Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
30
C HAPTE R
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
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End
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Government
And
Market Failure
Copyright McGraw-Hill/Irwin, 2005
PUBLIC GOODS
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Rivalry & Excludability
(Chapter 5)
Private Goods
Divisibility
Demand Curve is Horizontal Summation
Public Goods
Key Terms
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End
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Indivisibility
Copyright McGraw-Hill/Irwin, 2005
DEMAND FOR A PUBLIC GOOD
Problems of Revealing Preferences
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Quantity
1
Adams’
Willingness
to pay (price)
Exclusion Principle
does not apply
Key Terms
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End
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30 - 3
Benson’s
Collective
Willingness Willingness
to pay (price) to pay (price)
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
DEMAND FOR A PUBLIC GOOD
Problems of Revealing Preferences
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Quantity
Adams’
Willingness
to pay (price)
1
$4
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
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End
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Copyright McGraw-Hill/Irwin, 2005
Benson’s
Collective
Willingness Willingness
to pay (price) to pay (price)
+ $5
= $9
DEMAND FOR A PUBLIC GOOD
Problems of Revealing Preferences
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Quantity
Adams’
Willingness
to pay (price)
1
2
$4
3
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
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End
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Copyright McGraw-Hill/Irwin, 2005
Benson’s
Collective
Willingness Willingness
to pay (price) to pay (price)
+ $5
+ 4
= $9
= 7
DEMAND FOR A PUBLIC GOOD
Problems of Revealing Preferences
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Quantity
Adams’
Willingness
to pay (price)
1
2
3
$4
3
2
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
Previous
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End
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30 - 6
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Copyright McGraw-Hill/Irwin, 2005
Benson’s
Collective
Willingness Willingness
to pay (price) to pay (price)
+ $5
+ 4
+ 3
= $9
= 7
= 5
DEMAND FOR A PUBLIC GOOD
Problems of Revealing Preferences
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Quantity
Adams’
Willingness
to pay (price)
1
2
3
4
$4
3
2
1
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
Previous
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End
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30 - 7
Next
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Copyright McGraw-Hill/Irwin, 2005
Benson’s
Collective
Willingness Willingness
to pay (price) to pay (price)
+ $5
+ 4
+ 3
+ 2
= $9
= 7
= 5
= 3
DEMAND FOR A PUBLIC GOOD
Problems of Revealing Preferences
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Quantity
Adams’
Willingness
to pay (price)
1
2
3
4
5
$4
3
2
1
0
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
Previous
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End
Show
30 - 8
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
Benson’s
Collective
Willingness Willingness
to pay (price) to pay (price)
+ $5
+ 4
+ 3
+ 2
+ 1
= $9
= 7
= 5
= 3
= 1
OPTIMAL AMOUNT OF A PUBLIC GOOD
P
Public Goods
Demand for a Public
Good
$9
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
7
5
Adams’
willingness
to pay
Society’s Optimal
Amount of Externality
Reduction
3
Recycling
Key Terms
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End
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1
D1
0
1
Copyright McGraw-Hill/Irwin, 2005
2
3
4
5
Q
OPTIMAL AMOUNT OF A PUBLIC GOOD
P
Public Goods
Demand for a Public
Good
$9
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Benson’s
willingness
to pay
7
5
Society’s Optimal
Amount of Externality
Reduction
3
Recycling
Key Terms
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End
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30 - 10
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D2
D1
1
0
1
Copyright McGraw-Hill/Irwin, 2005
2
3
4
5
Q
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
OPTIMAL AMOUNT OF A PUBLIC GOOD
P
When vertically
$9
added equals
collective
7
willingness
to pay
5
Society’s Optimal
Amount of Externality
Reduction
3
Recycling
Key Terms
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End
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D2
D1
1
0
1
Copyright McGraw-Hill/Irwin, 2005
2
3
4
DC
5
Q
OPTIMAL AMOUNT OF A PUBLIC GOOD
P
Public Goods
Demand for a Public
Good
$9
S
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
7
The public good’s
marginal cost
as shown by S
5
Society’s Optimal
Amount of Externality
Reduction
3
Recycling
Key Terms
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End
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DC
1
0
1
Copyright McGraw-Hill/Irwin, 2005
2
3
4
5
Q
OPTIMAL AMOUNT OF A PUBLIC GOOD
P
Public Goods
Demand for a Public
Good
$9
S
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Yields the
optimum amount
of the public good
7
5
Society’s Optimal
Amount of Externality
Reduction
MB = MC
3
Recycling
Key Terms
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End
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DC
1
0
1
Copyright McGraw-Hill/Irwin, 2005
2
3
4
5
Q
COST-BENEFIT ANALYSIS
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Marginal Cost = Marginal Benefit Rule
Externalities
Spillover Costs
Overallocation
Recycling
Key Terms
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End
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Spillover Benefits
