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Public Goods, Goods Public Bads, Bads and Impure mp Public Goods Outline • 1. Public Goods • 2. Two Types of Market Failure with ith Public P bli Goods G ds • 3. Public ubl c Bads • 4. Public Goods and Common Res urces as Undesirable Outputs Resources • 5. Mixed Goods ((Impure mp Public Goods) 1. PUBLIC GOODS Public Goods • Goods that h are non-rivall and non- excludable in consumption p • Private markets generally do not guarantee efficient production. production • Undersupplied pp and underinvestment • Free riding a chronic problem Four Types Of Goods (Reminder) High g High Rivalry y Low Private Goods Collective Goods (Toll Goods) (Social Goods) Common Resources Public Goods E l d bl Excludability Low Public Goods • Effi Efficient i t production d ti of f public bli goods d requires q collective action to overcome the inability of private firms to benefit from privately supplying public goods. • Inefficiencies I ffi i i are the h greatest f for global public g p goods, g , whose benefits are spread most widely across space and time. time Public Goods • Public goods are non non-rival rival in consumption. • The marginal benefit of Q accrues to everyone. n • Marginal g Social Benefit: MSBQ MBi Q n Q qi i1 i 1 • Thus hus max of Total otal Economic Econom c Value implies mpl es n * * MB Q MSC Q i i1 Public Goods P • Market demand public goods • Vertical summation because of non non-rivalry rivalry in consumption (benefits accrue to everyone, non-rivalry in consumption). • Market demand private goods • Horizontal summation because of rivalry in consumption Aggregate A t MSBQ MB Q i Demand i1 n P Individual P Individual Market P Individual 3 Q qi i1 y1 2 y2 Y yi i 1 Public Goods • Market demand private goods • Horizontal summation because of rivalry in consumption • Market demand public goods • Vertical V tic l summation summ ti n because b c us of non-rivalry in consumption P Aggregate gg g Demand MSC n MB Q MSCQ * * i i1 P Individual P Individual P Market Demand Individual 3 Q qi i1 MSC y1 y2 Y Global Public Goods as Stocks • Most global l b l public bl goods d are stock k variables bl that change according to flows. • Their impact depends upon a stock of a capital-like variable that accumulates over time. • For example, flow of ozone accumulates slowly to form stock of ozone. Global Public Goods as Stocks • Technological h l l stock k externalities l with h public goods. p g • Stocks accumulate, often very slowly, • Makes M k it difficult diffi lt to t recognize i the th symptoms y p of the external costs until too late to address. Global Public Goods as Stocks • St Stock k externalities t liti often ft have h longl lasting consequences and are i irreversible ibl or near-irreversible. i ibl • For example, p , once the stock of a species has disappeared, it is gone foreverr as a viable for a biological o og ca system. syst m. Congestion g with Some Environmental Public Goods • Some environmentall public l goods are only y non-rival up p to a point. p • At low levels of demand for ecosystem services non-rivalry. services, non rivalry • As demand g grows, non-rivalry y may y decline and congestion set in. • Raises marginal cost of others. others Congestion MPC MSC MPC, Congestion starts here M Marginal i l Social S i l Cost C t (MSC) Marginal Private Cost (MPC) • Marginal g social cost of consumption p or production exceeds marginal private cost when congestion starts • MSC-MPC = marginal externality • Externality grows with increasing congestion g • Extent of congestion depends on level of demand. Quantity 2. Two Types of Market 2 Failure with Public Goods 1. Supply pp y Function Has External Costs • D Divergence between b private and d sociall costs of provision – Price generally captures only direct use value from private good consumption • The environmental cost or damage is not taken into account. – Foregone public benefits – Indirect use, existence, and option values excluded 1. Supply pp y Function Has External Costs • Agents do not base harvesting h decisions on the marginal g social cost (the ( ‘true’ supply curve), but on private marginal costs. costs – Private good portion only, not public portion • When h uncorrected, d they h will ll supply l too much,, and social marginal g cost lies above marginal benefit. 2. External Benefits and Free Riding • Presence of f externall benefits f leads l to free riding g and private p underprovision p of public good 2 Private Provision of Public Goods 2. • E Example: l Public l goods such h as wilderness,, biodiversity, y, and other environmental amenities will not be supplied privately at socially optimal amount • Free F riding: idi B Because the h provider id cannot capture p the benefits of so doing g – once provided, no one can be excluded 2 Private Provision of Public Goods 2. • Market k failure f l occurs because the h amount of a p public good g is underprovided, and thus marginal social benefits exceed marginal social costs. costs • In this case, more of the (public) good should h ld be b provided, id d b but iit iis forthcoming g only y if society y subsidizes a private supplier, or provides it publicly • Public provision is a collective action issue. 