ECS1010.09.post

ECS1010.09.post - UNIT IV: GAMES & INFORMATION 7/27...

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UNIT IV: GAMES & INFORMATION Decision under Uncertainty Externalities and Public Goods Review FINAL: Aug 3 7/27
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Markets Imperfections Externalities Remedies Property Rights Coase Theorem Common Resource Problems Public Goods Asymmetric Info (Uncertainty) Adverse Selection Moral Hazard
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Externalities Externalities are the effects of consumption and production that are not accounted for in the market (e.g., steel industry creating air pollution). When externalities are present, the price of a good may not reflect its true social cost. As a result, firms may produce too much (or too little) and the market outcome may be inefficient. Remedies include government regulations, taxes, legal recourse, and bargaining among those affected., and bargaining among those affected.
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Externalities Consider a farmer and a rancher that produce on neighboring land. The rancher’s cattle stray onto the farmer’s land, causing damage to his crops. Number in Herd Annual Crop Loss Crop Loss per Add/l (Steer) (Tons) Steer (Tons) 1 1 1 2 3 2 3 6 3 4 10 4
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Externalities Consider a farmer and a rancher that produce on neighboring land. The rancher’s cattle stray onto the farmer’s land, causing damage to his crops. Should the rancher be prohibited from grazing his cows to prevent damage to the farmer’s crops? Coase noted that while this prohibition would remove the cost to the farmer, it would also impose a cost on the rancher (and on society). He called this the reciprocal nature of the externality.
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Externalities We know that in a market equilibrium, both consumers (MRS = Px/Py) and firms (MR = MC) are optimizing, and we used these conditions to derive Demand and Supply curves. that burning gasoline causes pollution which is harmful to peoples health, and that this harm is measured to be $1 for each gallon gasoline burned. What is the optimal level of gasoline consumption, taking this externality into account? P P* Q* Q Q D = MSB Q S = MSC The supply curve accounts for the total social cost of production; the demand curve
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Externalities In the presence of a negative production externality (e.g. pollution), the marginal social cost (MSC) is higher than the marginal cost of production (MC). MSC PP = 4 - 1/3Q D MSB = (4 - 1/3Q D ) - 1 Suppose that burning gasoline causes pollution which is harmful to peoples health, and that this harm is measured to be $1 for each gallon gasoline burned. What is the optimal level of gasoline consumption, taking this externality into account? P P 1 Q* Q 1 Q Q D = MSB Q S = MC MSC The industry’s competitive output (Q 1 ) is greater than the efficient output (Q*), where MSC = MSB. Price does not reflect the externality.
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Remedies There are several ways to remedy, or internalize an externality : MSC PP = 4 - 1/3Q D MSB = (4 - 1/3Q D ) - 1 Suppose that burning gasoline causes pollution which is harmful to peoples health, and that this harm is measured to be $1 for each gallon gasoline burned. What
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ECS1010.09.post - UNIT IV: GAMES & INFORMATION 7/27...

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