Chapter 18
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Chapter 18. Externalities and Public Goods DERYA GÜLTEKİN-KARAKAŞ. Topics to be Discussed. Externalities Public Goods. Externalities. Negative Action by one party imposes a cost on another party Positive Action by one party benefits another party. External Cost. Scenario

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Chapter 18

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Chapter 18

Chapter 18

Externalities and Public Goods

DERYA GÜLTEKİN-KARAKAŞ


Topics to be discussed

Topics to be Discussed

  • Externalities

  • Public Goods

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Externalities

Externalities

  • Negative

    • Action by one party imposes a cost on another party

  • Positive

    • Action by one party benefits another party

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External cost

External Cost

  • Scenario

    • Steel plant dumping waste in a river

    • The entire steel market effluent can be reduced by lowering output (fixed proportions production function)

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External cost1

External Cost

  • Scenario

    • Marginal External Cost (MEC) is the cost imposed on fishermen downstream for each level of production.

    • Marginal Social Cost (MSC) is MC plus MEC.

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External costs

The differences is

the marginal external

cost MEC.

The profit maximizing firm

produces at q1 while the

efficient output level is q*.

When there are negative

externalities, the marginal

social cost MSC is higher

than the marginal cost.

MSC

MSCI

MC

S = MCI

The industry competitive

output is Q1 while the efficient

level is Q*.

Aggregate

social cost of

negative

externality

P*

P1

P1

MECI

MEC

D

q*

q1

Q*

Q1

External Costs

Price

Price

Industry output

Firm output

Firmaların MC eğrilerinin


External cost2

External Cost

  • Negative Externalities encourage inefficient firms to remain in the industry and create excessive production in the long run.

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Externalities1

Externalities

  • Positive Externalities and Inefficiency

    • Externalities can also result in too little production, as can be shown in an example of home repair and landscaping.

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External benefits

When there are positive

externalities (the benefits

of repairs to neighbors),

marginal social benefits

MSB are higher than

marginal benefits D.

MSB

A self-interested home owner

invests q1 in repairs. The

efficient level of repairs

q* is higher. The higher price

P1 discourages repair.

D

P1

MC

P*

MEB

q1

q*

External Benefits

Value

Is research and development

discouraged by positive

externalities?

Repair Level

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Public goods

Public Goods

  • Question

    • When should government replace firms as the producer of goods and services?

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Public goods1

Public Goods

  • Public Good Characteristics

    • Nonrival

      • For any given level of production the marginal cost of providing it to an additional consumer is zero.

    • Nonexclusive

      • People cannot be excluded from consuming the good.

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Public goods2

Public Goods

  • Not all government produced goods are public goods

    • Some are rival and exclusive

      • Education

      • Parks

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Efficient public good provision

When a good is nonrival, the social marginal

benefit of consumption (D) , is determined by

vertically summing the individual demand

curves for the good.

Marginal Cost

D2

Efficient output occurs

where MC = MB at 2

units of output. MB is

$1.50 + $4.00 or $5.50.

D

$1.50

D1

Efficient Public Good Provision

Benefits

(dollars)

$7.00

$5.50

$4.00

Output

0

1

2

3

4

5

6

7

8

9

10

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Public goods3

Public Goods

  • Public Goods and Market Failure

    • How much national defense did you consume last week?

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Public goods4

Public Goods

  • Free Riders

    • There is no way to provide some goods and services without benefiting everyone.

    • Households do not have the incentive to pay what the item is worth to them.

    • Free riders understate the value of a good or service so that they can enjoy its benefit without paying for it.

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Public goods5

Public Goods

  • Establishing a mosquito abatement company

    • How do you measure output?

    • Who do you charge?

    • A mosquito meter?

Chapter 18


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