Lecture 3 Flashcards
What is economic utility?
negative (loud music when going to bed from neighbor) and positive (loud music when partying)
negative utility => costs
the benefit of all is aggregated and defined as COMMUNITY WELFARE
the socially optimal state is reached when the difference between aggregate costs & agg. utility is maximized
=> max. possible utility with min. costs
What is a market failure?
A problem that causes the market economy to deliver an outcome that does not maximize efficiency
=when market is not perfectly efficient (not pareto optimal)
What states the Coase Theorem?
MISSING PROPERTY RIGHTS
Besagt, dass Marktteilnehmer externe Effekte selbstständig internalisieren können, wenn Eigentumsrechte klar verteilt sind, keine transaktionskosten und vollst. Info => mikroökonomische Verhandlungslsg. mit effizienter Ressourcenallokation
INTERNALIZATION of the externality: entweder durch private negotiation oder government action
The misallocation can be solved if the actors negotiate with each other, and property rights exist. Who owns the property rights and to what extent is irrelevant. In every case of
distribution of property rights, an improvement can be expected.
Example for Coase Theorem
Roommates A und B wollen Bier abends trinken und laut quatschen (external effect) und C will schlafen, property rights nicht verteilt
2 Möglichkeiten:
A und B müssen ab 21h still sein => pareto efficient
C muss bis 23h wach sein => pareto efficient
entweder A und B zahlen je 3€ an C und bleiben in der WG oder C zahlt 6€ an A und B und sie gehen aus der WG
=> Buying property rights
both parties are better off, every one benefits and no one is worse off (pareto optimal)
geht nicht darum wer die property rights hat, sondern nur, dass es ausgehandelt wird
What happened?
there was a misallocation. => market failure
Solution: resource (quitness) is made marketable => absorbed into the market and internalized; states intervenes in the market exclusively by assigning property rights
Example for Externalities in Politics
Global Warming
=> kind of market failure
What is an Externality?
Externalities arise whenever actions of one party make another party worse/ better off
yet, 1st party neither bears the costs, nor receives the benefits of doing so
What kinds of Externalities exist?
Positive production externality: when a firm´s production increases the well-being of others but the firm is not compensated by others ( Carbon Capturing for free)
positive consumption externality: firm´s production reduces well-being of others who are not compensated by the firm (pollution from production)
Negative Production externality: when a individual´s consumption increases the well-being of others but the firm is not compensated by others
Negative Consumption externality: individual´s production reduces well-being of others who are not compensated by the individual (smoking at a restaurant)
What is Private Marginal Costs? PMC
PMC
The direct cost to producers of producing an additional unit of a good.
Grafik auf S. 13
What is Social Marginal Costs? SMC
SMC
The private marginal cost to producers plus any costs associated with the
production of the good that are imposed on others.
Grafik auf S.13
What is private and social marginal benefit?
PMB and SMB
Neg consumption externalities drive a wedge between private and social marginal benefit
Private marginal benefit (PMB): The direct benefit to consumers of consuming an additional unit of a
good by the consumer.
- Social marginal benefit (SMB): The private marginal benefit to consumers minus any costs associated
with the consumption of the good that are imposed on others.`
Example:
The loss of health or dining pleasure is a cost of smoking imposed on others.
How do externalities affect efficiency?
Efficiency requires that SMC=SMB (Gesellschaft muss nicht extra für PMB aufkommen)
Automatisch: market sets PMC=PMB (nur wenn es sich vom benefit her für mich lohnt, zahle ich dafür)
when PMC=SMC and PMB=SMB => efficient market
HOWEVER: Production or consumption externalities lead to inefficiency
Beispiel Neg. Externality: Steel Production
x-achse: Quantity
y-achse: price
D= PMB=SMB
S= PMC
JEDOCH: SMC= PMC+ Marginal Damage
SMC höher als PMC (Anzahl Höhe= marginal damage) => PMC Schnittpunkt D und gleich x Koordinate von SMC + Schnittpunkt D und SMC = DEADWEIGHT LOSS(zeigt nach links)
Internalize externality: fishermen could pay steel producer to reduce production (Internalisierung durch Geld)
this removes the inefficiency of the neg. externality
Bsp. Externalities of SUVs
3 types of neg. externalities
- environmental: verbrauchen mehr Sprit
- wear and tear on roads: larger cars wear down the roads more
- safety: avrg. car odds of having a fatal accident quadruple it the accident is with a typical SUV instead of same size
Beispiel pos. Externality
x-achse: Quantity
y-achse: price
D= PMB=SMB
S= PMC
JEDOCH: SMC= PMC - Marginal BENEFIT
PMC höher als SMC (Anzahl Höhe= marginal benefit) => SMC Schnittpunkt D und gleich x Koordinate von PMC + Schnittpunkt D und PMC = DEADWEIGHT LOSS (zeigt nach rechts)
What is certificate trading? Describe.
