P

Q

S =Marginal Social Cost (MSC) =Marginal Private Cost (MPC)

D =Marginal Social Benefit (MSB) =Marginal Private Benefit (MPB)

P

Q

When Markets Work(a) Producers are responsible for all costs & those costs are reflected in the price of the good or service.

The private costs and social costs are both reflected in the

supply curve

P

Q

S=Marginal Social Cost (MSC) =Marginal Private Cost (MPC)

D =Marginal Social Benefit (MSB) =Marginal Private Benefit (MPB)

P

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.

The private benefits and social benefits are both reflected in

the demand curve

When Markets Don’t Work

Market FailureExternalities

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 FailureExternalities

AKA

or Third Party Spillover

Costs/Benefits

Negative Externality (or spillover)

Example:

Factory pollution contaminating water supply

The firm is passing on – externalizing- the cost to villagers

Negative Externality

Example: Factory Pollution

P

Q

Marginal Private Cost (MPC)

D =Marginal Social Benefit (MSB) =Marginal Private Benefit (MPB)

Pmarket

Qm

Marginal Social Cost (MSC)

Psocial

Qso

MSC > MPC

There is an OVERALLOCATION (making too much) of the good at too low a price

Negative Externality

Why is this bad?

P

Q

MPC

MSB

Pm

Qm

Pso

Qso

MSC

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

Deadweight loss

Negative Externality

P

Q

MPC

MSB

Pm

Qm

Pso

Qso

MSC

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

Deadweight lossWhy is this bad?Why does this happen?

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 theoil before someone else does--

Private Bathroom in Doctor’s office

Access is restricted

Clean, decorated, well stocked

Public High School Bathroom

Possible Solutions:

Negative Externality

Property Rights: establishing ownership can provide motivation to include external costs into the price

http://ens.lycos.com/ens/oct2000/2000L-10-16-15.html

http://www.fayettevilleobserver.com/news/archives/1998/tx98aug/n19buff.htm

You better quick and hunt them before someonebeats you to the punch.

The hunters shootthe buffalo.

The herdsget smaller.

Barb wire saved the buffalo by establishingproperty rights at a relatively low cost. Prior tobarb wire, it was too expensive to establish propertyrights.

Did barb wire helpor hurt the buffalopopulation?

Possible Solutions:

Negative Externality

Property Rights: establishing ownership can provide motivation to include external costs into the price

But, this often isn’t a plausible option

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.

Ronald H. Coase

It used to be,“Would you likea smoke”?

Then it became, “Do you mind if I smoke”?

Property rights of smoking have changed over the years.

Then it became, “Thank you for not smoking.”

Finally, an outright ban on smoking.

Negative Externality

Government intervention:1. Tax – could pay for fixing extra cost

– or at least decrease Q2. Q Restriction – establish a law to

force correction3. Price Control – establish an effective

price floor4. Permits – i.e.. pollution permits that

can be bought and sold among polluters

Possible Solutions:

Pass out Negative Externalities Homework

& do example together

Pass Out

& do example together

P

Q

MPC

MSB

Pm

Qm

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

- label supply MPC and demand MSB

- Label P&Q - Pm & Qm

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 externalityP

Q

MPC

MSB

Pm

Qm

Pso

Qso

- Draw social equilibrium lines and labels Pso & Qso

- Add arrow to show direction of change in cost lines, P’s and Q’s

MSC

- Add in the social cost (MSC) line

P

Q

MPC

MSB

Pm

Qm

Pso

Qso

MSC

TAX

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

When Markets Don’t WorkMarket FailurePositive Externality (or spillover)

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

There is an UNDERALLOCATION (making too little) of the good at too high a price

Qm

P

Q

Marginal Social Cost (MSC)

Marginal Private Benefit (MPB)

Pmarket

MSB > MPBMarginal Social Benefit (MSB)

Qso

Psocial

Positive Externality

Why is this bad? Deadweight loss

Qm

P

Q

MSC

MPB

MSB

Qso

Pm

Pso

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

Positive Externality

Why is this bad? Deadweight loss

Qm

P

Q

MSC

MPB

MSB

Qso

Pm

Pso

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

Why does this happen?

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 goods1. 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

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

Public vs. Private Goods

Public goodsExamples:

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

Anyone walking by benefits from the light, but does not have to pay for the benefit

Street Light Systems

Examples:

Public vs. Private Goods

Public goodsThe 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 tworobbers. 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. 

Possible Solutions:

Positive Externality

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 sprayingof neighborhoods? Why isn’t this privatized?

Possible Solutions:

Positive Externality

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

Possible Solutions:

Positive Externality

Example:

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

Education – all 3 are used

Possible Solutions:

Positive Externality

Education produces a positive externality

It is under produced or underallocated at too high a price

Example: Education – all 3 are used

Possible Solutions:

Positive Externality

Example: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

Education – all 3 are used

Pass out Negative Externalities Homework

& do example together

Pass Out

& do example together

P

Q

MSC

MPB

Pm

Qm

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

- label supply MSC and demand MPB

- Label P&Q - Pm & Qm

2. Add the externality

Qm

P

Q

MSC - Add in the social

benefit (MSB) line

MSB

Pm- Draw social

equilibrium lines and labels Pso & Qso

Qso

Pso

- Add arrow to show direction of change in lines, P’s and Q’s

The government decides to subsidize consumers for tuberculosis vaccinations by issuing discount coupons to parents of school children. Graph the externality including the subsidy.

Qm

P

Q

MSC

MSB

Pm

Qso

Pso

You have drawn the Externality, now add the subsidy

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

SUBSID

Y

The government decides to subsidize consumers for tuberculosis vaccinations by issuing discount coupons to parents of school children. Graph the externality including the subsidy.