Econ 206(A) Tutorial 8

Externalities & Public Goods

Seminar Topic 1

1. Is the market always the most efficient solution to the problem of resource allocation?

Externalities

• Defn: indirect products of production or consumption (can be positive or negative)

• In the presence of externalities, the market mechanism does not produce the optimum level of production.

• In this case we have `market failure’ (social optimum does not equal private optimum)

Seminar Topic 2

• What is meant by social opportunity cost? Provide examples.

Negative Externalities

• Social Cost incorporates private opportunity cost (given by market supply) and social opportunity cost.

• Production externalities affect supply.

• Social cost > private cost when there are negative externalities.

• The market produces too much of a good/service.

Negative Externalities in Production

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Price, Price, pp

Quantity, Quantity, qq

MPC = SMPC = S

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MPB = DMPB = D

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Positive Externalities - Production

• Social cost < private cost when there are positive production externalities.

• For instance: production of the good by one firm reduces the cost of production of other firms.

• The market produces too little of a good/service.

• An example is general training provided by firms.

Externalities in Production: Benefits

00

Price, Price, pp

Quantity, Quantity, qq

MPC = SMPC = S

MSCMSC

MPB = DMPB = D

pp11

p*p*

q*q*qq11

E*E*

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Externalities in Consumption

• Negative: Social benefit < Private Benefit when there are negative consumption externalities.

• i.e. another individuals consumption of a good, reduces others benefit.

• For instance; negative effects of car travel on others consumption (pollution, increased congestion).

• Too much is consumed in the market

Externalities in Consumption: Costs

00

Price, Price, pp

Quantity, Quantity, qq

MSBMSBMPB = DMPB = D

p*p*

q*q* qq11

E*E* EE11 s

Externalities in Consumption

• Positive: Private Benefit < Social Benefit when there are positive consumption externalities.

• i.e. another individuals consumption of a good increases others benefit.

• For instance; increased use of public transport reduces traffic congestion and increases others benefit from less congestion, pollution etc.

• • Too little is consumed in the market (from society’s

point of view)

Externalities in Consumption: Benefits

00

Price, Price, pp

Quantity, Quantity, qq

MSBMSB

MPB = DMPB = D

p*p*

q*q*qq11

E*E*EE11 s

Market Failure

• Where the market produces a sub-optimal level of production (either too little or too much).

• This occurs because producers and consumers do not consider the full `social’ costs (or benefits) of production/consumption when making economic decisions.

Seminar Topic 3

• Should students contribute to the cost of their university education?

Private vs Public Goods

Public goods have the following features:• They are non-rival (consumption of the

good/service by one individual does not reduces its value to others)

• They are non-excludable. You cannot prevent someone from consuming the good/service.

Public goods

• Many non-rival goods have high external benefits but low individual private benefit.

• This means individuals would not provide the good as the private costs far exceed the private benefits (think infrastructure, roads, street lights, telephone lines).

• Non-excludable goods have a `free rider’ problem. Why pay for something that you can use for free?