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Stationary: Power plants and factories
Mobile: Cars |
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| Greenhouse gasses increase the temperature of the earth. Studies show that temp increased 1 degree in the last 100 years, most of it in the last 20 years. |
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| Causes many problems: Health, Rising sea levels, Storms, Deforestation |
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| Resource scarcity: Water accessibility |
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| 40% of the world live in areas under moderate or high water stress. (2/3 of the pop will live like that by 2025). |
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| Two Current Theories on the Environment |
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1. The current development path is unsustainable, and will lead to catastrophic consequences(extinction of species, global warming, extinction of mankind)
2. Societies always have found, and will find, solutions to their environmental problems |
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| If we do this, then that will happen. Looks at reality, and tries to find the truth. |
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| What should be? Value judgment |
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| We concentrate on positive analysis most of the time, but sometimes touch on normative questions |
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| Area under demand curve where price is |
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| Horizontal sum of individual demands |
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| Consecutive units become more expensive |
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| Above the supply curve to the price, Total cost is below the supply curve |
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An outcome is efficient if all possible surplus (net benefit) is obtained
Result: 1st fundamental theorem of welfare economics |
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| Loss from goods being sold at not the equilibrium price and quantity |
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| Basic condition for efficiency |
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| Marginal Benefit = Marginal Cost |
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An outcome is Pareto efficient if no individual can be made better off without making some individual worse off
Pareto efficient does not mean fair>
Competitive market is Pareto efficient (under some efficient) |
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| Why is Efficiency important? |
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Definition
Inefficient outcomes imply waste.
Moving to efficiency creates more total surplus.
Does efficiency imply fairness? |
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| Present Value x (1+i) ^ n |
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| Valuing the environmental impact of an action |
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Definition
1) Estimate the environmental impact in terms of the environmental variables, ex/ how much will pollution emissions change due to the policy
2)Place a monetary value on the impact
-Valuation of the benefits
-Valuation of the costs |
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| 3 Types of environmental goods or assets |
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Definition
1) Use value
2) Option value
3) Nonuse (existence) value |
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Value obtained from the environmental good derived from its direct use.
Ex/value of crab harvested each year from Alaska...oil spill in Alaska..company will have to compensate fisherman..
Use value can help determine extent of damages |
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Value placed on the option of using the resource in the future.
Value beyond use value, since the resource may be used more or differently in the future.
Ex/If fishers over extract certain specie and it is extinguished, then the damage of that extraction should include the value of the fish that could have been extracted in the future. |
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It is the value placed on the environment beyond its direct(current or future) use value.
Ex/You may be willing to contribute money to help save some endangered species, even though you may never see them, eat them, or benefit in any way..
Difficult to measure: WTP for something they never use |
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| Total Value of an Environmental Asset |
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Used to calculate OV, UV, and NV.
Goal of valuation methods is to put a price tag on environmental assets |
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| Classification of Valuation Methods |
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Definition
1) Direct Observational Methods
2) Direct Hypothetical Methods
3) Indirect Observational Methods
4) Indirect Hypothetical Methods |
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| Direct observational methods |
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Definition
Methods based on actual observable choices
Mostly used for goods that have market prices
Value can be calculated easily if prices are directly observable
Ex/use value of the extinction of king crab in Alaska = Present val of extracted crab at market prices |
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| Direct Hypothetical Methods: Contingent Valuation |
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Direct hypothetical methods use surveys to elicit willingness to pay
The contingent valuation method is the most important
Respondents are asked what value they would place on some environmental asset
Ex/What value would you place on reducing the contamination of San Diego bay to zero.
