Chapter 4morolda.pbworks.com/w/file/fetch/87923107/Chap004.pdf · 44 ’ Supply-Side Market...

Chapter 4 Market Failures: Public Goods and

Externali7es Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

4-‐2

Market Failures

•  Market failures • Markets fail to produce the right amount of the product

•  Resources may be • Over-‐allocated •  Under-‐allocated

LO1

4-‐3

Demand-Side Market Failures

•  Demand-‐side market failures •  When it is not possible to charge consumers for the product

•  Some can enjoy benefits without paying •  Firms not willing to produce since they cannot cover the costs

LO1

4-‐4

Supply-Side Market Failures

•  Supply-‐side market failures •  Occurs when a firm does not pay the full cost of producing its output

•  External costs of producing the good are not reflected in supply

LO1

4-‐5

Efficiently Functioning Markets

•  Demand curves must reflect the consumers full willingness to pay

•  Supply curve must reflect all the costs of produc7on

LO2

4-‐6

Consumer Surplus

•  Consumer surplus •  Difference between what a consumer is willing to pay for a good and what the consumer actually pays •  Extra benefit from paying less than the maximum price

LO2

4-‐7

Consumer Surplus

LO2

Consumer Surplus

(1) Person

(2) Maximum Price Willing to Pay

(3) Actual Price (Equilibrium

Price)

(4) Consumer Surplus

Bob $13 $8 $5 (=$13-‐$8)

Barb 12 8 4 (=$12-‐$8)

Bill 11 8 3 (=$11-‐$8)

Bart 10 8 2 (=$10-‐$8)

Brent 9 8 1 (= $9-‐$8)

Be[y 8 8 0 (= $8-‐$8)

4-‐8

Consumer Surplus

Price (per bag)

QuanGty (bags)

D

Q1

P1

Consumer surplus

Equilibrium price = $8

LO2

4-‐9

Producer Surplus

•  Producer surplus •  Difference between the actual price a producer receives and the minimum price they would accept •  Extra benefit from receiving a higher price

LO2

4-‐10

Producer Surplus

LO2

Producer Surplus

(1) Person

(2) Minimum Acceptable

Price

(3) Actual Price (Equilibrium

Price)

(4) Producer Surplus

Carlos $3 $8 $5 (=$8-‐$3)

Courtney 4 8 4 (=$8-‐$4)

Chuck 5 8 3 (=$8-‐$5)

Cindy 6 8 2 (=$8-‐$6)

Craig 7 8 1 (=$8-‐$7)

Chad 8 8 0 (=$8-‐$8)

4-‐11

Producer Surplus

LO2

Price (per bag)

QuanGty (bags)

S

Q1

P1 Equilibrium price = $8

Producer surplus

4-‐12

Efficiency Revisited

LO2

Price (per bag)

QuanGty (bags)

S

Q1

P1

D

Consumer surplus

Producer surplus

4-‐13

Efficiency Losses

•  Efficiency loss (or deadweight losses)

LO2 QuanGty (bags)

Price (per bag)

c

S

Q1 Q2

D

bd

a

e

Efficiency loss from underproducGon

4-‐14

Efficiency Losses

LO2

c

S

Q1 Q3

D

bf

a

g

QuanGty (bags)

Price (per bag)

Efficiency loss from overproducGon

4-‐15

Private Goods

•  Private goods are produced in the market by firms

•  Offered for sale •  Characteris7cs •  Rivalry •  Excludability

LO3

4-‐16

Public Goods

•  Public goods are provided by government •  Offered for free •  Characteris7cs • Nonrivalry • Nonexcludability •  Free-‐rider problem

LO3

4-‐17

Demand for Public Goods

LO3

Demand for a Public Good, Two Individuals

(1) QuanGty of Public Good

(2) Adams’ Willingness to

Pay (Price)

(3) Benson’s

Willingness to Pay (Price)

(4) CollecGve Willingness

to Pay (Price)

1 $4 + $5 = $9

2 3 + 4 = 7

3 2 + 3 = 5

4 1 + 2 = 3

5 0 + 1 = 1

4-‐18

Demand for Public Goods

LO3

$6 5 4 3 2 1 0

P

Q 1 2 3 4 5

$6 5 4 3 2 1 0

P

Q 1 2 3 4 5 Adams

Benson

D1

D2

Adams’ Demand

Benson’s Demand

$3 for 2 Items

$4 for 2 Items

$1 for 4 Items

$2 for 4 Items

$9

7

5

3

1 0

P

Q 1 2 3 4 5 CollecGve Demand and Supply

DC

S CollecGve Demand $7 for 2 Items

$3 for 4 Items

OpGmal quanGty

CollecGve willingness to pay

4-‐19

Cost-Benefit Analysis

•  Cost-‐benefit analysis •  Cost •  Resources diverted from private good produc7on •  Private goods that will not be produced

