chapter 4 market failures: public goods and externalities copyright © 2015 mcgraw-hill education....
TRANSCRIPT
Chapter 4
Market Failures: Public Goods and Externalities
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
4-2
Market Failures
• Market failures • Markets fail to produce the right amount of
the product• Resources may be• Over-allocated• Under-allocated
LO1
4-3
Demand-Side Market Failures
• Demand-side market failures• Demand does not reflect full amount
consumers are willing to pay• Some can enjoy benefits without paying• Firms won’t produce the good
LO1
4-4
Supply-Side Market Failures
• Supply-side market failures• Occurs when a firm does not pay the full cost
of producing its output• External costs of producing the good are not
reflected in supply
LO1
4-5
Efficiently Functioning Markets
• Demand curve must reflect the consumers full willingness to pay
• Supply curve must reflect all the costs of production
LO2
4-6
Consumer Surplus
• Consumer surplus• Difference between what a consumer is
willing to pay for a good and what the consumer actually pays• Extra benefit from paying less than the
maximum price
LO2
4-7
Consumer Surplus
LO2
Consumer Surplus
(1)Person
(2)Maximum Price Willing to Pay
(3)Actual Price (Equilibrium
Price)
(4)Consumer
Surplus
Bob $13 $8 $5 (=$13-$8)
Barb 12 8 4 (=$12-$8)
Bill 11 8 3 (=$11-$8)
Bart 10 8 2 (=$10-$8)
Brent 9 8 1 (= $9-$8)
Betty 8 8 0 (= $8-$8)
4-8
Producer Surplus
• Producer surplus• Difference between the actual price a
producer receives and the minimum price they would accept• Extra benefit from receiving a higher price
LO2
4-9
Producer Surplus
LO2
Producer Surplus
(1)Person
(2)Minimum
Acceptable Price
(3)Actual Price (Equilibrium
Price)
(4)Producer Surplus
Carlos $3 $8 $5 (=$8-$3)
Courtney 4 8 4 (=$8-$4)
Chuck 5 8 3 (=$8-$5)
Cindy 6 8 2 (=$8-$6)
Craig 7 8 1 (=$8-$7)
Chad 8 8 0 (=$8-$8)
4-10
Efficiency
• Allocative Efficiency• Correct amount of a good is produced
• Productive Efficiency• Produced at lowest possible cost
LO3
4-11
Private Goods
• Private goods are produced in the market by firms
• Offered for sale• Characteristics• Rivalry• Excludability
LO3
4-12
Public Goods
• Public goods are provided by government• Offered for free• Characteristics• Nonrivalry• Nonexcludability• Free-rider problem
LO3
4-13
Demand for Public Goods
LO3
Demand for a Public Good, Two Individuals
(1)Quantity of Public Good
(2)Adams’ Willingness to
Pay (Price)
(3)Benson’s
Willingness to Pay (Price)
(4)Collective Willingness
to Pay (Price)
1 $4 + $5 = $9
2 3 + 4 = 7
3 2 + 3 = 5
4 1 + 2 = 3
5 0 + 1 = 1
4-14
Cost-Benefit Analysis
• Cost-benefit analysis• Cost• Resources diverted from private good
production• Private goods that will not be produced
• Benefit• The extra satisfaction from the output of
more public goods
LO4
4-15
Cost-Benefit Analysis
LO4
Cost-Benefit Analysis for a National Highway Construction Project (in Billions)
(1)Plan
(2)Total Cost of Project
(3)Marginal
Cost
(4)Total
Benefit
(5)Marginal Benefit
(6)Net Benefit
(4) – (2)
No new construction $0 $0 $0
A: Widen existing highways 4 $4 5 $5 1
B: New 2-lane highways 10 6 13 8 3
C: New 4-lane highways 18 8 23 10 5
D: New 6-lane highways 28 10 26 3 -2
4-16
Quasi-Public Goods
• Quasi-public goods could be provided through the market system
• Because of positive externalities the government provides them
• Examples are education, streets, museums
LO4
4-17
The Reallocation Process
• Government• Taxes individuals and businesses• Takes the money and spends on production
of public goods
LO4
4-18
Externalities
• An externality is a cost or benefit accruing to a third party external to the market transaction
• Positive externalities• Too little is produced• Demand-side market failures
• Negative externalities• Too much is produced• Supply-side market failures
LO4
4-19
Government Intervention
• Correct negative externalities• Direct controls• Specific taxes
• Correct positive externalities• Subsidies• Government provision
LO4
4-20
Government Intervention
LO4
Methods for Dealing with Externalities
ProblemResource Allocation Outcome Ways to Correct
Negative externalities (spillover costs)
Overproduction of output and therefore overallocation of resources
1. Private bargaining2. Liability rules and lawsuits3. Tax on producers4. Direct controls5. Market for externality rights
Positive externalities (spillover benefits)
Underproduction of output and therefore underallocation of resources
1. Private bargaining2. Subsidy to consumers3. Subsidy to producers4. Government provision
4-21
Government’s Role in the Economy
• Government’s role in correcting externalities• Optimal reduction of an externality• Officials must correctly identify the existence
and cause• Has to be done within a political environment
LO5