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Externalities, Asymmetric Information, and Government Intervention
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  1. Externalities, Asymmetric Information, and Government Intervention Chapter 16 Government and Market Failure

  2. Private goods • Private goods are rivalous and excludable • Both features must be present • Rivalry means when someone buys and consumes a good, they prevent anyone else from buying and consuming that good • Excludability means the seller can exclude non-payers from enjoying the product • These characteristics are not found for public goods—their absence makes it impossible for private providers to profit from offering these products

  3. Public goods • Public goods are nonrivalous and nonexcludable • Nonrivalry means that more than one person can consume the same good at the same time • Watching a ballgame is a nonrivalrous good, though particular seats in a ballbark are rivalous. Ballgames are provided privately because they are excludable. • Nonexcludability means that the good’s benefits cannot be limited to those who pay for it

  4. The free rider problem • If consumers can enjoy satisfaction from a nonrivalous good, and cannot be excluded from using it even when they don’t pay…. • There’s no incentive to pay for the good if it is offered on the market, • And there’s no incentive for private agents to offer it for sale…. • So it must be provided by the government or not at all.

  5. Optimal amount of a public good • The optimal amount is determined by the collective willingness to pay, the vertical sum of the prices for a given quantity (marginal social benefit) • And the intersection with the marginal cost

  6. Cost-benefit analysis • Net benefit = marginal benefit – marginal cost • NB = MB – MC • Determines the socially optimal quantity

  7. Externalities • aka “spillover” costs and benefits • Negative externalities (external costs) result in a lower production cost being borne by the producer and being passed onto consumers • Creates an overallocation of resources—producers produce too much • Positive externalities (external benefits) result in more satisfaction being received by consumers than producers can charge for • Results in underallocation of resources—producers produce too little

  8. The Coase theorem • Market processes can internalize all costs and benefits, provided • A. Property rights are well understood, enforced, and mutually agreed on, • B. The number of independent negotiating agents is small, and • C. Transaction costs, including costs of bargaining, are small enough to be negligible. • Too many participants or too high transaction costs make a private solution unworkable.

  9. Information asymmetries • Only producers know their marginal costs, and only consumers know their own marginal benefits • Used car dealers know whether the car is a lemon • Buyers find out later • Results in a market solution that all used cars are worth significantly less than new cars

  10. External benefits • Lojack and other car antitheft devices lower car theft, even of cars without them • Local crackdowns on chopshops reduce theft • Crackdowns on traffickers in stolen car audio equipment yield even better benefits