Microeconomics 6, Apuntes de Relaciones Internacionales

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Unit 6:

Externalities and

Public Goods

What have we learnt the last

class?

• Regulated prices
  • Effect of a price ceiling
  • Exercise: effect of a price floor.
• The cost of taxes and subsidies.
  • Tax/subsidy on producers or consumers.
  • Effects of a tax/subsidy on efficiency and surpluses
• Determinants of the deadweight loss
• Elasticities and the distortion of taxes/subsidies.
• Incidence of a tax/subsidy.

• (^) How do markets work

when the choices of

some agents affect

(positively or

negatively) the welfare

of other agents?

Externalities

• (^) Externalities arise if the choices of production or

consumption of some agents have effects on other

agents without any monetary compensation

• (^) Negative externality: the impact is adverse
• (^) Positive externality: the impact is beneficial

Positive and Negative Externalities

Examples

• (^) Positive
  • (^) Vaccination
  • (^) Education
  • (^) R+D
  • (^) Reconstruction of

historical buildings

• (^) When there are externalities in production, the social cost

is different than the private cost.

• (^) If the externality is negative  social cost > private cost.
• (^) If the externality is positive  social cost < private cost.
• (^) Examples:
• (^) The production of aluminium generates negative externalities

because the social cost includes the production cost plus the

cost of contamination

• (^) The production of honey generates positive externalities

because bees pollinate cultivations.

Externalities in production

• (^) If there is a negative externality (pollution from aluminum factories), the social cost of the production of aluminum is higher than the private cost

Negative externalities

Market quantity Aluminum quantity 0 Aluminu m price Demand (private value) Supply (private cost) Cost of Social cost pollution Equilibrium

• (^) The social cost is given by the private cost of the producers PLUS the cost of pollution.
• (^) The production of aluminum will be higher than the optimum.

Negative externalities

Market quantity Aluminum quantity 0 Aluminu m price Demand (private value) Supply (private cost) Cost of pollution Social cost Equilibrium Optimal quantit y Optimum

• (^) There are externalities in consumption when the social value

differs from the private value.

• (^) Negative externality: social value <private value.
• (^) Positive externality: social value > private value.
• (^) Examples:
• (^) Alcohol consumption generates negative externalities because it generates health problems, delinquency, violence, etc.
• (^) Vaccinations generate positive externalities because they also reduce the risk of contagion for those not vaccinated.

Consumption externalities

Consumption externalities

Quantity of Vaccinations 0 Price of Vaccinations Q Q (b) Positive externality in consumption Quantity of alcohol 0 Price of alcohol Q market Demand (private value) Supply (private cost) Social value Q optimal (a) Negative externality in consumption (private cost) Supply Demand (private value) Social value market optimal

• (^) How to induce

agents to take into

account the external

effect of their

choices and to get to

the social optimum?

Solutions to externalities

• (^) One step to solve the externalities is to internalize them - (^) To internalize an externality it is necessary to modify

incentives to make the agents take into account the

external effect of their choices.

• (^) Internalization can take place in two ways:
  • (^) Private solutions.
  • (^) Public solutions.

Internalization of externalities

• (^) The Coase theorem says that
  • (^) if all property rights are well defined and private parties can bargain at sufficiently low cost over the allocation of resources,
  • (^) and whatever the initial distribution of rights,
  • (^) the interested parties can always reach an agreement in which everyone is better off and the outcome is efficient.
• (^) The distribution of rights is not irrelevant because it determines the distribution of welfare.

The Coase Theorem

• (^) Owner of a noisy bar (B) and a neighbor (N).
  • (^) Value for B is 500€; Cost of the noise for N is 800€.
  • (^) If the bar is open : welfare 500-800=-300.
  • (^) If the bar is closed : welfare 0>-300.
• (^) Let’s assume that the law allows the bar to open:
  • (^) If N offers 700€ to B to keep the bar closed, B accepts and the bar remains closed.
  • (^) Welfare of N -700>-800; welfare of B 700>500.
• (^) Let’s assume that the law does not allow the bar to open:
  • The result does not change because B can not make any offer to N which is acceptable for both.
  • The distribution of welfare is different from previous case!

Example of Coase Theorem