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When Markets Work
(a) Producers are responsible for all costs & those costs are
reflected in the price of the good or service.
P
S =Marginal Social Cost (MSC)
=Marginal Private Cost (MPC)
The private costs and social
costs are both reflected in the
supply curve
P
Q
D =Marginal Social Benefit (MSB)
=Marginal Private Benefit (MPB)
Q
When Markets Work
(a) Producers are responsible for all costs & those costs are
reflected in the price of the good or service.
(b) Paying customers are the only beneficiaries of the good
or service.
P
S=Marginal Social Cost (MSC)
=Marginal Private Cost (MPC)
The private benefits and social
benefits are both reflected in
the demand curve
P
Q
D =Marginal Social Benefit (MSB)
=Marginal Private Benefit (MPB)
Q
When Markets Don’t Work
Market Failure
Externalities
When someone other than
the buyer and seller receives
a cost or benefit for which
they didn’t ask/pay
When Markets Don’t Work
Market Failure
Externalities
AKA
Costs/Benefits
Negative Externality (or spillover)
Example:
Factory pollution
contaminating
water supply
The firm is passing
on – externalizingthe cost to villagers
Negative Externality
Example: Factory Pollution
Marginal Social Cost (MSC)
P
Marginal Private Cost (MPC)
MSC > MPC
Psocial
There is an
OVERALLOCATION
(making too much) of the
good at too low a price
Pmarket
Qso Qm
D =Marginal Social Benefit (MSB)
=Marginal Private Benefit (MPB)
Q
Negative Externality
Why is this bad?
Deadweight loss
MSC
P
MPC
TO FIND THE AREA OF
THE DEADWEIGHT LOSS
FOLLOW THE MARKET Q
UP TO THE MSC CURVE.
IT’S THE AREA BETWEEN
MSC, MSB AND QMARKET
Pso
Pm
MSB
Qso Qm
Q
Negative Externality
Why is this bad?
Deadweight loss
Why does this happen?
MSC
P
MPC
TO FIND THE AREA OF
THE DEADWEIGHT LOSS
FOLLOW THE MARKET Q
UP TO THE MSC CURVE.
IT’S THE AREA BETWEEN
MSC, MSB AND QMARKET
Pso
Pm
MSB
Qso Qm
Q
Where there is no clear ownership
of rights to a natural resource,
the users of the resource are
likely to overexploit it.
Drilling for Oil
http://www.petroleum.co.uk/geograph/page4.htm
Pump as much oil as fast as you can to get the
oil before someone else does--
Private Bathroom in Doctor’s office
Access is restricted
Clean, decorated, well stocked
Public High School Bathroom
Negative Externality
Possible Solutions:
Property Rights: establishing ownership can
provide motivation to include external costs into
the price
The herds
get smaller.
http://ens.lycos.com/ens/oct2000/2000L-10-16-15.html
The hunters shoot
the buffalo.
http://www.fayettevilleobserver.com/news/archives/1998/tx98a
You better quick and hunt them before someone
beats you to the punch.
Did barb wire help
or hurt the buffalo
population?
Barb wire saved the buffalo by establishing
property rights at a relatively low cost. Prior to
barb wire, it was too expensive to establish property
rights.
Negative Externality
Possible Solutions:
Property Rights: establishing ownership can
provide motivation to include external costs into
the price
Ronald H. Coase
Coase Theorem: as long as
transaction costs are low, it
doesn’t matter which party has
property rights, they will
negotiate a solution to the
externality without the need for
gov’t intervention.
But, this often isn’t a plausible option
Property rights of smoking have changed over
the years.
It used to be,
“Would you like
a smoke”?
Then it became,
“Do you mind if I smoke”?
Then it became, “Thank
you for not smoking.”
Finally, an outright
ban on smoking.
Negative Externality
Possible Solutions:
Government intervention:
1. Tax – could pay for fixing extra cost
– or at least decrease Q
2. Q Restriction – establish a law to
force correction
3. Price Control – establish an effective
price floor
4. Permits – i.e.. pollution permits that
can be bought and sold
among polluters
Pass out Negative Externalities
Homework
Pass Out
& do example together
& do example together
ABC Plastics is polluting the ground water surrounding
it’s factory. The Gov’t decides to tax their product and use
the $ to treat the area. Graph the externality including the
tax.
1. Start with a base S/D
graph, except
P
MPC
- label supply MPC and
demand MSB
- Label P&Q - Pm & Qm
Pm
MSB
Qm
Q
ABC Plastics is polluting the ground water surrounding
it’s factory. The Gov’t decides to tax their product and use
the $ to treat the area. Graph the externality including the
tax.
2. Add the externality
- Add in the social cost
(MSC) line
MSC
P
MPC
Pso
- Draw social
Pm
equilibrium lines and
labels Pso & Qso
- Add arrow to show
direction of change in
cost lines, P’s and Q’s
MSB
Qso Qm
Q
ABC Plastics is polluting the ground water surrounding
it’s factory. The Gov’t decides to tax their product and use
the $ to treat the area. Graph the externality including the
tax.
