Session-3-4-5 Public Goods and Externalities
-
Upload
sadiakhn03 -
Category
Documents
-
view
214 -
download
0
Transcript of Session-3-4-5 Public Goods and Externalities
Economic Policy and Regulatory Environment in India
Market Failure and Need forGovernment Regulation
Rachna GangwarInstitute of Management Technology Ghaziabad
Market Failure and Need forGovernment Regulation
Learning Objectives
• Why do markets fail to produce efficientoutcomes?
• Why is government’s role important?• What is the trade-off between efficiency and
equity?
• Why do markets fail to produce efficientoutcomes?
• Why is government’s role important?• What is the trade-off between efficiency and
equity?
Market Failures
• A situation where free markets fail to– Allocate resources efficiently– Provide goods beneficial to society– Stop production and consumption of
harmful goods
• A situation where free markets fail to– Allocate resources efficiently– Provide goods beneficial to society– Stop production and consumption of
harmful goods
Examples of Market Failure
• Pollution - air, water, soil• Deforestation and loss of biodiversity• Traffic congestion• Health problems associated with consumption
of tobacco, alcohol, and drugs• Depleted fish stock• Global warming
• Pollution - air, water, soil• Deforestation and loss of biodiversity• Traffic congestion• Health problems associated with consumption
of tobacco, alcohol, and drugs• Depleted fish stock• Global warming
Reasons for Market Failure
• Imperfect competition• Public goods• Externalities• Incomplete markets• Imperfect information• Unemployment, inflation, and disequilibrium
• Imperfect competition• Public goods• Externalities• Incomplete markets• Imperfect information• Unemployment, inflation, and disequilibrium
Imperfect Competition
Imperfect competition
• For markets to work efficiently, there shouldbe perfect competition – a sufficiently largenumber of firms that each believes it has noeffect on prices.
• For markets to work efficiently, there shouldbe perfect competition – a sufficiently largenumber of firms that each believes it has noeffect on prices.
Imperfect competition
• Monopoly: E.g. city-wide electrical distribution– Competitive advantage– High transportation costs– Barriers to entry
• Oligopoly: automobile manufacturing• Monopsony: employment in a company town• Oligopsony: employment in professional sports• Patents
– Xerox, Kodak
• Monopoly: E.g. city-wide electrical distribution– Competitive advantage– High transportation costs– Barriers to entry
• Oligopoly: automobile manufacturing• Monopsony: employment in a company town• Oligopsony: employment in professional sports• Patents
– Xerox, Kodak
Imperfect Competition
• Private airports (Delhi, Mumbai etc)• Toll roads• Un-viable markets (rural telecom, air
connectivity to north eastern routes etc)• Power distribution companies• Governments sometimes regulate prices and
profits• Competition commission of India
• Private airports (Delhi, Mumbai etc)• Toll roads• Un-viable markets (rural telecom, air
connectivity to north eastern routes etc)• Power distribution companies• Governments sometimes regulate prices and
profits• Competition commission of India
Aeronautical Non-Aeronautical
Landingcharges
Aero Related
Cargo handling
Commercial(Terminal)
Advertisingfee
Commercial(Other)
Real estatedevelopment
Airport Operator Revenue Streams
Landingcharges
Passengerservice fee
Aircraft refueling
Aircraftmaintenance
Catering services
Advertisingfee
Revenue fromconcessionaires
Rental fromairlines,business, shops
Car parking,publicadmission fee
Real estatedevelopment
Hotel, businessand industrialparks
Retail andentertainment,residential
Parking charges
[Source: Communication from GMR, 2006]
Delhi Airport
• Awarded to GMR in 2006 though competitivebidding
• Airport development fee (ADF) and userdevelopment fee (UDF)
• Awarded to GMR in 2006 though competitivebidding
• Airport development fee (ADF) and userdevelopment fee (UDF)
AERA Constituted
• Airports Economic Regulatory Authority (AERA) wasconstituted in December 2008:– To determine the tariff for the aeronautical
services– To determine the amount of the development fees– To determine the amount of the passengers
service fee– To monitor the set performance standards relating
to quality, continuity and reliability of service
• Airports Economic Regulatory Authority (AERA) wasconstituted in December 2008:– To determine the tariff for the aeronautical
services– To determine the amount of the development fees– To determine the amount of the passengers
service fee– To monitor the set performance standards relating
to quality, continuity and reliability of service
Public Good
Public Goods
• Private good: A good or service whoseconsumption by one person excludesconsumption by others
• Public good: A good or service whoseconsumption by one person does not excludeconsumption by others
• Private good: A good or service whoseconsumption by one person excludesconsumption by others
• Public good: A good or service whoseconsumption by one person does not excludeconsumption by others
Public Goods
– Non-rival competition(one person’s consumption does not preventother person’s consumption)
– Non-excludability (difficult to exclude anyone fromthe benefits)
– E.g. National defence, lighthouse, public health(international vaccine prgramme), street light etc
– Free rider problem
– Non-rival competition(one person’s consumption does not preventother person’s consumption)
– Non-excludability (difficult to exclude anyone fromthe benefits)
– E.g. National defence, lighthouse, public health(international vaccine prgramme), street light etc
– Free rider problem
Public Goods
• Pure public goods– Marginal cost is zero– E.g. National defence
• Impure public goods– Marginal cost very small but not zero– Though expansive, possible to exclude– E.g. un-crowded highways
• Pure public goods– Marginal cost is zero– E.g. National defence
• Impure public goods– Marginal cost very small but not zero– Though expansive, possible to exclude– E.g. un-crowded highways
Public Goods
Congestedhighway Health services,
Education
Mar
gina
l cos
t of u
sePure private good
Nationaldefence
Fireprotection
Mar
gina
l cos
t of u
se
Ease of exclusion
Pure public good
• A local park• College education• Sewage collection• Water• Electricity• Telephone service• Medicine• Police protection• Cable service• Applied research
• A local park• College education• Sewage collection• Water• Electricity• Telephone service• Medicine• Police protection• Cable service• Applied research
• What happens to the efficient allocationbetween public and private goods as aneconomy becomes wealthier?