3. P Public bl Bads B d Public Bads • An A undesirable d i bl public bli good. d • Reduces consumer utility y or firm profits p • Examples: – Pollution Pollution, noise noise, biodiversity loss loss, coral reef loss, loss in mortality of protected species – Loss suffered by one person from pollution of air does not reduce loss suffered by another • Public goods are undersupplied • Public P bli b bads ds are oversupplied s li d Public Bads • Excludability E l l • A bad is excludable if it is feasible and practical to selectively allow consumers to avoid consumption of the bad. bad Public Bads • Rivalry • A bad is rival if one person person’ss consumption of a unit of the bad di i ish s th diminishes the amountt off the th b bad d available for others to consume, i.e. there is a negative social opportunity cost to others associated with consumption. • A bad is nonrival otherwise. otherwise Supply pp y and Demand Public Bads • Viewing a bad as a commodity, it has h a negative g price. p • To be willing to consume (i.e. store) a bad consumer must pay a negative price bad, (i.e. receive a positive price -compensation). i ) Supply pp y and Demand for Public Bads Quantity of Bad Consumed 0 • Demand is downward sloping • If price (compensation) is low, consumer is not willing illi tto ttake k much h Demand Price of bad S Supply l Public Bads • T To make k compatible tibl with ith standard t d d model of supply and demand, refashion approach h • Instead of a bad,, think in terms of a bad’s disposal or abatement -- which is a goo good • A consumer of a bad is a consumer of its disposal or abatement or avoidance • Instead of whale mortality, whale mortality t lit abated b t d Supply pp y and Demand for Public Bads Avoided or Abated P i of Price f Bad B d (Whale (Wh l Mortality) M t lit ) Avoided A id d or Ab Abated t d Supply Demand Quantity of Bad (Whale Mortality) Avoided or Abated 4. P 4 Public bli B Bads d and dC Common Resources as Undesirable Joint Jo nt Products roducts Joint Production of Private Good and Public Bad Swordfish Private Good Direct Use Value Longline Fishing Indirect Use Value Sea T tl Turtles Public G d/ Good Bad Existence Value Option Value • P Production d ti P Possibility ibilit F Frontier ti B Between t Two Desirable Outputs • Trade-offs Output of Desirable Output Y1 (Fish Species 1) between Y1 and Y2 • Producing g more of one g good requires producing less of other good Output of Desirable Output Y2 (Fish Species 2) Production Possibility Frontier w. One Private Good and One Public Bad Output • Increased Desirable Output of Private Good (Swordfish) production of good output requires increased production of bad output • Reducing g bad requires q reduced production of good output • Generates a cost of reduced good output • Called weak disposability Undesirable Output or Bad (Sea Turtle Mortality) PPF with Bad-Reducing Technical Change • Reducing Desirable Output of Private Good (Swordfish) bad does not require reduced production of good output • Called strong g disposability p y Undesirable Output or Bad (Sea Turtle Mortality) Mixed Goods Also Called Impure Public Goods Mixed Goods • Environmental Assets as Mixed Goods • Environmental assets which provide both private and public good services ( h (characteristics) t isti s) are called ll d mixed i d goods. ds • Also called impure public goods • Different than joint product of private good and public good/bad, / which has two outputs. outputs Impure Public Goods High g Rivalryy Private Goods High Excludability Low Low Collective Goods (Toll Goods) (Social Goods) IMPURE PUBLIC GOODS Common Resources Public Goods • An individuall commodity appears twice in consumer’s utility y function,, once on its own as a private commodity, and once in combination with the quantities consumed by others, thereby forming a public good or bad. bad Public good services enjoyed by consumer h Private good services enjoyed by consumer h • Consumer’s ’ problem is: • subject to: Public good services enjoyed by other consumers Maxy h ,zhU h y h ,zzh Z h py y h pzzh I h • Where: Income Private good Public good services enjoyed by consumer h Impure Public Good with Whaling Private Good/Uses Renewable Resource Private Benefits IImpure Public Good (Whales) Direct Use Value Indirect Use Value Public Benefits Public G d/U Good/Uses Existence Value Option Value Biodiversity as Mixed Goods • Species provide public good services in the generation of ecological services that in turn are of f value l tto h human society. i t • Species provide private good services of direct economic value in b hh both human consumption and d production. Characteristics of Mixed Goods • Consumption ump of f mixed m good g as private good is unaffected by consumption of same good as public g good • Because of non-rivalrous characteristic when public good Characteristics of Mixed Goods • Whereas consumption p of mixed good as public good is affected by consumption of same mixed good as a private good •B Because of f rivalrous i l nature t of f private i t goods Mixed Goods and Market Failure • Often overexploitation p of the mixed good and underinvestment and under-supply under supply in public good aspect of mixed good • Pareto-inefficient allocation • Free riding • Market only y values private p good g uses Mixed Goods and Market Failure • Negative Externalities or External Costs Price of Private Good Marginal social cost = Private + marginal external cost Social Optimum C POPTIMUM PMARKET D B Total E t External l Cost A Supply pp y (private marginal cost) ABCD = ttotal t l external cost M k t Equilibrium Market E ilib i Demand QOPTIMUM QMARKET Quantity Marginal Social Costs in More Detail • M Marginal i l social i l costs t iinclude: l d • ((i)) the loss in situ ((existence,, viewing) g) value from wildlife, • (ii) the opportunity cost from harvesting the wildlife today rather than waiting for a more opportune time in the future when the