MARKET FAILURES:

Externalities and public goods

 Microeconomics
• Basic Economic concepts
• Suply, Demand and Market equilibrium
• Suply, Demand and Government Policies
• Elasticity
• International trade
• Externality and Public goods
• Production and Cost
• Market structures
Public goods and Common resources
 Look for the answers to these questions:
• What are public goods?
• What are common resources?
Give examples of each.
• Why do markets generally fail to provide the efficient
amounts of these goods?
• How might the government improve market outcomes
in the case of public goods or common resources?
 Introduction

• We consume many goods without paying:

• Parks, national defense, clean air & water
• When goods have no prices, the market forces that normally
allocate resources are absent
• The private market may fail to provide the socially efficient
quantity of such goods
• ‘Governments can sometimes improve market outcomes’

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 The Different Kinds of Goods
• Excludability
• Property of a good whereby a person can be prevented from
using it
• Excludable: fish tacos, wireless Internet access
• Not excludable: radio signals, national defense
• Rivalry in consumption
• Property of a good whereby one person’s use diminishes
other people’s use
• Rival: fish tacos
• Not rival: An MP3 file of Lady Gaga’s latest single
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 The Different Kinds of Goods

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1. A pizza is
a. excludable and nonrival in consumption. 4. The best example of a non-rival good on the
b. nonexcludable and rival in consumption. following list is:
c. excludable and rival in consumption. a. a tuna sandwich provided as part of a school lunch
d. nonexcludable and nonrival in consumption. program.
b. an umbrella mistakenly left in a classroom after a
rainstorm.
2. A cable television broadcast of a movie is
c. a federally funded JOBS program that reduces
a. excludable and rival in consumption. teenaged unemployment.
b. excludable and not rival in consumption. d. a TV weather report that picnickers can use to
c. not excludable and rival in consumption. make weekend plans.
d. not excludable and not rival in consumption.

3. To say that a good is excludable means that: 5. Pure public goods tend to be provided by
a. once a person consumes the good, no one else can the government primarily because:
have access to it. a. user charges boost tax revenues.
b. it is economically feasible to restrict access to this b. quantity buyers are able to negotiate excessive
good and charge a price for it. discounts.
c. it is prohibitively expensive to prevent people from c. "free riders" prevent private markets from
enjoying a good. providing optimal amounts.
d. once the good is provided for the consumption of d. policy makers are intelligent
one person, several others can also enjoy it at zero
cost
6. Under which of the following scenarios would a park be considered a club good?
a. Vistors to the park must pay an admittance fee and frequently all of the picnic tables are in use.
b. Visitors can enter the park free of charge and there are always plenty of empty picnic tables.
c. Visitors to the park must pay an admittance fee, but there are always plenty of empty picnic tables.
d. Visitors can enter the park free of charge, but frequently all of the picnic tables are in use.
7. Under which of the following scenarios would a park be considered a public good?
a. Visitors can enter the park free of charge and there are always plenty of empty picnic tables.
b. Visitors to the park must pay an admittance fee, but there are always plenty of empty picnic tables.
c. Visitors to the park must pay an admittance fee and frequently all of the picnic tables are in use.
d. Visitors can enter the park free of charge, but frequently all of the picnic tables are in use.
8. If a road is congested, then use of that road by an additional person would lead to a
a. negative externality.
b. positive externality.
c. Pigovian externality.
d. free-rider problem with rush hour drivers stuck in traffic.
9. Reggie owns 3 acres of beautiful wooded land. When Reggie decides to move to be closer to his
grandchildren, he donates the land to the state with the understanding that the land will be used as a
state park. This state park is large enough that it is not congested. It is an example of a good that is
a. both rival in consumption and excludable.
b. neither rival in consumption nor excludable.
c. nonrival in consumption and excludable.
d. rival in consumption and nonexcludable.
Congestion Pricing
“In general, using more congestion charges in crowded transportation
networks — such as higher tolls during peak travel times in cities, and
peak fees for airplane takeoff and landing slots — and using the
proceeds to lower other taxes would make citizens on average better off.”

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 The Different Kinds of Goods
• Public goods and common resources
• Externalities arise because something of value has no price attached to it
• Private decisions about consumption and production can lead to an
inefficient outcome
• Public policy can potentially raise economic well-being
• Free rider
• Person who receives the benefit of a good but avoids paying for it
• The free-rider problem
• Public goods are not excludable, so people have an incentive to be free
riders
• Prevents the private market from supplying the goods
• Market failure
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 Public Goods
• Government can remedy the free-rider problem
• If total benefits of a public good exceeds its costs
• Provide the public good
• Pay for it with tax revenue
• Make everyone better off
• Problem: Measuring the benefit is usually difficult

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 Public Goods
• Cost–benefit analysis
• Compare the costs and benefits to society of providing a
public good
• Doesn’t have any price signals to observe
• Government findings: rough approximations at best
• Cost-benefit analyses are imprecise, so the efficient
provision of public goods is more difficult than that of
private goods

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 Public Goods
• National defense
• Very expensive public good
• $748 billion in 2014
• Basic research
• General knowledge
• Subsidized by government
• The public sector fails to pay for the right amount and the right kinds
• Antipoverty programs financed by taxes
• Welfare system: Provides a small income for some poor families
• Food stamps: Subsidize the purchase of food for those with low incomes
• Government housing programs: Make shelter more affordable
 Common Resources
• Common resources are not excludable
• Cannot prevent free riders from using
• Little incentive for firms to provide
• Role for government: seeing that they are provided
• Common resources: rival in consumption
• Each person’s use reduces others’ ability to use
• Role for government: ensuring they are not overused

