Download
1 / 76
760 likes | 1.22k Views
2. Externalities. Sometimes costs or benefits that result from an activity accrue to people not directly involved in the activity. These are called external costs or external benefits -- externalities for short.. 3. Example 12.1.. Sara is an accomplished classical violinist. Her neighbor Tom is a
E N D
1. 1 Zhigang Li University of Hong Kong
2. 2 Externalities Sometimes costs or benefits that result from an activity accrue to people not directly involved in the activity.
These are called external costs or external benefits -- externalities for short.
3. 3 Example 12.1. Sara is an accomplished classical violinist.
Her neighbor Tom is a fan of classical violin music, and on summer evenings enjoys listening to Sara play in her garden.
For Tom, Sara's music is a positive externality.
If Sara plays only in response to her own costs and benefits, will the amount of time she plays be socially optimal?
4. 4 Example 12.1. If Sara plays in response to her own costs and benefits, she will continue to play until the marginal benefit of playing another minute is equal to the marginal cost.
But since Tom also benefits from her playing, at that point the total marginal benefit of playing another minute will be greater than the marginal cost.
5. 5 Example 12.1. Thus, if Sara plays in response to her own costs and benefits, Sara plays too little.
6. 6 Example 12.2. Sara is an accomplished classical violinist.
Her neighbor Harry hates the sound of violin music, and on summer evenings becomes distressed when Sara plays in her garden.
For Harry, Sara's music is a negative externality.
If Sara plays only in response to her own costs and benefits, will the amount of time she plays be socially optimal?
7. 7 Example 12.1. If Sara plays in response to her own costs and benefits, she will continue to play until the marginal benefit of playing another minute is equal to the marginal cost.
But since Harry also incurs costs from her playing, at that point the marginal benefit of playing another minute will be greater than their combined marginal costs.
8. 8 Example 12.2. Thus, if Sara plays in response to her own costs and benefits, Sara plays too much.
9. 9 Externalities and activity Negative externalities => too much activity
Positive externalities => too little activity
10. 10 Example 12.3. Smith can produce with or without a filter on his smokestack.
Production without a filter results in greater smoke damage to Jones.
11. 11 Example 12.3.
12. 12 Example 12.3.
13. 13 The Coase Theorem
14. 14 Example 12.3. Traditional (pre-Coase) view:
Smith is the perpetrator (the person who committed a crime), Jones is the victim.
If it is Smith's smoke that is causing the damage to Jones, why should Jones pay Smith to install a filter on his smokestack?
15. 15 Example 12.3. Coases insight was that externalities are purely reciprocal.
The smoke harms Jones, true enough.
But to restrain Smith from producing smoke would harm Smith.
The two parties have a shared interest in achieving the outcome that is least costly overall.
16. 16 Benefit to all when the pie is larger
17. 17 Example 12.4.
18. 18 Example 12.4.
19. 19 Example 12.4.
20. 20 Example 12.4. Ted would pay up to $150/mo rather than reschedule his playing.
Bill would pay up to $80 per month not to have his sleep disturbed.
Will they live together or separately?
21. 21 Example 12.4. The question is whether the benefits of joint living exceeds the costs.
The benefit is the $100 per month reduction in rent.
What is the least costly accommodation to the trumpet problem?
22. 22 Example 12.4. If they live together
Cost to Ted of stopping playing: $150/mo
Cost to Bill of tolerating the noise: $80/mo
So the least costly solution is for Bill to put up with the noise (since $80 < $150).
Since this cost ($80) is less than the $100/mo gain, they should live together.
23. 23 Example 12.5. In the preceding example, what is the largest rent Bill would be willing to pay if the two were to live together?
24. 24 Example 12.6. How should Ted and Bill split the $500/mo rent if they agree that each should benefit equally from living together?
25. 25 Costly negotiations It is often impractical to negotiate solutions to the problems created by externalities.
Hospital patients, for example, are unable to negotiate with passing motorists about not blowing their horns.
In such cases, the law tries to impose the burden of adjustment on the party that can accomplish it at lowest cost.
26. 26 Costly negotiations
27. 27 Costly negotiations
28. 28 Example 12.7. The Right to an Unobstructed View Lehman owns a house overlooking the lake, from which he enjoys a commanding sunset view.
29. 29 Example 12.7. The Right to an Unobstructed View Now Martin purchases the property below Lehman's and is considering which of two houses to build:
a one-story house that would leave Lehman's view intact;
or a two-story design that would completely block Lehman's view.
