Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Lecture 11: Externalities and Public Goods November 10, 2015 Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Overview Course Administration Positive and Negative Externalities Fixing Externalities Defining Public Goods Optimal Provision of Public Goods Private Provision of Public Goods Public Provision of Public Goods Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Course Administration 1. Bookstore website says reading packet needed for next week is available 2. Problem Set 10 is posted, problem set 8 answers posted 3. Elasticity paper: voluntary classmate feedback • Post paper by Nov. 17 8 pm to Blackboard discussion board called \elasticity paper draft" • Put last name at beginning of file name • You'll need to return comments on 2 to 3 papers by 8 pm 12/22 (Sunday) { and you could make alternate arrangements with your group • I'll assign groups randomly after papers are posted • Suggestions? 4. Office hours extended: Wednesdays 10 am to 1 pm 5. Last class: probably 1/2 class asymmetric information, 1/2 review 6. Questions? Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Ripped from the Headlines Next Week Afternoon Finder Presenter Lily Robin Carly Evans Evening Finder Presenter Amber Ebarb Jenny Lewis • Positive externality ≡ benefit accruing to party not involved in economic transaction • Negative externality ≡ cost accruing to party not involved in economic transaction Examples, please. Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Externality Definition Externality ≡ cost or benefit accruing to party not involved in economic transaction • Negative externality ≡ cost accruing to party not involved in economic transaction Examples, please. Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Externality Definition Externality ≡ cost or benefit accruing to party not involved in economic transaction • Positive externality ≡ benefit accruing to party not involved in economic transaction Examples, please. Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Externality Definition Externality ≡ cost or benefit accruing to party not involved in economic transaction • Positive externality ≡ benefit accruing to party not involved in economic transaction • Negative externality ≡ cost accruing to party not involved in economic transaction Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Externality Definition Externality ≡ cost or benefit accruing to party not involved in economic transaction • Positive externality ≡ benefit accruing to party not involved in economic transaction • Negative externality ≡ cost accruing to party not involved in economic transaction Examples, please. Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG In a Market Without Externalities • If private demand = private marginal benefit = social P marginal benefit • And Private supply = private marginal cost = S social marginal cost • Then market equilibrium maximizes social welfare, D which is total surplus Q • Provides goods to consumer at lowest possible cost Assume a positive externality • =) Social marginal benefit 6= private marginal benefit • =) Social marginal benefit = Private marginal benefit + external marginal benefit What does this mean for the relationship between market equilibrium PMKT and QMKT and socially optimal PSOC and QSOC ? Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG In a Market With Externalities Assume a negative externality • =) Social marginal cost 6= private marginal cost • =) Social marginal cost = Private marginal cost + external marginal cost What does this mean for the relationship between market equilibrium PMKT and QMKT and socially optimal PSOC and QSOC ? Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG In a Market With Externalities Assume a negative externality • =) Social marginal cost 6= private marginal cost • =) Social marginal cost = Private marginal cost + external marginal cost Assume a positive externality • =) Social marginal benefit 6= private marginal benefit • =) Social marginal benefit = Private marginal benefit + external marginal benefit Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG In a Market With Externalities Assume a negative externality • =) Social marginal cost 6= private marginal cost • =) Social marginal cost = Private marginal cost + external marginal cost Assume a positive externality • =) Social marginal benefit 6= private marginal benefit • =) Social marginal benefit = Private marginal benefit + external marginal benefit What does this mean for the relationship between market equilibrium PMKT and QMKT and socially optimal PSOC and QSOC ? Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG What Does a Negative Externality Do to Market Supply? Where Are the Private Market P and Q? P S = MC D Q Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG What Does a Negative Externality Do to Market Supply? Where is the Social Marginal Cost? P S = MC PMKT D QMKT Q Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG What Does a Negative Externality Do to Market Supply? What are the Socially Optimal P and Q? P S = MC + EMC S = MC PMKT D QMKT Q Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG What Does a Negative Externality Do to Market Supply? What is the Vertical Distance Between the Supply Curves? P S = MC + EMC P SOC S = MC PMKT D QSOC QMKT Q Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG What Does a Negative Externality Do to Market Supply? Where is the Deadweight Loss? P S = MC + EMC P EMC SOC S = MC PMKT D QSOC QMKT Q Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG What Does a Negative Externality Do to Market Supply? Too Much Production, at Too Low a Price P S = MC + EMC DWL P EMC SOC S = MC PMKT D QSOC QMKT Q Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Positive Externalities Where Are Market Equilibrium P and Q? P S D= PMB Q Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Positive Externalities Where is the Social Marginal Benefit Curve? P S PMKT D= PMB QMKT Q Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Positive Externalities What are the Socially Optimal P and Q? P S PMKT D = PMB + EMB D= PMB QMKT Q Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Positive Externalities What is the Vertical Difference Between the Demand Curves? P S PSOC PMKT D = PMB + EMB D= PMB QMKT QSOC Q Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Positive Externalities Where is the Deadweight Loss? P S EMB PSOC PMKT D = PMB + EMB D= PMB QMKT QSOC Q Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Positive Externalities Too Little Production, at Too High a Price P S EMB DWL PSOC PMKT D = PMB + EMB D= PMB QMKT QSOC Q Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Try It Yourself: Negative Externalities Suppose that leather is sold in a perfectly competitive industry. The industry short-run supply curve (marginal cost curve) is P = MC = 3Q, where Q is measured in millions of hides per year. The demand for leather hides is given by Q = 60=7 − P=7. 1. Find the equilibrium market price and quantity. 2. Suppose that the leather tanning releases bad stuff into waterways. The external marginal cost is $4/hide. Calculate the socially optimal level of output and price for the tanning industry. Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG What is the Right Level of Production with Negative Externalities? • Efficient level of production ≡ level of production necessary to produce the efficient quantity of the good tied to the externality • Assume that there is a marginal cost of production (= private cost + external cost) • Assume that there is a marginal benefit of production (= marginal cost of abatement) • What level of production is optimal? Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Optimal Provision of a Good with a Negative Externality Why is POLL∗ 6= 0? Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG Getting to the Socially Optimal P and Q Three methods 1. Change prices 2. Change quantities 3. Tradeable permits Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG 1. Using Taxes and Subsidies to Return to the Efficient Point • Suppose we know the external marginal cost • Charge a tax equal to the external marginal cost • This returns us to the socially optimal equilibrium outcome • Called a Pigouvian tax • Requires that you (the policymaker) know the cost exactly • Can redistribute tax revenues to those harmed by policy After tax, T = EMC • private marginal cost = MC + T • social marginal cost = MC + EMC Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG To Be Clear Before tax • private marginal cost = MC • social marginal cost = MC + EMC Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG To Be Clear Before tax • private marginal cost = MC • social marginal cost = MC + EMC After tax, T = EMC • private marginal cost = MC + T • social marginal cost = MC + EMC Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG 1a. Correcting for a Negative Externality Private and Social Supply Before a Tax P S = MC + EMC P EMC SOC S = MC PMKT D QSOC QMKT Q Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG 1a. Correcting for a Negative Externality After the Tax, Private Supply = Social Supply P S = MC + EMC = MC + T P EMC = T SOC S = MC PMKT D QSOC QMKT Q Admin Externalities Fix Ext. Public Goods Q∗PG Private PG Public PG 1b.