Chp 5b Public Goods and Externalities Flashcards
What are the characteristics of public goods?
Non-rivalry in consumption, non-excludability in consumption, and non-rejectability in consumption.
What is non-rivalry in consumption?
Consumption of the good does not reduce the total supply available to others. The same unit of the good can be collectively consumed.
What is non-excludability in consumption?
A good is non-excludable in consumption if the supplier cannot prevent consumption by people once it is made available. It would be difficult or costly to exclude people from consuming the good once it is made available.
What is non-rejectability?
Inability of consumers to refuse the consumption of a good once it has been produced.
How does non-rivalry in consumption leads to market failure?
Consumption of the good does not reduce the total supply available to others. The marginal cost of serving another consumer is 0 once the good has been made available. This implies that there is no effective supply.
How does non-excludability in consumption lead to market failure?
Free-rider problem. It is difficult or costly to exclude anyone from enjoying a good. Thus there is no incentive for people to pay for the good because they can consume it without paying. Nobody would thus be paying for the public good even if they would want to consume it. Thus no effective demand, no private firms would want to undertake production of goods that are purely non-rivalrous.
What is the 5-step approach to explain the problem of externalities leading to market failure?
- Define and illustrate MPB and MPC.
- Identify and explain market equilibrium (MPB=MPC)
- Explain how third parties are affected by decisions of consumers and producers.
- Identify and explain socially optimal level of output (MSB=MSC)
- Explain that the market has failed
How does negative externality of production effect society?
- When a firm produces a good, it will take into account its MPB, which is the additional revenue generated from the sale of product and its MPC, which is the additional cost of raw materials.
- Profit-motivated firms would maximise their net private benefit by equating its MPB to MPC by producing at Qp.
- Explain negative spill-over on 3rd party.
- Creates a divergence between MPC and MSC equal to the value of the externality. (MSC=MPC+MEC). Society would maximise its net social benefit at output where MSB=MSC.
- Over-production from a societal perspective, market is no longer allocatively efficient, there is DWL.
What is the effect of taxation?
The tax should be equal to the MEC. If tax accurately reflects MEC, firms internalise the externality. Taking account of the amount of the tax, the firms, MPC will rise from MPC to MPC1. , their new MPC1 coincides with MSC. Quantity being produced after the imposition of the indirect tax now corresponds to socially optimal level, Qs.
What are the advantages and disadvantages of taxation?
Adv:
A price can now be placed on the external costs arising from production that was previously unpriced.
Imposing a tax enables the government to raise revenue, channelled to reduce harm inflicted on third parties.
Tax can be varied or adjusted according to the magnitude of the problem or the size of the MEC.
As a MARKET BASED APPROACH, market participants still have the liberty to pursue their self-interests so long as they account for the full costs of their actions.
Disadv:
Value of external cost is arbitrary and very difficult to estimate due to external cost being intangible and differing between the various third parties. This makes it difficult for the government to determine the right amount of taxation to be imposed on the producers. Leads to UNDER OR OVER TAXATION
The administrative or implementation cost of imposing this tax may offset the benefits from the welfare losses prevented. Using indirect taxation as a deterrent or an incentive to reduce or internalise the externality could be rather cumbersome, tedious and administratively costly. Hence, DWL may persist despite intervention.
What is the dis/advantages of the use of environmentally methods of production?
Adv:
This is a long-term measure, allowing the government to achieve its aim of sustainable growth.
The use of more environmentally friendly methods of production will raise the socially efficient output. The socially optimal output under this measure is larger than that when taxes were used. Hence even if additional measures are used to ensure that production takes place at the socially optimal level, -ve impact on growth and employment due to falling output will be lesser compared to simply imposing taxes on pollution.
Disadv:
Firms may not be keen in conducting R&D or change their current method of production using renewable sources of energy as it may be more costly to do so in the short term. Hence, firms may not be willing to take it up if ultimately their profit margin is reduced due to rising costs of production.
What are the dis/advantages of imposing a quota?
+what is a quota?
Adv:
Socially optimal output can be attained and a reduction in overall pollution level is certain.
Quotas are easy to understand, implement and relatively easy to monitor. Heavy penalty must be imposed on those who fail to comply with the quotas in order to prohibit firms from flouting the rules.
Disadv:
Government regulators will need to be able to identify socially efficient output before they can decide on the quota.
Restrict output would lead to higher prices for paper. This would contract other related industries such as books, flyers, packaging ect.
Higher prices of paper and thus cost of living.
Prevent producers from over-producing at Qp with a quota at Qs.
What is the dis/adv to banning the production of goods?
A:
IF the MEC is estimated to be sufficiently large, banning the product produces a desirable outcome for the society.
D:
Government intervention may be costly to administer and enforce. It may outweigh any social benefit.
What are tradable pollution permits?
Permits that are issued to firms by a government or an international body that can be traded in a market.
Tradable permits provides an incentive for firms to reduce pollution so that they can sell their unused portion of their permits at price p1 to earn additional revenue. At the same time, firms that need to purchase more permits mat choose to use alternate means of production that emits lesser pollution to avoid buying more permits at price p1.
What are the advantages of tradable pollution permits?
- By providing these permits the government can progressively reduce the number of credits issued. As a result, total pollution in the affected industry will reduce over time.
- More cost effective than regulation since price of permit is determined by market forces. If firms can cut back on their emissions at a relatively low cost, it is in their interest to do so and will sell excess permits for profit. Firms that can only reduce pollution at a high cost will be forced to buy additional permits.
- This system encourages the promotion of technology to reduce pollution as it provides firms with the incentive to reduce their emissions further since it can sell any excess permits for a price.