Problem: You don't actually have to pay, so you may say anything. If forced to pay, your answer may be very different. |
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| Contingent Valuation: Biases |
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Definition
Strategic Bias: respondents overstate or understate WTP in order to affect policy
Information Bias: respondents are asked to evaluate goods/attributes for which they have little or no experience
Starting point bias: Survey design may influence the answers
Hypothetical bias: Difficulty of the respondent in correctly picturing the situation |
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| Indirect Observational Methods |
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Definition
Utilize spending on other goods in order to elicit environ. value of good
Ex/
Property values are lower in areas of pollution..etc
Cost of water treatment system can be used to elicit the value of reducing water pollution |
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| Indirect Observational Methods |
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Definition
Utilize spending on other goods in order to elicit environ. value of good
Ex/
Property values are lower in areas of pollution..etc
Cost of water treatment system can be used to elicit the value of reducing water pollution |
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| Indirect Hypothetical Methods |
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Definition
Surveys that ask respondents to rank a set of hypothetical situations in terms of their desirability
Bundles of attributes to choose from |
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More straightforward than evaluating benefits
Difficulties:
-Estimating expected future costs
-Getting reliable cost information from firms |
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| Valuation of Costs Approaches |
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Definition
Survey: involves asking polluters about their control costs
Engineering: uses engineering info to estimate the tech needed and the costs of purchasing and using those technologies |
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| Cost Effectiveness Analysis |
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Definition
Alternative to benefit-cost analysis
We use it when the measurement of benefits is impossible or estimates are unavailable
Minimization of the costs of achieving a policy target
Various proposed standards can be compared for their cost-effectiveness |
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| First Fundamental Theorem of Welfare Economics |
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Definition
Market outcome is efficient if:
- perfectly competitive market
- good is a private good
- no externalities
- g |
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| Welfare of some agent depends not only on her own activities but also on the activities under the control of some other agent (can be positive or negative) |
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Ex/ You drive your car to LA, creating pollution that affects other individuals in addition to you
Private Cost: Cost faced by the economic agent pursuing the activity
External Cost: A cost of an activity that falls on people or firms other than those who pursue the activity
Social Cost: Total cost to society of pursuing the activity
social cost = private cost + external cost |
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Definition
| Ex/Your roommate installs a water filter, and you get to use it |
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| Problems with Externalities |
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Definition
| Supply/demand do not reflect correctly the total social benefits and costs. MB does not equal MC. We want social MC = social MB. |
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| Command and Control Approach to environmental externalities |
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Definition
1) Pollution limits (quotas)
2) Technology standards to directly regulate polluters |
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| Market solution to environmental externalities |
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Definition
Incentive based policy tools to motivate abatement through market forces...
-Property Rights
-Taxes |
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| More on the command and control approach |
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Definition
Dominates environmental policy in most nations
Has not met with consistent success
US and others have been incorporating more market based appraoaches
Hard to implement..you need a lot of information |
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Definition
Specify pollution(emission) limit that every polluter must achieve
Each polluter can select the means by which they achieve the objective (e.g. at a lower cost) |
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| Technology Based Standards |
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Definition
Stipulate the equipment or process to be used to achieve abatement.
Example: EPA selects "best" technology and requires all polluters to adopt it |
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| Cost Effective Abatement Criterion |
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Desired level of abatement is achieved: A1 + A2 + A3..+ AN = AD
MAC1 = MAC2 = MACN |
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| More on Cost Effective Abatement Criterion |
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Definition
Allocate abatement across polluting sources such that the MACs for each source are equal.
"Equi-marginal principle of optimality" |
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Uniform standards are usually imposed
If abatement cost conditions differ among sources, this will not be cost-effective
Some firms can meet standards at lower marginal cost than others
Forces high-cost abaters to reduce pollution as much as low-cost abaters
Could reduce costs if more of the abatement is accomplished by lower-cost abaters |
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| In order to reach optimal, we need to know the marginal costs of each firm. In practice, both firms will have an incentive to overstate their costs. |
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Uses price or other economic variables to provide incentives for polluters to reduce emissions
Allows polluters to respond according to their own self interest
Brings back the external costs of environmental damage back into the decision making of firms and consumers(internalize the externality) |
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Deals with the way environmental objectives are implemented, as opposed to the level at which objectives are set
Can achieve a cost-effective solution to environmental problems |
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| Types of Market Based Policy Instruments |
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Definition
1. Pollution Charges (charging for amt of pollution they generate)
2. Environmental Subsidies (pay them not to pollute)
3. Marketable Permit Systems (cap and trade system)
4. Property Rights Assignment |
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Definition
Fees imposed on polluting sources that vary directly with the amount of contaminants released to the environment. Internalize cost of environmental damages by pricing the pollution-generating activity
"Polluter pays principle"
It is a tax imposed on pollution |
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| Pollution Charges Two Types |
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Definition
Product Charges (amount of output produced)
Emission charges (carbon emissions?) |
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| Pollution Generating Commodoties |
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| Gasoline, Tires, Batteries, Fertilizers, Pesticides |
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Definition
Impose a unit tax EXACTLY EQUAL to the MEC at the EFFICIENT OUTPUT LEVEL
PIGOUVIAN TAX
This induces firms to INTERNALIZE the EXTERNALITY BY TAKING ACCOUNT OF THE MEC IN THEIR PRODUCTION DECISIONS |
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| Marginal private cost function will change to account for the tax. MPC = MPC + Tax |
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| MPC + t will be parallel to MPC! |
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| Problems with Product Charges |
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Definition
Not commonly used in practice because need to identify the dollar value of MEC at Qe to know the appropriate tax.