=Internalization of external effects by means of secuitized rights to damages (neg. externalities)
Certificates are securitized rights to negative externalities.
By holding a certificate, one has the permission to emit a certain amount of pollutants.
The number of certificates is determined by the state and placed on the market.
Allocation of allowances can be done through free distribution or auctioning.
Companies are able to trade certificates among themselves.
The sale of certificates can be a source of income for low-emission companies.
If companies emit a lot, they have to buy many certificates.
When many companies demand allowances, the price increases because they have to be bought from another company.
The price increase of the certificates makes the avoidance of negative externalities more profitable. (weniger CO2 verbrauchen => billiger als Zertifikate einzukaufen=> macht dadurch für U mehr Sinn zu sparen)
What is certificate trading? Graphically
beginning: market in equilibrium
number of certificates issued is fixed: Supply line cannot be shifted
more certificates are demanded=> higher prices
Graph:
x: Quantity (feste x-Koordinate)
y: P
Demand: marginal avoidance cost=> CO2 reduzieren
Supply: Marginal certificate cost
The cost of each additional certificate increases. The
first certificates are distributed by the state at fixed MAC prices or even free of charge. For each additional
certificate, another company must be convinced by
means of money to surrender its own certificate.
The higher the price, the more companies are willing to sell their certificates.
Which companies sell their certificates first? => die für die es am billigsten ist, CO2 zu sparen => mit niedrigster MAC
Solange: MAC < MCC damage is avoided
wenn noch Zertifikate übrig sind: sold for profit
firmen verkaufen solange bis MAC<MCC
Verbrennermotorenautoverkäufer müssen Zertificate abgeben für verkaufte Autos; außer wenn es E-Autos sind (hier jedoch externe Effekte während Produktion vernachlässigt)
Advantages of Certificates
The maximum amount of pollutants is fixed in advance
The possibility to sell certificates creates incentives to avoid negative externalities. (CO2)
Even for very profitable companies the maximum amount of externalities is fixed
Precise quantity control
Ecological accuracy
Dynamic incentive effect
Adjustment of the quantity of certificates
Emission trading worldwide
enabled by Kyoto Agreement
=industrialized signatory countries may trade emissions allowances among themselves as long as overall emissions targets are met.
efficient countries can reduce their emissions on behalf odfless efficient countries (at a certain price)
solange MAC costs more than 50$ per metric ton
Viel billiger in Entwicklungsländern eine nachhaltige basis aufzubauen, also eine bereits stehende Nation nachhaltig zu machen. JEDOCH WOLLEN DIE ENTWICKLUNGSLÄNDER NICHT MITMACHEN
sie haben nicht viel zur Klimakrise beigetragen, also warum mit beteiligen?
Who is Arthur Cecil Pigou?
founder of S/D Model
founder of welfare economics
wanted economics to make the world better
he knew that the industrialisation harms the environment
1st economist to highlight the idea of externalities (nannte sie noch nicht so)
Conerned with intergenerational externalities and their internalization
Bsp.: Cars => damage to roads, too low chimneys=> poor air quality
What are the Pigou-Taxes?
misallocations result from a divergence of private and social costs
Solution: controlling the market through government taxes:
Tax:reduce or eliminate negative externalities
Subsidies: promote and support positive externalities
government should also recognize intertemporal externalities. (Example: reforestation)
Pigouvian tax in general:
The state should influence the behavior
Steering (in eine Richtung bringend) taxes should be used precisely so that polluters have an incentive to adjust their activities to a socially optimal level.
How does the Pigou tax affect market participants?
