGraw-Hill Companies 28-3 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Economic Functions of US Gov’t Enforce laws & contracts Maintain competition Provide an economic safety net Provide public goods Correct market failures correct negative externalities, subsidize positive externalities, provide market information Stabilize the economy (macro) Unemployment, inflation, promote economic growth

4. Copyright 2008 The McGraw-Hill Companies 28-4 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Public Goods Private Goods –Rival –Excludable Public Goods –Nonrival –Nonexcludable –The Free-Rider Problem W 28.1

5. Copyright 2008 The McGraw-Hill Companies 28-5 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Public vs. Private Goods NON- EXCLUDABLE Excludable NON-RIVAL Pure Public Goods Club Goods (aka Toll Goods) Rival Common Resources (aka common-pool resources) Pure Private Goods

6. Copyright 2008 The McGraw-Hill Companies 28-6 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Public vs. Private Goods Examples? NON- EXCLUDABLE Excludable NON-RIVAL Rival

7. Copyright 2008 The McGraw-Hill Companies 28-7 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Public vs. Private Goods NON- EXCLUDABLE Excludable NON-RIVAL National Defense Free Public Radio Street Lights Judicial System Cable TV Health Care Roads (toll) Rival Public Park Fish Water Roads (non-toll) Hunting Grounds Ice Cream Clothes Restaurants Cars TVs

8. Copyright 2008 The McGraw-Hill Companies 28-8 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Cost-Benefit Analysis Concept Marginal Cost = Marginal Benefit Rule (MC=MB) Private vs. Social

9. Copyright 2008 The McGraw-Hill Companies 28-9 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Externalities Negative Externalities Positive Externalities 0 D=MPB MPC MSC Overallocation Negative Externalities S=MPC Underallocation Positive Externalities QoQo QoQo QeQe QeQe P P 0 Q Q Negative Externality: –draw MSC above MPC Positive Externality: –draw MSB above MPB Note diff. between Q e & Q o D=MPB D 1 =MSB G 28.1 O 28.1O 28.2

10. Copyright 2008 The McGraw-Hill Companies 28-10 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Negative Externalities Creates costs in addition to the private costs Examples: Pollution, Drum Set, ethanol plant, 2nd hand smoke… (MSC > MPC) How we can compensate for neg. externality? Individual bargaining Liability through lawsuit Price Control (ie. ceiling) Taxes Market Externality Rights –ie. fee for creation of X amount of pollution. D=MPB S=MPC MSC Overallocation Negative Externalities QoQo QeQe

11. Copyright 2008 The McGraw-Hill Companies 28-11 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show D D

12. Copyright 2008 The McGraw-Hill Companies 28-12 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show B B

13. Copyright 2008 The McGraw-Hill Companies 28-13 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show A A

14. Copyright 2008 The McGraw-Hill Companies 28-14 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show A A

15. Copyright 2008 The McGraw-Hill Companies 28-15 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show C C

16. Copyright 2008 The McGraw-Hill Companies 28-16 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Positive Externalities Provides benefits in addition to the private Benefits (MSB > MPB) Examples: rose bushes, education, … How we can compensate for pos. externality? Individual bargaining Subsidize either production or consumption (the one producing the externality 0 Underallocation Positive Externalities QoQo QeQe D=MPB MSB S=MPC

17. Copyright 2008 The McGraw-Hill Companies 28-17 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show E E

18. Copyright 2008 The McGraw-Hill Companies 28-18 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Example: Neg. Externality Carbon-Dioxide Emissions, Tons Per Capita, Selected Nations 2004 GLOBAL PERSPECTIVE United States Australia Canada Czech Republic Germany Japan United Kingdom Italy Spain France 0 5 10 15 20 25 19.8 17.0 16.2 11.8 10.3 9.2 8.8 7.4 7.2 6.2 Source: OECD Environmental Data

19. Copyright 2008 The McGraw-Hill Companies 28-19 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Asymmetric Information Discuss with a partner... BRAINSTORM Question: WHY does a new car lose substantial market value as soon as it is purchased?

20. Copyright 2008 The McGraw-Hill Companies 28-20 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Lojack: A Case of Positive Externalities Private Crime Reduction Expenditures $300 Billion Some Redistribute Rather than Reduce Crime Lojack Car Recoveries are 95% Versus 60% for Others Locates and Stops Chop Shops Estimated 15 Times MSB to Consumers Underallocation Result Subsidize Consumer Purchase with Lower Insurance Rates Discounts too Small to Offset Underallocation Last Word

21. Copyright 2008 The McGraw-Hill Companies 28-21 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show

22. Copyright 2008 The McGraw-Hill Companies 28-22 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Types of Taxes Progressive Income increase, you pay a HIGHER percent of income to tax Proportional Income increase, you pay the SAME percent of income to tax Regressive Income increase, you pay a LOWER percent of income to tax

23. Copyright 2008 The McGraw-Hill Companies 28-23 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Measuring Income Inequality The Lorenz Curve Gini = A / (A+B) [larger = more unequal]

24. Copyright 2008 The McGraw-Hill Companies 28-24 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show B B

25. Copyright 2008 The McGraw-Hill Companies 28-25 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show A A

26. Copyright 2008 The McGraw-Hill Companies 28-26 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Tariff Graph

27. Copyright 2008 The McGraw-Hill Companies 28-27 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Key Terms private goods public goods free-rider problemfree-rider problem cost-benefit analysiscost-benefit analysis marginal-cost- marginal-benefit- rulemarginal-cost- marginal-benefit- rule Externalities (+/-)Externalities market for externality rightsmarket for externality rights optimum reduction of an externalityoptimum reduction of an externality asymmetric information moral hazard problem adverse selection Lorenz Curve Gini Coefficient Tariff Graph

28. Copyright 2008 The McGraw-Hill Companies 28-28 Public Goods Cost-Benefit Analysis Externalities Information Failures Last Word Key Terms End Show Information Failures Asymmetric Information: Inadequate Information Involving Sellers –Example: Gasoline Market –Example: Licensing of Surgeons Inadequate Information Involving Buyers –Moral Hazard Problem –Adverse Selection Problem –Workplace Safety Qualification O 28.3