If demand changes, then the tax level will be inefficient and will have to be revised.
We are not directly taxing what is causing the problem. |
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Definition
A tax imposed directly on the discharge of pollution.
Firm has several options:
1. Continue polluting at the same level and pay the charge
2. Reduce pollution discharge (and thus tax burden)
-By reducing output
-By investing in abatement technology
Each firm chooses whatever minimizes costs |
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Definition
Government sets standard at As
Polluter must pay per unit tax, t, on amount of amount of abatement BELOW standard. Total tax = t(As - Ai) (we are measuring units abated)
Or polluter can incur the cost of abating |
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| Assessing Emission Charges |
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Definition
Emission charges change the incentives facing polluters in two ways:
1. Make polluters to account for external costs
2. Encourage polluters to seek out cheaper methods of abatement, in order to avoid paying the emission tax |
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| Emission Charges are Cost-Effective |
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Definition
The correct level of emission charges will enable society to achivee a desired level of abatement in a cost-effective manner
Each polluter independently chooses to abate such that MAC = t.
If each polluter faces the same emission charge, then the chosen abatement levels will satisfy the cost effective abatement criterion
MAC1 = MAC2 = t
Therefore this method is preferred to imposing uniform abatement standards |
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Total Abatement Costs --> Real Cost to Society
Total Tax Payment --> Transfer of money from firm to government, and gives it back by doing something that benefits society |
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| Conclusion: Emission Charges |
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Definition
Advantages:
Costs are minimized
Government revenue is generated, which may be used for monitoring and enforcement costs
Problems:
Need to set correct charge
Monitoring costs(of emissions)
Taxes cause higher prices for consumers
Incentive to evade tax through illegal means |
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Definition
Similar to taxes...
The idea is that if a subsidy is paid per unit of pollution abated, then not abating it has a cost (opportunity cost) equal to the subsidy not received
Then we can change incentives in the same way than with taxes, i.e. we make the polluters to internalize the externality |
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| The govt decides the amount of pollution desired and issues permits to pollute up to that amount. Then the permits are either auctioned among potential polluters or distributed among them in some other way. |
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With imperfect information about abatement costs, government does not know what tax or subsidy will lead to efficient outcome
Permits take the socially desirable quantity of pollution or abatement and let market establish price
With perfect information, either approach leads to the same out come, but the adv is that with permit systems, you do not need perfect information |
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Traders who buy permits can either use them themselves, or sell them to other polluters later.
Each polluter will weigh the costs of abating with the cost of acquiring permits
High-cost abaters would be expected to bid for permits
Low-cost abaters would be expected to sell their permits |
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There are gains from trade as long as the 2 firms face different MACs
There is incentive for high cost abaters to continue purchasing permits from low cost abaters until MACs across firms are equal |
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| Conclusion: Pollution permits |
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Definition
To implement this system, we just need to know how much pollution, we can tolerate.
Market determines price.
Tradable permit system can achieve cost-effectiveness
Number of permits can be easily adjusted to change the environmental objective
Can introduce more permits or have government or environmental groups buy them up |
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| Property Rights Assignment |
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Definition
The problem that causes the externality is that there is no clear property right on some resource
Example: If a firm pollutes the river, in principle it can do so, because "nobody owns the river"
This suggests another possible solution: Give the right over the river to some agent (e.g. the firm) and let agents negotiate
For example, the firm may accept payments from the community in order to reduce pollution
We will see that who receives the property rights is irrelevant for efficiency, although not for fairness |
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If negotiation costs are negligible and effected parties can freely negotiate, the resource can be allocated by the courts to either party and an efficient allocation will result
Only the distribution of costs and benefits among the effective parties is changed
Regardless of which party the property right is assigned to, an efficient level of production will result
Inefficiency causes the pressure for improvement |
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| Issues with Coase Theorem |
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Definition
If the property right is assigned to the polluter, pollution could become a profitable activity
Negotiation costs are often large
The number of polluters has to be small, otherwise negotiation is very costly
"Victim pays" outcomes tend to be unsatisfactory for society |
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| Solutions to Externalities: Conclusions |
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Definition
We have seen that there are control and market based approaches
In general market approaches are preferred since they don't need as much information as the control systems
Pollution permit systems are increasingly being used with good results |
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Definition
| possibility of preventing someone from consuming the good. Unless you pay for it, you can't consume it |
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| No one can prevent you from using it... National security..Once we provide it for a country, difficult to exclude one individual |
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| It is rival if a good can only be consumed by one person and it is not available for someone else |
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Definition
Pure private goods: Excludable and rival in consumption
Ex: A bottle of Coke, a restaurant meal
Pure public goods:
Non-excludable and non-rival in consumption.
