economic analysis for business session xviii: public goods and common resources instructor sandeep...

Economic Analysis Economic Analysis for Businessfor Business

Session XVIII: Public Goods Session XVIII: Public Goods and Common Resourcesand Common ResourcesInstructorInstructorSandeep BasnyatSandeep Basnyat98418922819841892281Sandeep_basnyat@yahooSandeep_basnyat@yahoo.com.com

““The best things in life are The best things in life are free. . .”free. . .”

Free goods provide a special challenge for economic analysis.

When goods are available free of charge, the market forces that normally allocate resources in our economy are absent.

Do you actually Do you actually need this much to need this much to

eat?eat?

Where is the Where is the theory of Demand theory of Demand

and Supply?and Supply?

THE DIFFERENT KINDS OF THE DIFFERENT KINDS OF GOODSGOODS

When thinking about the various goods in the economy, it is useful to group them according to two characteristics:◦ Is the good excludable?◦ Is the good rival?

THE DIFFERENT THE DIFFERENT KINDS OF GOODS KINDS OF GOODS Excludability

◦Excludability refers to the property of a good whereby a person can be prevented from using it.

Rivalry◦Rivalry refers to the property of a

good whereby one person’s use diminishes other people’s use.

THE DIFFERENT THE DIFFERENT KINDS OF GOODSKINDS OF GOODSFour Types of Goods

◦Private Goods◦Public Goods◦Common Resources◦Natural Monopolies

THE DIFFERENT KINDS OF GOODSTHE DIFFERENT KINDS OF GOODSPrivate Goods: Private Goods: Both excludable and rival.

THE DIFFERENT KINDS OF GOODSTHE DIFFERENT KINDS OF GOODSPublic Goods: NPublic Goods: Neither excludable nor rival.

Street Lights

National Defense

Court room services

THE DIFFERENT KINDS OF GOODSTHE DIFFERENT KINDS OF GOODSCommon Resources: RCommon Resources: Rival but not excludable.

Fish in the Ocean

People in the public park

THE DIFFERENT KINDS OF GOODSTHE DIFFERENT KINDS OF GOODSNatural Monopolies: Natural Monopolies: Are excludable but not rival.

Cable TV

Telecommunication Services

PUBLIC GOODS: ProblemPUBLIC GOODS: ProblemA free-rider is a person who receives the

benefit of a good but avoids paying for it.

The free-rider problem prevents private markets from supplying public goods.

The Free-Rider Problem The Free-Rider Problem

Solving the Free-Rider Problem◦The government can decide to

provide the public good if the total benefits exceed the costs.

◦The government can make everyone better off by providing the public good and paying for it with tax revenue.

The Difficult Job of Cost-Benefit The Difficult Job of Cost-Benefit AnalysisAnalysisCost benefit analysis refers to a

study that compares the costs and benefits to society of providing a public good.

In order to decide whether to provide a public good or not, the total benefits of all those who use the good must be compared to the costs of providing and maintaining the public good.

COMMON RESOURCESCOMMON RESOURCESCommon resources,

like public goods, are not excludable. They are available free of charge to anyone who wishes to use them.

Common resources are rival goods because one person’s use of the common resource reduces other people’s use.

Tragedy of the CommonsTragedy of the Commons

The Tragedy of the Commons is a parable that illustrates why common resources get used more than is desirable from the standpoint of society as a whole.◦Common resources tend to be used

excessively when individuals are not charged for their usage.

Solution: Solution: Why Isn’t the Cow Extinct?Why Isn’t the Cow Extinct?

Solution: Solution: Why Isn’t the Cow Extinct?Why Isn’t the Cow Extinct?

Will the market protect me?

PrivateOwnership and

the Profit Motive!

CONCLUSION: THE IMPORTANCE OF CONCLUSION: THE IMPORTANCE OF PROPERTY RIGHTSPROPERTY RIGHTS

The market fails to allocate resources efficiently when property rights are not well-established (i.e. some item of value does not have an owner with the legal authority to control it).

When the absence of property rights causes a market failure, the government can potentially solve the problem.

Community Forest: Case of Community Forest: Case of Property Rights in NepalProperty Rights in Nepal

Leftover/ MiscellaneousLeftover/ Miscellaneous(Recommended to find (Recommended to find more information on more information on

these)these)

Agency theoryAgency theoryTheory describing conflicting

relationship between principal and agents.◦Principal: employers◦Agent: employees◦Cause of conflict: difference of interests

(self interests) due to delegation of authority

◦Agency relationship: (1) between stockholders and managers and (2) between debtholders and stockholders.

◦As an impact Agency relationship moral hazard problem may arise.

Behavioral Theory-Cyert and Behavioral Theory-Cyert and March March Contrary to traditional

microeconomic theories-firms take multiple of objectives due to various internal conflicting factors.

Cyert and March:◦Various groups or coalitions exist

within the organization as that shares a consensus on the goals

◦Goals: production, stock, sales, market shares, profit and so on.

Oligopoly pricing modelsOligopoly pricing modelsPrice Leadership modelCartel kinked demand curve

model

Price leadership modelPrice leadership modelAssumes that in some market, there is

one dominant firm in the industry that ◦Determine the level of demand and sets

the price ◦Other firms in the industry behave like

perfectly competitive price-taking firmsPossible due to large amount of

market sharePrice leader maintains the price such

that the level of demand remains unreduced

Kinked demand-curve Kinked demand-curve modelmodelEconomic theory regarding

monopolistic competitive and oligopoly market structures

Assumes that the Oligopoly/ Monopolistic competitive market faces the kinked demand curved to maximize the profit.

Regular Oligopoly demand Regular Oligopoly demand curvecurve

Quantity

Costs and Revenue

MR

D

MC

Profit-maximizing output

P

Q

Decrease in MC?Decrease in MC?

Quantity

Costs and Revenue

MR

D

MC

New Profit-maximizing output

New P

Q

MC

Kinked-Demand curveKinked-Demand curve

Quantity

Costs and Revenue

MR D

MC

New Profit-maximizing output

New P

Q

MC

MC

Pricing MethodPricing MethodCost plus pricing Method (adding up

profit margin after calculating all costs)Incremental cost pricing (pricing based

on variable cost, not on the basis of total cost)

Multiple product pricing or Product line pricing (same MC but different MR)

Transfer pricing (price charged by one department to other dept. of the same company for providing goods and services)

Economics with corporate Economics with corporate decision makings and public decision makings and public policy designpolicy design

Decision making in Corporations involves:◦ Demand analysis, production functions and

costs, pricing decisions and policies, entry and exit strategies and so on..

◦ Understanding of economics (managerial economics) provides strong foundations for such analyses

Public policy design requires understandings various conditions such as efficiency, effects of taxes, externalities, international trade, elasticity and so on.

FYI-ForecastingFYI-ForecastingPredicting demand for future based on

available informationCommon forecast techniques:Qualitative analysis

◦ Expert opinion◦ Survey

Trend analysis and projection◦ Economic data, growth, business cycle etc.

Exponential smoothing (forecasting in unit-sales, growth, cost etc.)

Econometrics method

Thank youThank you