P axis = cost
Q-axis =quantity
Supply: MD => CO2
Demand: MAC
t: Pigou tax (fixer y wert)
Q*: The starting point (Preis=0)
Q: corresponds to the emission quantity of the company
t** (Preis= Pigou tax)
=> weniger Quantity und höherer Preis
However, the economically (socially) optimal quantity would be X. The level would therefore have to go from X* to X.
=> optimal Pigou tax: tax the emission quantity so that the polluter adjusts the quantity from Q* to Q**
The Pigou tax burdens each emission unit with the target: t*=MD(Q).
* Thus, each emission unit (pollutant unit) is taxed. Thus, there is a cost equal to Q times t**.
* As long MAC > tax => tax is paid and emissions continue.
* Once the MAC < tax => tax prevents further emissions.
* In P (equilibrium) the MAC are the same as the Pigou tax
Pigou tax- consideration of an explicit industry
SMC: social marginal cost = (marginal private cost + marginal external cost).
SMCkurve gleicher unsprung wie S aber steiler
The market equilibrium is in X (Schnittpunkt S & D)
The market equilibrium ignores total social costs.
Producers and consumers do not bear the costs of their respective benefits alone, but others (society) must share their costs.
Solang Total social cost below demand curve, additional social welfare is created. (=- schnittpunktD/ SMC)
For each additional unit of Q in which the SMC is below demand, social welfare increases (under blau und under D)
For each additional unit in which the SMC is above demand, social welfare decreases. (über D und rechts von Schnittpunkt SMC und D)
The initial situation X is not socially optimal
wenn jetzt aber Pigou tax:
Tax makes Supply more expensive=> S up (zu Schnittpunkt S+t und SMC)
quantity decreases
Dreieck: Schnittpunkt D&S und D und S+t = CO2 Reduction
neue Quantity als social optimum
late Q als find. optimum => quantity too high
PIGOU INTERNALIZATION: welfare gain equal to triangle
dt: mineralölsteuer: ca 50 ct +19% Mwst.
Ecotax: surcharge on mineral oil tax => environm. ctax= chargeable to external costs pro KWh
Grafiken dazu anschauen
Difficulties of Pigouvian Tax
The curve runs must be known precisely for the respective industry.
The damage (Klimawandel) determines the social costs incurred (angefallen), which is very difficult to determine and assess.
With an increasing number of polluters and injured parties, correct tax rates are almost impossible to determine precisely.
The same applies to Pigou subsidies, but here usually no precise quantity limit is defined
Pigouvian Subsidies
for pos externalities
gleiches ausgangsszenario wie bei tax
=Pay producer a subsidy per unit of quantity
=> für höhere Anzahl
eig: S
aber mit Subsidy supply curve weitr unten da billiger
=> dan optimal quantity demanded
kann man damit auch neg. ext. abwenden? ja, solange Subsidy > MAC => dann nicht genutzt und emission is avoided
in the short run possible to replace taxes with subsidies
PROBLEM: subsidies distort equilibrium prices in the long (subsidy costs attract other firms => noch mehr Q => equilibrium is distorted &doch mehr CO2 ausgestoßen)
Quantity Regulation/ Corrective Tax when there are several plants
Quantity regulation with tradeable permits
Regulation: For each plant, the marginal cost of pollution reduction is set equal to the marginal social benefit of that reduction. (MCr=MSBr)
Tax: Pigouvian taxes induce efficient production by increasing the cost of the input by the amount
of its external damage.
Quantity regulation with tradeable permits: training allows the market to account for differences in pollution reduction costs across firms
MULTIPLE PLANTS WITH DIF. REDUCTION COSTS
What is the difference between price regulation (taxes) and quantity regulation?
Quantity regulation ignores the fact that plants have different marginal costs of reducing pollution.
Pigouvian taxes lead to efficient production by increasing the cost of inputs by the amount of external damage, raising marginal private costs to social marginal costs.
Taxes are preferable to quantity regulation, which distributes reductions evenly across plants, because taxes give plants more flexibility in choosing their optimal level of reductions and allow them to choose the efficient level.
To summarize:
The main advantage of taxation over regulation arises when plants have different pollution reduction costs.
How can we determine how much each plant should produce?
Regulation often requires that each plant reduce consumption by the same amount, but it would be more efficient if the plants with the lowest costs reduced consumption more.