30. 30 Example 12.7. The Right to an Unobstructed View Suppose the gain to Lehman from an unobstructed view is 100, the gain to Martin from having a one-story house is 200, and the gain to Martin from a two-story house is 280.
If the laws of property let people build houses of any height they chose, and if negotiation between property owners were costless, which of the two houses would Martin build?
31. 31 Example 12.7. The Right to an Unobstructed View Value of view to Lehman: 100
Value of second story to Martin: 280-200=80
The increase in Martin's gain from having the taller house is 80, which is 20 less than the cost to Lehman from the loss of his view.
The efficient outcome is thus for Martin to build the one-story house.
And that is exactly what would happen if the two parties could negotiate costlessly.
32. 32 Example 12.7. The Right to an Unobstructed View Rather than see Martin build the taller house, it will be in Lehman's interest to compensate Martin for choosing the shorter version.
To do so, he will have to give Martin at least 80.
The most Lehman would be willing to pay is 100, since that is all the view is worth to him.
For some payment P, where 80?P?100, Lehman will get to keep his view.
33. 33 Example 12.7. The Right to an Unobstructed View Suppose, however, that negotiations between the two parties were impractical.
Martin would then go ahead with the two-story house, since that is the version he values most.
By comparison with the one-story design, Martin would gain 80, but Lehman would lose 100.
The optimal structure of property rights in this particular example would be to prohibit any building that blocks a neighbor's view.
34. 34 Example 12.7. The Right to an Unobstructed View If the valuations assigned by the parties were different, a different conclusion might follow.
If, for example, Martin valued the two-story house at 300 and Lehman valued the view at only 80, the optimal structure of property rights would be to allow people to build to whatever height they chose.
35. 35 Modified Coase Theorem The optimal structure of property rights is the one that places the burden of adjustment (either the loss of a view or the loss of a preferred building design) on the party that can accomplish it at the lowest cost.
As a practical matter, the laws of property in many jurisdictions often embody precisely this principle.
36. 36 Modified Coase Theorem In cities like San Francisco, strict zoning laws prohibit construction that blocks an existing building's line of sight
37. 37 Modified Coase Theorem Zoning laws in cities where there is less to look at are generally much more liberal in the kinds of buildings they permit.
38. 38 Example 12.8. Taxing Negative Externalities Two firms, X and Y, have access to five different production processes, each one of which has a different cost and gives off a different amount of pollution.
39. 39 Example 12.8. Taxing Negative Externalities The city council wants to cut smoke emissions by half. To accomplish this, they are considering two options.
Require each firm to curtail its emissions by half.
Set a tax of T on each ton of smoke emitted each day.
How large would T have to be in order to curtail emissions by half?
And how would the total costs to society compare under the two alternatives?
40. 40 Example 12.8. Taxing Negative Externalities A: If each firm is required to cut pollution by half, each must switch from process A to process C.
The result will be two tons/day of pollution for each firm.
41. 41 Example 12.8. Taxing Negative Externalities B: How will each firm respond to a tax of T per ton of pollution?
Switching to the next process will cut pollution by 1 ton per day and save tax of T/day.
If cost of switching to the next process is less than or equal to T, it will switch, otherwise not.
42. 42 Example 12.8. Taxing Negative Externalities T= 50/ton: Firm X would stick with process A. Firm Y will switch to process B.
43. 43 Example 12.8. Taxing Negative Externalities T= 91/ton. X will adopt process B, Y will adopt process D.
44. 44 Example 12.8. Taxing Negative Externalities Note that the taxes paid by the firm are not included in our reckoning of the social costs of the tax alternative, because this money is not lost to society.
It can be used to reduce whatever taxes would otherwise have to be levied on citizens.
45. 45 Example 12.9. Pollution Permits Similar to the preceding example but now the government issues pollution permits to the two firms, allowing them to generate 4 tons of smoke daily, in total.
Will the pollution generated by the two firms change with the different allocation of permits?
46. 46 Example 12.9. Pollution Permits Similar to the preceding but now the government issues pollution permits to the two firms, allowing them to generate 4 tons of smoke daily, in total.
Suppose each firm is given permits to generate 2 tons of smoke.
47. 47 The Tragedy of the Commons
48. 48 Example 12.10 A village has five residents, each of whom has accumulated savings of $100.
Each villager has two investment opportunities:
Buy government bond for $100 that pays 12% interest per year.
Buy a year-old steer for $100, send it onto the commons to graze, then sell it after one year.