• Think of an example of a free rider problem inyour city. Think of a way for your localgovernment to overcome this problem.
• Think of an example of a free rider problem inyour city. Think of a way for your localgovernment to overcome this problem.
Merit Goods
• Goods that government compels individualsto consume
• E.g. seat belts, helmets, elementary education
• Goods that government compels individualsto consume
• E.g. seat belts, helmets, elementary education
Demerit Goods
• A demerit good is a good or service whoseconsumption is considered unhealthy,degrading, or otherwise socially undesirabledue to the perceived negative effects on theconsumers themselves. It is over-consumed ifleft to market forces.
• A demerit good is a good or service whoseconsumption is considered unhealthy,degrading, or otherwise socially undesirabledue to the perceived negative effects on theconsumers themselves. It is over-consumed ifleft to market forces.
Club Goods
• Club goods (also artificially scarce goods) are atype of good that are excludable but non-rivalrous, at least until reaching a pointwhere congestion occurs.
• e.g. golf courses, cinemas, cable television,access to copyrighted works, and the servicesprovided by social or religious clubs to theirmembers.
• Club goods (also artificially scarce goods) are atype of good that are excludable but non-rivalrous, at least until reaching a pointwhere congestion occurs.
• e.g. golf courses, cinemas, cable television,access to copyrighted works, and the servicesprovided by social or religious clubs to theirmembers.
Excludable Non-excludable
RivalrousPrivate goodsfood, clothing, cars,personal electronics
Common goodsfish stocks
Private goodsfood, clothing, cars,personal electronics
Common goodsfish stocks
Non-rivalrous
Club goodscinemas, private parks,satellite television
Public goodsnational defense,air
Externalities
Externalities
• Costs (or benefits) of a market activity borneby a third party; the difference between thesocial and private costs (benefits) of a marketactivity
• When externalities are present, market pricesare not a valid measure of a good’s value tosociety
• Costs (or benefits) of a market activity borneby a third party; the difference between thesocial and private costs (benefits) of a marketactivity
• When externalities are present, market pricesare not a valid measure of a good’s value tosociety
Positive Externalities
Externalities
Negative Externalities
Third parties benefit fromproduction of goods andservices
Third parties bear spillovercosts of the production ofgoods and services
Third parties benefit fromproduction of goods andservices
Third parties benefit fromconsumption of goods andservices
Third parties bear spillovercosts of the production ofgoods and services
Third parties bear spillovercosts of the consumption ofgoods and services
Externalities
• Negative externalities.– e.g. air, water, noise pollution, smoking, garbage
• Positive externalities.– e.g flower garden
• Overproduction of goods generatingnegative externalities
• Undersupply of goods generating positiveexternalities
• Environmental policy
• Negative externalities.– e.g. air, water, noise pollution, smoking, garbage
• Positive externalities.– e.g flower garden
• Overproduction of goods generatingnegative externalities
• Undersupply of goods generating positiveexternalities
• Environmental policy
Pollution related New Items
• Delhi's air pollution level is up by five times in eightyrs, says study (India today, July 08, 2012)
• Indian coal power plants kill 120,000 people a year,says Greenpeace(http://www.guardian.co.uk/world/2013/mar/10/india-coal-plants-emissions-greenpeace)
• India River Pollution: 80 Percent of Indian SewageFlows Untreated Into Country's Rivers(http://www.huffingtonpost.com/2013/03/05/india-river-pollution-sewage_n_2810213.html)
• Delhi's air pollution level is up by five times in eightyrs, says study (India today, July 08, 2012)
• Indian coal power plants kill 120,000 people a year,says Greenpeace(http://www.guardian.co.uk/world/2013/mar/10/india-coal-plants-emissions-greenpeace)
• India River Pollution: 80 Percent of Indian SewageFlows Untreated Into Country's Rivers(http://www.huffingtonpost.com/2013/03/05/india-river-pollution-sewage_n_2810213.html)
Social Demand
• Market demand• Social demand• Externalities
• Market demand• Social demand• Externalities
Social Demand Market Demand Externalities Subtract external costs, a negative impactAdd external benefits, a positive impact
• The optimal production mix is where the socialdemand curve intersects the supply curve
Negative Production Externalities
• When an firm’s consumption reduces thewell-being of others who are notcompensated by the firm
Negative Production Externality
Negative Production Externality• When a firm’s production reduces the well-being of
others who are not compensated by the firm– Private marginal cost (PMC) The direct cost to producers of
producing an additional unit of a good.– Social marginal cost (SMC) The private marginal cost to
producers plus any costs associated with the production of thegood that are imposed on others.
