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Week+11.MarketFailures-ExternalitiesandPublicGoods.2009

Week+11.MarketFailures-ExternalitiesandPublicGoods.2009 -...

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1 Week 11 – ECMA04 Externalities and Public Goods When markets work well, they work very well… Competitive markets (usually) allocate resources to deliver maximum Gain to Society! At competitive equilibrium, P = MC or the marginal benefit of additional output = marginal cost of additional output
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2 But markets sometimes do not work well (i.e., markets fail)… - when there is only a small number of producers (oligopoly) or only one producer (monopoly), - when a good (or service) has substantial external costs (external costs are ones that producers ignore in their decisions to produce – e.g., pollution) - when a good (or service) has substantial external benefits (external benefits are ones that consumers ignore in their decisions to consume – e.g., education) - when a good is a public good: i.e., it is collectively consumed, and consumers cannot be “excluded” from consuming the good (or service)
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3 - In all these cases, markets fail to work well, so governments may need to correct what markets would naturally do! - Side note: Another form of “failure” that governments address is income distribution: governments redistribute income from rich to poor, or provide services for “needy” individuals. However this is an equity rather than an efficiency issue
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4 Positive and Negative Externalities (also called external benefits and external costs) Goods or services that affect others (not just the direct consumer and producer) Positive: - education - beautiful garden - raising bees - raising well-educated children Negative: - pollution (e.g., greenhouse gas emissions) - second-hand smoke - noisy activities
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5 Problem: When there are external effects (i.e., externalities), markets do not receive the right signals about all the benefits and all the costs, and therefore make the wrong decisions. Consumers and producers do not face the correct incentives. They will consume and/or produce too much or too little of the good. When small numbers of people are affected, private negotiations can solve the problem. When large numbers of people are affected, this is a form of market failure.
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A first look at the problem: MSC (marginal social cost) Demand for $ per unit of abatement Q opt (optimum quantity) Q* (market quantity) MC (marginal private cost) – Supply Curve 0 Price ($/Q) Quantity (tons/year) MEC (marginal external cost) Market for Gasoline (MPC + MEC = MSC)
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7 However, this approach assumes production and pollution are inseparably linked. Better to develop a model that focuses on pollution reduction (abatement) itself. First, some background about GHG’s as an introduction to discussing the Marginal Cost of Abatement and the Marginal Benefit of Abatement.
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8 Greenhouse Gas Emissions (GHG emissions) - the earth’s surface temperature has risen by a little less than one degree Celsius in the 20 th century. Mostly (3/4) due to increased burning of fossil fuels. Also deforestation and agricultural practices.
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