•  Benefit •  The extra sa7sfac7on from the output of more public goods

LO4

4-‐20

Cost-Benefit Analysis

LO4

Cost-‐Benefit Analysis for a NaGonal Highway ConstrucGon Project (in Billions)

(1) Plan

(2) Total Cost of Project

(3) Marginal Cost

(4) Total Benefit

(5) Marginal Benefit

(6) Net Benefit (4) – (2)

No new construc7on $0 $0 $0 A: Widen exis7ng highways 4 $4 5 $5 1 B: New 2-‐lane highways 10 6 13 8 3 C: New 4-‐lane highways 18 8 22 10 5 D: New 6-‐lane highways 28 10 26 3 -‐2

4-‐21

Quasi-Public Goods

•  Quasi-‐public goods could be provided through the market system

•  Because of posi7ve externali7es the government provides them

•  Examples are educa7on, streets, museums

LO4

4-‐22

The Reallocation Process

•  Government •  Taxes individuals and businesses •  Takes the money and spends on produc7on of public goods

LO4

4-‐23

Externalities

•  An externality is a cost or benefit accruing to a third party external to the market transac7on

•  Posi7ve externali7es •  Too li[le is produced •  Demand-‐side market failures

•  Nega7ve externali7es •  Too much is produced •  Supply-‐side market failures

LO4

4-‐24

Externalities

LO4

(a) NegaGve externaliGes

(b) PosiGve externaliGes

0

D

S

St

OverallocaGon

NegaGve externaliGes St

UnderallocaGon

PosiGve externaliGes

Qo Qo Qe Qe

P P

0 Q Q

D

Dt

a

c

z

x

b y

4-‐25

Government Intervention

•  Correct nega7ve externali7es •  Direct controls •  Specific taxes

•  Correct posi7ve externali7es •  Subsidies •  Government provision

LO4

4-‐26


LO4

(a) NegaGve externaliGes

D

S

St

OverallocaGon

NegaGve externaliGes

Qo Qe

P

0 Q

a

c

b

(b) Correct externality with tax

D

S

St

Qo Qe

P

0 Q

a

T

4-‐27


LO4

(a) PosiGve externaliGes

0

St

UnderallocaGon

PosiGve externaliGes

Qo Qe

D

Dt

z

x

y

(b) CorrecGng via a subsidy

to consumers

0

St

Qo Qe

D

Dt

(c) CorrecGng via a subsidy

to producers

0

S't

Qo Qe

D

Subsidy

St Subsidy

U

4-‐28


LO4

Methods for Dealing with ExternaliGes

Problem Resource AllocaGon Outcome Ways to Correct

Nega7ve externali7es (spillover costs)

Overproduc7on of output and therefore overalloca7on of resources

1.  Private bargaining 2.  Liability rules and lawsuits 3.  Tax on producers 4.  Direct controls 5.  Market for externality rights

Posi7ve externali7es (spillover benefits)

Underproduc7on of output and therefore underalloca7on of resources

1.  Private bargaining 2.  Subsidy to consumers 3.  Subsidy to producers 4.  Government provision

4-‐29

Society’s Optimal Amounts

LO5

0

Society’s m

argina

l ben

efit a

nd m

argina

l cost of p

olluGo

n ab

atem

ent (do

llars)

Q1

MB

MC

Socially opGmal amount of polluGon abatement

4-‐30

Government’s Role in the Economy

•  Coase theorem •  Private sector bargaining can solve externality problem

•  Government’s role in correc7ng externali7es •  OpGmal reducGon of an externality •  Officials must correctly iden7fy the existence and cause

•  Has to be done within a poli7cal environment

LO5

4-‐31

Controlling CO2 Emissions

•  Cap and trade •  Sets a cap for the total amount of emissions •  Assigns property rights to pollute

•  Rights can then be bought and sold •  Carbon tax •  Raises cost of pollu7ng •  Easier to enforce

Chapter 4morolda.pbworks.com/w/file/fetch/87923107/Chap004.pdf · 44 ’ Supply-Side Market...

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