– Private marginal benefit (PMB) The direct benefit to consumersof consuming an additional unit of a good by the consumer.
– Social marginal benefit (SMB) The private marginal benefit toconsumers plus any costs associated with the consumption ofthe good that are imposed on others.
• When a firm’s production reduces the well-being ofothers who are not compensated by the firm– Private marginal cost (PMC) The direct cost to producers of
producing an additional unit of a good.– Social marginal cost (SMC) The private marginal cost to
producers plus any costs associated with the production of thegood that are imposed on others.
– Private marginal benefit (PMB) The direct benefit to consumersof consuming an additional unit of a good by the consumer.
– Social marginal benefit (SMB) The private marginal benefit toconsumers plus any costs associated with the consumption ofthe good that are imposed on others.
Negative Consumption Externalities
• When an individual’s consumption reducesthe well-being of others who are notcompensated by the individual.
Negative Consumption Externalities
Externality of SUVs The typical driver in 2008 was in a car that weighed about 4,117 pounds. The
major culprits in this evolution of car size are sport utility vehicles (SUVs)with an average weight size of 4,742 pounds.
The consumption of large cars such as SUVs produces three types of negativeexternalities: Environmental Externalities:
The contribution of driving to global warming is directly proportional to theamount of fossil fuel a vehicle requires to travel a mile. SUV drivers usemore gas to go to work or run their errands, increasing fossil fuel emissions.
Wear and Tear on Roads: Each year, federal, state, and local governments spend $33.1 billion repairing
our roadways. Damage to roadways comes from many sources, but a majorculprit is the passenger vehicle, and the damage it does to the roads isproportional to vehicle weight.
Safety Externalities:One major appeal of SUVs is that they provide a feeling of security because
they are so much larger than other cars on the road. Offsetting this feeling ofsecurity is the added insecurity imposed on other cars on the road.
The typical driver in 2008 was in a car that weighed about 4,117 pounds. Themajor culprits in this evolution of car size are sport utility vehicles (SUVs)with an average weight size of 4,742 pounds.
The consumption of large cars such as SUVs produces three types of negativeexternalities: Environmental Externalities:
The contribution of driving to global warming is directly proportional to theamount of fossil fuel a vehicle requires to travel a mile. SUV drivers usemore gas to go to work or run their errands, increasing fossil fuel emissions.
Wear and Tear on Roads: Each year, federal, state, and local governments spend $33.1 billion repairing
our roadways. Damage to roadways comes from many sources, but a majorculprit is the passenger vehicle, and the damage it does to the roads isproportional to vehicle weight.
Safety Externalities:One major appeal of SUVs is that they provide a feeling of security because
they are so much larger than other cars on the road. Offsetting this feeling ofsecurity is the added insecurity imposed on other cars on the road.
Positive Production Externalities
Global Warming
CO2 Emmission
• Can an activity generate both positive andnegative externalities at the same time?
Others
Incomplete markets
• Complete market will provide all goods andservices for which the cost of provision is leesthan what individuals are willing to pay
• E.g. insurance and loans. life insurance, cropinsurance, education loan etc
• Underinvestment in innovation• Enforcement costs
• Complete market will provide all goods andservices for which the cost of provision is leesthan what individuals are willing to pay
• E.g. insurance and loans. life insurance, cropinsurance, education loan etc
• Underinvestment in innovation• Enforcement costs
• Imperfect information– Imperfect information prevents consumers from
making utility-maximizing decisions.– E.g. Insurance policies, loans
• Unemployment, inflation and disequilibrium
• Imperfect information– Imperfect information prevents consumers from
making utility-maximizing decisions.– E.g. Insurance policies, loans
• Unemployment, inflation and disequilibrium
Government Inventions
• Taxes• Subsidies• Regulation
• Taxes• Subsidies• Regulation
Taxes07_08A
New supply curve
Old supply curve
Demand curve
QUANTITY
PRICE
Quantity declines by this amount.
New quantity Old quantity
New price
Old price
Price rises by this amount.
Price receivedby sellers aftersending tax togovernment
Deadweight lossAmount ofsales tax
Deadweight Loss from a Sales Tax
07_08A
New supply curve
Old supply curve
Demand curve
QUANTITY
PRICE
Quantity declines by this amount.
New quantity Old quantity
New price
Old price
Price rises by this amount.
Price receivedby sellers aftersending tax togovernment
Deadweight lossAmount ofsales tax
Deadweight Loss from a Sales Tax