Pigouvian correction taxes that correspond to marginal damage are more efficient
What is the difference between Price and Quantity regulation when there are multiple plants with different reduction costs
Quantity regulation ignores the fact that plants have different marginal costs of reducing pollution.
Pigouvian taxes lead to efficient production by increasing the cost of inputs by the amount of external
damage, raising marginal private costs to social marginal costs.
Taxes are preferable to quantity regulation, which distributes reductions evenly across plants, because taxes
give plants more flexibility in choosing their optimal level of reductions and allow them to choose the efficient level.
D=PMB => no altruism / ppl don´t care about environm.
MD= SMB
S=PMC=SMC
The efficient solution is for SMB = SMC and SMC = PMC.
* To find an efficient set, the entire SMC curve must be known.
* When MD is constant, setting a tax is easier than regulation because one does not need to know the shape of the MC curve.
* However, if the marginal damage were unknown or not constant, the government would need to know the shape of both the MC and MD curves to set either the optimal tax or the optimal regulation
The efficient solution is to equate, for each facility, the marginal cost of pollution avoidance with the marginal social benefit of that avoidance, i.e., the marginal cost curve of each facility intersects the marginal benefit curve
1. Quantity regulation: gov. knows: 200 ideal => 100 reduction everyone, not efficient because together A+B >200
2. Pigou taxation: bis zu tax bei 100: MAC< paying tax => efficient da delta A+ delta B= delta T
summarize wether price or quantity regulation is better.
Which of these methods leads to the most efficient regulatory outcomes depends on factors such as the heterogeneity of the firms being regulated, the flexibility associated with quantity regulation, and uncertainty about the costs of reducing externalities.
wenn MD kurve steep dann regulation
wenn flach dann tax
jew dann weniger großer deadweight loss
Uncertainty about the cost of the reduction
wenn MD flach => introduction of a tax => samller deadweight loss that with regulation
wenn MC steil => regulation => smaller DWL than taxes
When is smoking an externality?
when neg. health consequences is the consequences, but not for the smoker but the environment
Externaility= if smoker does not bear all the costs
raucher, die alle Konsequenzen kennen, können diese Kosten internalisieren
Health Care Costs: smoking increases health care costs => externaility?
(how is the gov. setting up its health insurance)
- Not if the indv. pays for the healthcare OR if insurance premium is adjusted (compensate for expense differences)
- Yes if the indv. is in public healthcare and others have to take over the costs.
Set Fires:
-Not if the indv. burns own stuff and pays for the firebregade
- Yes if they burn other ppls stuff OR fire insurance costs aren´t actuarilly adjusted
Workplace productivity:
- Not If ppl are paid on productivity
- Yes if people get paid while they are taking more breaks
Death Benefit:
- Not if we dont have to pay for them when they are old
- Yes because they dont pay taxes anymore once they are dead!
OVERALL neg. exte.: ca. 54ct aber tax 1$
Second Hand Smoking. Is it an Externality?
Secondhand smoke: Tobacco smoke inhaled by individuals close to the smokers.
The costs of secondhand smoke are not easily added to the list of external costs:
* There is considerable medical uncertainty about the damage done by secondhand smoke.
* Most of the damage from secondhand smoke is delivered to the spouse and children of smokers.
aber darüber zu diskutieren wäre teurer (negotiation cost/time/energy) als der tatsächliche Schaden
Summarize Externalities
It is theoretically possible to counteract problems like climate change etc.
Externalities occur when the actions of one party affect another party and the first party does not fully compensate (or is compensated by) the other party for those effects.
Externalities are the classic answer to the “when” question of public finance: When externalities are present, the market has failed and intervention may be warranted.
This leads naturally to the question of the “how” of public finance. There are two solutions here: Price-based measures (taxes and subsidies).
Quantity-based measures (regulation).
Which of these methods leads to the most efficient regulatory outcomes depends on factors such as the heterogeneity of the firms being regulated, the flexibility associated with quantity regulation, and uncertainty about the costs of reducing externalities
Stupid example and question for externality
The non-cultivation of tobacco is subsidized by the European Union.
* Germany therefore receives subsidies for not growing tobacco plants.
* However, the climate in Germany is not at all suitable for tobacco plants.
* Antibiotics are very cheap, but there are more and more antibiotic resistant germs.
* In the future new antibiotics will be important
* Could an intertemporal Pigou subsidy help here? => ja für Forschung antreiben
