Week_11.MarketFailures-ExternalitiesandPublicGoods.2010

Week_11.MarketFailures-ExternalitiesandPublicGoods.2010 -...

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Week 11 – ECMA04 Answers to midterm test on the Intranet (full answers) What about preparations for the final exam? Final exam is Thursday, December 9 th (9 a.m. – 12 noon) 1
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Externalities and Public Goods When markets work well, they work very well… Competitive markets (usually) allocate resources to deliver maximum Gain to Society! 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) 2
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- 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) - In all these cases, markets deliver an inefficient allocation of resources , 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” 3
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individuals. However this is an equity rather than an efficiency issue 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 - raising bees - raising well-behaved children ready for school Negative: - pollution (e.g., greenhouse gas emissions) - second-hand smoke 4
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- noisy activities 5
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Problem: When there are external effects (i.e., positive and negative 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. 6
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A first look at the problem: 7 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 (margina l external cost)
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8 Market for Gasoline (MPC + MEC = MSC)
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9 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 (margina l external cost)
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10 Market for Gasoline (MPC + MEC = MSC)
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On these graphs: What is the gross benefit of producing Q*? What is the gross cost of producing Q*? What is the net benefit (GTS) of producing Q*?
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This note was uploaded on 08/17/2011 for the course ECON A04 taught by Professor Mk during the Fall '07 term at University of Toronto- Toronto.

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Week_11.MarketFailures-ExternalitiesandPublicGoods.2010 -...

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