Examples: National defense, air, city, landscape |
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| Public Goods, Implications: |
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Definition
For a non-rival good, the marginal cost of providing the good to an additional consumer is zero
--> It is socially efficient to provide the good to as many consumers as possible
For a non-exclusive good:
any consumer who wants to consume the good can consume it
--> Non exclusiveness gives rise to the free rider problem:
No consumer has an incentive to pay for the provision of the public good as long as other consumers provide it |
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| Public Goods: Inefficient Provision |
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Definition
Free rider: Someone who derives benefits from a commodity without contributing to its supply, causing underprovision
Example: You refuse to contribute money to the preservation of whales, but go often to watch them. Others?
Public goods will be under provided in a competitive market |
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| Public Goods: Problem of Market Failure |
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Definition
In a competitive market, there is no or insufficient incentive to provide a public good.
You can think of this problem as an extreme form of an externality: An individual who provides the public good will be able to enjoy it herself and at the same time has a large positive externality on all other consumers.
Also, even if a good is exclusive and therefore there is no free rider problem, it is inefficient to exclude someone from consuming a non-rival good that has already been produced.
Positive externalities cause inefficiencies. |
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| Efficient provisions of public goods: |
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Definition
Since all consumers can consume the public good at no extra cost (i.e. it is non rival) we will add their individual marginal benefits(demands) to find their total marginal benefit (vertical sum of demands)
Then we set total marginal benefit equal to the marginal cost and find the optimal quantity of the public good that should be provided. |
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Definition
In theory, the optimal provision of public goods can be achieved if all consumers contribute an amount equal to their individual marginal benefit of consumption.
Individuals might be willing to be taxed for public goods if they knew others were being taxed. Each individual would be presented by the government with the proportion of a public good's cost he was expected to pay and then reply with the level of public good he would prefer. |
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Definition
Each individual has an incentive to free ride
That causes the market to provide less than the efficient quantity (that quantity maximizes total surplus)
By free riding, an individual can increase his/her own surplus at the expense of others
But in the end, there is a net loss due to free riding, i.e. gain by some is less than the loss by others
Lindahl solution problems:
-free riding
-imperfect information about who benefits from the good |
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| Determining private benefits |
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Definition
Optimal public goods provision requires knowledge of each person's marginal benefit. In practice, one needs to use estimates based on:
-Market values, e.g. wage as estimate of value of time
-Survey results
Using that information, the govt. can collect taxes and then provide the optimal amount of that good |
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Definition
Single firm serves the "relevant market"
The demand for the firm's product is the market demand curve
Firm has control over the price
-But the price charged affects the quantity of the monopolist's product |
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| Sources of Monopoly Power |
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Definition
Economies of Scale (cost per unit is cheaper) ex/water utilities
Patents and other legal barries (like licenses, copyrights)
Exclusive contracts
Collusion (OPEC)--> Assign quotas, control quantity of oil that's available and thus price |
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| Monopoly Profit Maximization |
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Definition
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| Why do societies dislike monopoly? |
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Definition
P > MC
-Too little output, too high a price
-This creates an inefficient allocation --> DL |
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The beneficial effects of economies of scale on price and output may outweigh the negative effects of deadweight loss
Encourages innovation |
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Definition
Regulation:
-Marginal cost pricing: The gov't requires the monopoly to sell at MC. The problem is that at this cost the monopoly may lose money, and therefore it will require a subsidy from the govt to operate under these conditions.
Average Cost Pricing: Require the monopolist to charge a break even price
Subsidies: The govt subsidizes the monopoly for producing above the monopolistic quantity (up to the efficient quantity) |
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| Problem 1 with Marginal Cost Pricing |
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Definition
It requires knowledge of MC
If Regulated Price is too low: DWL is larger without regulation |
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| Problem 2 with Marginal Cost Pricing |
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Definition
Possibility of ATC > Pc.
Zero long run output for the monopolist, since it looses on every unit sold.
Government will have to subsidize the firm to convince it to produce. |
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| Problems with Average Cost Pricing |
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Definition
As with MCP, the government needs to know the cost curves of the firm, information that is not usually available
ACP is still inefficient, since for efficiency we need P = MC, not to AC.
Less incentive for firms to reduce costs, since they charge AC. |
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| State ownership and management |
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Definition
Government sets P = MC covers any losses.
One problem is that public firms are usually more inefficient than private firms.
So, though P = MC, MC is not the lowest possible. |
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