You have drawn the
Externality, now add
the tax
4. Shade in the area of
the tax and label it
You can either write it
inside the shaded area
or outside with an
arrow
MSC
P
MPC
Pso
Pm
MSB
Qso Qm
Q
Positive
WhenExternality
Market
MarketsFailure
Don’t
(or spillover)
Work
Example:
Getting a vaccine for
a contagious disease
The rest of the population
benefits from the protect,
but doesn’t pay for it.
Positive Externality
Example: Vaccinations
P
Marginal Social Cost (MSC)
There is an
UNDERALLOCATION
(making too little) of the
good at too high a price
MSB > MPB
Psocial
Pmarket
Marginal Social Benefit (MSB)
Marginal Private Benefit (MPB)
Qm Qso
Q
Positive Externality
Why is this bad?
Deadweight loss
P
MSC
Pso
Pm
TO FIND THE AREA OF
THE DEADWEIGHT LOSS
FOLLOW THE MARKET Q
UP TO THE MSC CURVE.
IT’S THE AREA BETWEEN
MSC, MSB AND QMARKET
MSB
MPB
Qm Qso
Q
Positive Externality
Why is this bad?
Deadweight loss
Why does this happen?
P
MSC
Pso
Pm
TO FIND THE AREA OF
THE DEADWEIGHT LOSS
FOLLOW THE MARKET Q
UP TO THE MSC CURVE.
IT’S THE AREA BETWEEN
MSC, MSB AND QMARKET
MSB
MPB
Qm Qso
Q
When the accessible and desirable
nature of public goods inclines
people to use these goods,
sometimes without paying for the
privilege
Public vs. Private Goods
Private goods
1. Exclusionary – owner can exclude those who
don’t pay for it
2. Rival – consuming it prevents others
from doing the same
Example: Can of soda
Public vs. Private Goods
Public goods
1. Non-exclusionary – owner cannot exclude
those who don’t pay for it
2. Nonrival – consuming it doesn’t prevent others
from doing the same
Public vs. Private Goods
Public goods
Examples:
Lighthouses
All the captains use it to keep
from crashing, but they don’t
pay for it and there isn’t a
good way to make them
Public vs. Private Goods
Public goods
Examples:
Street Light Systems
Anyone walking by benefits
from the light, but does not
have to pay for the benefit
Public vs. Private Goods
Public goods
The market will not provide optimum amounts of
these good, or provide them at all because there is
no way to make a profit from them.
The production of public goods results in positive
externalities which are not paid for, so there is less
incentive to produce it.
In a family of four, there are two cops and two
robbers. Who are the “free” riders and why?
What’s Wrong with this picture?
It wouldn’t work because Sunsets are a
non-excludable good, in that non-payers
can't be prevented from enjoying them.
Positive Externality
Possible Solutions:
1. Government Production: have the gov’t
produce the good using tax dollars
Examples:
National Defense
Interstate Highway
System
Why do governments pay for mosquito spraying
of neighborhoods? Why isn’t this privatized?
Positive Externality
Possible Solutions:
1. Government Production: have the gov’t
produce the good using tax dollars
2. Subsidy: to either producer or consumer
of the product
3. Legal Mandate: legally require
consumption or production of the good
Positive Externality
Possible Solutions:
Example: Education – all 3 are used
The more education a
person has, the less likely
they are commit crimes &
the more likely they are
to solve problems, help
people….contribute to
society
Positive Externality
Possible Solutions:
Example: Education – all 3 are used
Education produces a
positive externality
It is under produced or
underallocated at too
high a price
Positive Externality
Possible Solutions:
Example: Education – all 3 are used
1. The gov’t produces it
(public schools)
2. They subsidize consumers
(low cost student loans &
scholarships)
They subsidize producers
(fed grants)
3. Require it 5-18yrs olds
Pass out Negative Externalities
Homework
Pass Out
& do example together
& do example together
The government decides to subsidize consumers for
tuberculosis vaccinations by issuing discount coupons to
parents of school children. Graph the externality including
the subsidy.
1. Start with a base S/D
graph, except
P
MSC
- label supply MSC and
demand MPB
- Label P&Q - Pm & Qm
Pm
MPB
Qm
Q
The government decides to subsidize consumers for
tuberculosis vaccinations by issuing discount coupons to
parents of school children. Graph the externality including
the subsidy.
2. Add the externality
- Add in the social
benefit (MSB) line
P
MSC
Pso
- Draw social
Pm
equilibrium lines and
labels Pso & Qso
- Add arrow to show
direction of change in
lines, P’s and Q’s
MSB
Qm Qso
Q
The government decides to subsidize consumers for
tuberculosis vaccinations by issuing discount coupons to
parents of school children. Graph the externality including
the subsidy.
P
You have drawn the
Externality, now add
the subsidy
Pso
4. Shade in the area of
the subsidy and label it
You can either write it
inside the shaded area
or outside with an
arrow
MSC
Pm
MSB
Qm Qso
Q