specimen(s) may fetch a higher price, price Marginal Social Costs in More Detail • (iii) th the llostt f future t value l of f offspring p g that might g result from leaving the specimen(s) in place, and • (iv) the opportunity cost of the resources employed in the harvest activity. i i High Marginal Social Costs So No Private Good in Optimum Level of Impure Public Good Price P i of f Private Good S’ = Social marginal cost S = Private marginal cost • Social marginal cost of harvesting a species is so high that harvesting is unprofitable. • No N private i t good d (h (harvesting) ti ) iis appropriate. • Only pure public good. Quantity of Private Good Positive Externalities or External Benefits Price of Private Good B A POPTIMUM Social Optimum Total External Benefit PMARKET Supply pp y C D Market Equilibrium QMARKET QOPTIMUM ABCD = T Total t l external benefit Marginal social benefit = Private + marginal external benefit Private Demand = Marginal Private Benefit Quantity of Private Good Social Welfare with Mixed Goods Social Welfare • Sociall welfare lf with h full f ll marginall sociall costs is illustrated in Figure g 2. • Failure to include all costs and benefits leads to suboptimal levels of harvest, harvest hS, that are likely well above those d i db desired by global l b l society, i h*. * • The loss to global society from harvesting hs rather than h* is area deg in Figure 2. 2 Social Welfare • User cost is marginall sociall cost of f using g a renewable resource – With insecure property rights, harvesters ignore this cost and ‘overharvest’ overharvest • Spillover Effects Example – External costs = spillover in following diagram – Private good is harvests of a wild animal on a ranch – Public good is existence value Social Welfare and Optimal Level (= external co bcef = welfare gain w. nonuse benefi f in situ wildlife for ildlif abfg = welfare gain w. secure prope rights Pareto optimum w. secure rights & nonuse benefits for in situ wildlife Suboptimal harvest insecure property & no nonuse benefits for in situ wildli Social Welfare • Compare outcomes relative l to the h suboptimal b l level of harvest hs (and even higher harvests if f harvest h subsidies b d are in place). l ) • If p property p y rights g to wildlife (and habitat) are clearly spelled out and protected by the courts, then the harvest level would fall to h1. • In that case, global benefits would increase by area abfg in n Figure F gure 2.. Social Welfare • If f in addition it is possible l to pay wildlife owners for the nonuse benefits of in situ wildlife, harvest levels would decline further to h*, the globally optimal level of harvest. • In I that h case, global l b l well-being ll b i would ld increase by y an additional amount given g by area bcef in Figure 2. • If f area abfg bf is larger l than h bcef, b f then h the h benefits for wildlife protection of specifying and d protecting property rights h is greater than those from attempting to subsidize “ “owners” ” of f wildlife ldl f for f protecting in situ numbers. • Without appropriate protection of property rights, g transfer payments p y to protect p in situ wildlife cannot even be attempted. Optimal Exploitation of Mixed Goods Optimal p Exploitation p of Mixed Goods Marginal M i lb benefit fit of private good Marginal benefit of public good Q1: Optimal private exploitation level where MBprivate = 0 Marginal benefit of private good exploitation MB < 0 Q1 Increasing private exploitation Increasing public exploitation Optimal p Exploitation p of Mixed Goods Marginal M i lb benefit fit of private good Marginal benefit of public good Marginal benefit of public good exploitation Increasing private exploitation Increasing public exploitation Optimal p Exploitation p of Mixed Goods Marginal benefit of private good Marginal M i lb benefit fit of f public good • Over time,, marginal g benefit of public p good g rises with income and education • Environmental Kuznets curve Increasing private exploitation Increasing public exploitation Optimal p Exploitation p of Mixed Goods Marginal M i lb benefit fit of private good Marginal benefit of public good • Q0: Socially optimal exploitation level where MBprivate = MBpublic • Optimum is example of equimarginal principle • Q1: Optimall private exploitation l level l l where MBprivate = 0 Q0 Increasing private exploitation Q1 Increasing public exploitation Optimal p Exploitation p of Mixed Goods Marginal M i lb benefit fit of private good Marginal benefit of public good • Q2: MB Private > MB Public Insufficient private, excessive public • Q3: MB Private < MB Public Insufficient ff public, bl excessive private • Failure of equimarginal principle Q2 Increasing private exploitation Q3 Increasing public exploitation Optimal p Exploitation p of Mixed Goods with Precautionary Approach Marginal M i lb benefit fit of private good Marginal benefit of public good Q0: Socially optimal exploitation level w/out precaution Q1: Optimal private exploitation level Q2: Socially optimal exploitation level with precaution to allow for uncertainty Precautionary level Q2 Q0 Increasing private exploitation Q1 Increasing public exploitation Optimal Exploitation of Only Public Good Optimum exploitation M Marginal i lb benefit fit is entire public good of private good Marginal benefit of public or common good Marginal benefits of public or common good always exceed (dominates) marginal i lb benefits fits of f private i t good d Q0: Socially optimal exploitation level Q1: Optimal private exploitation level Q0 Increasing private exploitation Q1 Increasing public exploitation