4 - Externalities and Public Goods Flashcards
What is an externality?
whenever the utility of a consumer or the production possibility of a firm are directly affected by the actions of another agent
How can you best analyze externalities in the economy?
- Partial Equilibrium analysis with three components: consumption good, numeraire, externality
What is the consumer’s indirect utility function (incl. externality in partial equilibrium analysis)?
vᵢ (p, ωᵢ, hᵢ) = max{xᵢ, mᵢ} mᵢ + Φᵢ(xᵢ, h)
s.t. mᵢ + p xᵢ =< ωᵢ
What are ways to deal with externalities?
- government intervention (quota, taxes)
- bargaining & property rights
What is a public good?
a commodity for which consumption by one agent does not preclude consumption by another agent
-> non depletable, non exclusion
What is the set-up for modeling public goods?
- partial equilibrium perspective
- quasi-linear utilites
- public good is q (utility is Φᵢ(q), costs c(q), pareto optimality max. total utility - total costs)
What happens when public goods are privately provided?
- underprovision of public good (q* < q°)
- free rider problem
What are depletable externalities and how do they affect consumers?
externality is depletable when the experience of the externality by one agent reduces the externality for others
-> consumers share the overall externality between them: Σhᵢ~ = h⁻
What is a solution for depletable externalities?
to introduce an explicit market where firms pay a price per unit of h and consumers receive a price per unit of h
What are nondepletable externalities and what could be solutions?
“public bads”, when the externality to one agent is independent of the experience of others
-> cannot be mitigated through market
How can you find out whether h is a public good or public bad?
Find out whether the marginal utility from h is smaller or bigger than zero.
if ∂uᵢ / ∂h = Φᵢ(h) > 0 public good
if ∂uᵢ / ∂h = Φᵢ(h) < 0 public bad
How can you find the pareto optimal level for an externality?
Maximize the social surplus.
total utility for h minus costs for h, or total utility + pofit
How do you find the aggregate demand for a public good?
Find the marginal utility of h for each consumer. The consumer whose marginal utility >= the price of the public good will buy.
Note: At most one consumer has positive demand! therefore that one consumer’s demand will be the aggregate demand.
Which four options do you have to correct the bias with externalities, and which do you use for over / undersupply?
- tax consumption = D(p+t) -> oversupply
- tax production = S(p - t) -> oversupply
- subsidize consumption = D(p-t) -> undersupply
- susidize production = D(p+t) -> undersupply
Why does at most one consumer have positive demand for a public good?
- Assume more than 1 consumer has positive demand
- When maximizing, we define Pₕ as a result of Φᵢ’(h)
- However, when inserting different values for i, we get different Pₕs, which is a contradiction