Underallocation
Copyright McGraw-Hill/Irwin, 2005
SPILLOVER COSTS AND BENEFITS
P
Public Goods
Demand for a Public
Good
St
Spillover
costs
Optimal Amount of a
Public Good
S
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
Previous
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End
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30 - 15
Overallocation
Next
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0
Copyright McGraw-Hill/Irwin, 2005
Q0
Qe
D
Q
SPILLOVER COSTS AND BENEFITS
P
St
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Spillover
Benefits
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Dt
Recycling
Key Terms
Previous
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End
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30 - 16
Underallocation
Next
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0
Copyright McGraw-Hill/Irwin, 2005
Qe
Q0
D
Q
SPILLOVER COSTS AND BENEFITS
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
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End
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Individual Bargaining –
Coase Theorem
Liability Rules and
Lawsuits
Government Intervention
Direct Controls
Specific Taxes
Subsidies and
Government Provision
Copyright McGraw-Hill/Irwin, 2005
CORRECTING SPILLOVER COSTS
P
Public Goods
Demand for a Public
Good
St
Spillover
costs
Optimal Amount of a
Public Good
S
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
Previous
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End
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30 - 18
TAX
Overallocation
Corrected
Next
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0
Copyright McGraw-Hill/Irwin, 2005
Q0
Qe
D
Q
CORRECTING SPILLOVER BENFITS
P
Public Goods
Demand for a Public
Good
S
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Spillover
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Dt
Recycling
Key Terms
D
Underallocation
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End
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30 - 19
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0
Copyright McGraw-Hill/Irwin, 2005
Qe
Q0
Q
CORRECTING SPILLOVER BENFITS
P Correcting by Subsidy to Consumers
Public Goods
Demand for a Public
Good
S
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Subsidy to
consumer
increases
demand
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Dt
Recycling
Key Terms
Previous
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End
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30 - 20
D
Underallocation
Corrected
Next
Slide
0
Copyright McGraw-Hill/Irwin, 2005
Qe
Q0
Q
CORRECTING SPILLOVER BENFITS
Public Goods
Demand for a Public
Good
P Correcting by Subsidy to Producers
St
Subsidy to
producers
increases
supply
Optimal Amount of a
Public Good
Cost-Benefit Analysis
S’t
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
Previous
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End
Show
30 - 21
Underallocation
Corrected
Next
Slide
0
Copyright McGraw-Hill/Irwin, 2005
Qe
Q0
D
Q
Demand for a Public
Good
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
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End
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Price per pollution right
Public Goods
A MARKET-BASED APPROACH
TO SPILLOVER COSTS
The Tragedy of the Commons
A Market for Externality Rights
•Operation of the Market
•Advantages
S = Supply of
pollution
rights
D 2004
$200
$100
D 2012
500
750
1000
Quantity of pollution rights
Copyright McGraw-Hill/Irwin, 2005
SOCIETY’S OPTIMAL AMOUNT
OF EXTERNALITY REDUCTION
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
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End
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30 - 23
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Application of MC = MB
Rule
MC, MB Equilibrium
Optimal Reduction of an
Externality
Shifts in the Curves
Graphically…
Copyright McGraw-Hill/Irwin, 2005
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
Previous
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End
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30 - 24
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Society’s marginal benefit and marginal
cost of pollution abatement
SOCIETY’S OPTIMAL AMOUNT
OF EXTERNALITY REDUCTION
MC
Socially optimum
amount of
pollution
abatement
MB
0
Q1
Amount of pollution abatement
Copyright McGraw-Hill/Irwin, 2005
RECYCLING
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
Previous
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End
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30 - 25
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Market for Recyclable
Inputs
Policy
•Demand Incentives
•Supply Incentives
Global Warming
Theory
Copyright McGraw-Hill/Irwin, 2005
RECYCLING
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
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End
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Information Failures
Asymmetric Information
Inadequate information …
about sellers
about buyers
Moral Hazard Problem
Adverse Selection Problem
•Workplace Safety
Copyright McGraw-Hill/Irwin, 2005
cost-benefit analysis
marginal-cost – marginal-benefit rule
externalities
Coase theorem
tragedy of the commons
market for externality rights
optimal reduction of an externality
asymmetric information
moral hazard problem
adverse selection problem
Copyright McGraw-Hill/Irwin, 2005
BACK
END
Public Goods
Demand for a Public
Good
Optimal Amount of a
Public Good
Cost-Benefit Analysis
Spillover Costs and
Benefits
Market-Based
Approach to Spillover
Rights
Society’s Optimal
Amount of Externality
Reduction
Recycling
Key Terms
Previous
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End
Show
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Public Choice Theory
And
The Economics of Taxation
Chapter 31
Copyright McGraw-Hill/Irwin, 2005