49. 49 Example 12.10 The Relationship Between Herd Size, Selling Price, and Profit per Steer
50. 50 Example 12.10 Opportunity cost of investing in steer = 12
Send steer if and only if price of 2-year-old steer is at least 112
Four of the villagers send 1 steer, and hence a total of 4 steers.
Total village income = 12 + 4(12) = 60
51. 51 Example 12.10 Decision rule for socially optimal investment: Send another steer only if the value of the herd increases by at least 12.
Thus, we should send a second steer but not a third. Total income = $32 + $36 = $68
52. 52 Tragedy of commons The problem with private decisions is that no individual has any incentive to take into account that an extra steer will eat grass that otherwise would have been available to the steers already on the commons.
The tragedy of the commons is thus a type of externality.
53. 53 Example 12.11. Sam and Stan are identical twins with a craving for chocolate malted milkshakes, and have agreed to share one.
54. 54 Example 12.11. Each knows that any part of the milkshake he doesn't drink will be drunk by the other.
So each consumes at a faster rate than he would if he had half the shake all to himself.
55. 55 Examples of Tragedies of the Commons Harvesting timber on public land.
56. 56 Examples of Tragedies of the Commons Picking blackberries in a public park
57. 57 Examples of Tragedies of the Commons Harvesting whales in international waters
58. 58 Examples of Tragedies of the Commons Pollution
59. 59 Tragedies of the Commons Clearly defined property rights are one way to solve the tragedy of the commons
60. 60 Example 12.12. (Chapter 1-4) Once a week, Smith purchases a six-pack of cola and puts it in his refrigerator for his two children. He invariably discovers that all six cans are gone on the first day. Jones also purchases a six-pack of cola once a week for his two children, but unlike Smith, he tells them that each may drink no more than three cans. If the children use cost-benefit analysis each time they decide whether to drink a can of cola, explain why the cola lasts much longer at Jones house than at Smiths.
61. 61 Example 12.12. (Chapter 1-4) At Smiths house, each child knows that the cost of not drinking a can of cola now is that it is likely to end up being drunk by his sibling. Each thus has an incentive to consume rapidly to prevent the other from encroaching on his share.
Jones, by contrast, has eliminated that incentive by making sure that neither child can drink more than half the cans. This step permits his children to consume at a slower, more enjoyable pace.
62. 62 Defined property rights as a solution to tragedy of the commons
63. 63 Defined property rights as a solution to tragedy of the commons
64. 64 Defined property rights as a solution to tragedy of the commons
65. 65 Regulation as a solution to tragedy of the commons
66. 66 Regulation as a solution to tragedy of the commons
67. 67 Regulation as a solution to tragedy of the commons
68. 68 Regulation as a solution to tragedy of the commons
69. 69 Example 12.13 In the cattle-grazing economy considered earlier, suppose there is now a 25% tax on income earned from cattle.
If people decide individually between bonds and cattle, how many steers will be sent onto the commons?
70. 70 Example 12.13
71. 71 Tragedy of the commons One of the continuing sources of inefficiency in modern economies involves the allocation of resources that no single nation's property laws and regulations can govern.
Several species of whales have been hunted to near extinction because international laws of property are insufficient to restrain individual incentives to kill whales.
The Mediterranean Sea has long had serious problems with pollution, because none of the many nations that border it has an economic incentive to consider the effects of its discharges on other countries.
72. 72 Example: Why do football players take anabolic steroids? Smith and Jones are competing for a single position and a $1 million contract.
73. 73 Example: Why do football players take anabolic steroids?
74. 74 Positional Arms Races and Positional Arms Control Agreements Positional Externality
When an increase in one persons performance reduces the expected reward of another in situations in which reward depends on relative performance
Positional Arms Race
A series of mutually offsetting investments in performance enhancement that is stimulated by a positional externality
75. 75 Positional Arms Races and Positional Arms Control Agreements Positional Arms Control Agreements
An agreement in which contestants attempt to limit mutually offsetting investments in performance enhancements
Campaign spending limits
Roster limits
Arbitration agreements
Mandatory starting dates for kindergarten
76. 76 Positional Arms Races and Positional Arms Control Agreements Social Norms as Positional Arms Control Agreements
Nerd norms
Good grades vs. all study too hard
Fashion norms
Avant-garde status vs. excessive body mutilation
Norms of taste
Catching attention vs. too much nudity
Norms against vanity
Cosmetic/reconstructive surgery vs. Michael Jackson
77. 77