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 The tragedy of the commons
• Parable that shows why common resources are used more than desirable
• Medieval town where sheep graze on common land
• As the population grows, the number of sheep grows
• The amount of land is fixed, the grass begins to disappear from overgrazing
• Social and private incentives differ
• The private incentives (using the land for free) outweigh the social incentives
(using it carefully)
• Arises because of a negative externality
• Allowing one’s flock to graze on the common land reduces its quality for other
families
• People neglect this external cost, resulting in overuse of the land
Policy options for common resources
• What could the townspeople (or their government) have
done to prevent the tragedy?
• Policy options.
• Impose a corrective tax on the use of the land to “internalize the
externality.”
• Regulate use of the land (the “command-and-control” approach).
• Auction off permits allowing use of the land.
• Divide the land, sell lots to individual families; each family will
have incentive not to overgraze its own land.

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 Policy Options to Prevent
Overconsumption of Common Resources

• Regulate use of the resource

• Impose a corrective tax to internalize the externality
• Hunting & fishing licenses, entrance fees for congested national parks
• Auction off permits allowing use of the resource
• Example: spectrum auctions by the
U.S. Federal Communications Commission
• If the resource is land, convert to a private good
• By dividing and selling parcels to individuals

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 Some important Common Resources

• Clean air and water • Fish, whales, and other wildlife

• Negative externality: pollution • Oceans: the least regulated common
• Regulations or corrective taxes resource
• Needs international cooperation
• Congested roads • Difficult to enforce an agreement
• Negative externality: • Fishing and hunting licenses
congestion • Limits on fishing and hunting
• Corrective tax: charge drivers a seasons
tool • Limits on size of fish
• Tax on gasoline • Limits on quantity of animals killed
 Importance of Property Rights
• Market fails to allocate resources efficiently
• Because property rights are not well established
• Some item of value does not have an owner with the legal authority to
control it
• The government can potentially solve the problem
• Help define property rights and thereby unleash market forces
• Regulate private behavior
• Use tax revenue to supply a good that the market fails to supply

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10. Consider the following problems: 11. Governments can grant private property
overcrowded public highways, rights over resources that were
overfishing in the ocean, polluted air, previously viewed as public, such as fish
and the near-extinction of the wild or elephants. Why would governments
rhinoceros. What do these problems want to do so?
have in common? a. to prevent overuse
a. Private markets could easily solve them if b. to decrease taxes
governments left the markets alone. c. to fight poverty
b. They would all go away if the government d. to increase consumption
sponsored an intensive public-information
campaign. 12. Private decisions about consumption of
c. They are all the result of a failure to common resources and production of
establish clear property rights over public goods usually lead to an
something of value. a. efficient allocation of resources and
d. They are all the result of a failure of external effects.
corrective taxes. b. efficient allocation of resources and no
external effects.
c. inefficient allocation of resources and no
external effects.
d. inefficient allocation of resources and
external effects.
13. Economists think that the best way to determine the 15. Highway engineers want to improve a dangerous
value of a human life is to stretch of highway. They expect that it will reduce the
a. evaluate the value of a person’s expected earnings in risk of someone dying in an accident from 5.3 percent
the labor market. to 2.1 percent over the life of the highway. If a human
b. evaluate the risks people are willing to take and what life is worth $10 million, then the project is worth
they would have to be paid to take them. doing as long as it does not cost more than
c. determine a person’s accumulated wealth at the time a. $53,000.
of death. b. $210,000.
d. do nothing; human life is priceless. c. $320,000.
d. $2.1 million.
14. Suppose that policymakers are doing cost-benefit
analysis on a proposal to add traffic barriers to divide 16. After a recent spike in violent crime, the local police
the flow of traffic in an effort to increase safety on a department wants to spend $550,000 on a new crime
given highway. Which of the following statements is fighting initiative. If a human life is worth $9 million,
correct? the crime fighting initiative is worth the cost if it
a. The benefits are usually easier to measure than the reduces the risk of someone dying from crime by at
costs. least
b. Because human life is priceless, any measure to a. 3.5 percentage points.
increase traffic safety would generate benefits that b. 5.5 percentage points.
outweigh the costs. c. 6.1 percentage points.
c. Estimating the value of a human life is difficult but d. 9.0 percentage points.
necessary to evaluate the proposal.
d. Both a and b are correct.
 Summary
• Goods differ in whether they are excludable and whether they
are rival in consumption.
• A good is excludable if it is possible to prevent someone from
using it.
• A good is rival in consumption if one person’s use of the good
reduces others’ ability to use the same unit of the good.
• Markets work best for private goods, which are both
excludable and rival in consumption.
• Markets do not work as well for other types of goods.
 Summary
• Public goods are neither rival in consumption nor
excludable.
• Examples of public goods include fireworks displays,
national defense, and the discovery of fundamental
knowledge.
• Because people are not charged for their use of the public
good, they have an incentive to free ride, making private
provision of the good untenable.
• Therefore, governments provide public goods, basing their
decision about the quantity of each good on cost–benefit
analysis.
 Summary
• Common resources are rival in consumption but not
excludable.
• Examples include common grazing land, clean air, and
congested roads.
• Because people are not charged for their use of common
resources, they tend to use them excessively.
• Therefore, governments use various methods, such as
regulations and corrective taxes, to limit the use of common
resources.