2 efficiency - market failure, public goods and externalities chapter 5

8/12/2019 2 Efficiency - Market Failure, Public Goods and Externalities Chapter 5

1/27

TheEconomicsofClimateChange C175

PublicGoods&Externalities

Spring09 UCBerkeley Traeger 2 Efficiency 26


2/27

Climatechange

as

a

market

failure


Environmentaleconomicsisforalargepartaboutmarketfailures:goods(orbads!)forwhichoneormoreoftheseassumptionsdoes

2007SternReviewontheEconomicsofClimateChange(politicalreportbySirNicholasStern(andcoauthors)toBritishgovernment):

Climatechangeisthebiggestmarketfailuretheworldhasever

seen.

GHGemissionsareduetoanexternality

w v reductionsbeinga(global)publicgood

2 Efficiency 27Spring09 UCBerkeley Traeger


3/27


4/27

Publicgoods

I


Characteristicsofprivateandpublicgoods:

Excludable Nonexcludable

Rival Pureprivategood Openaccessresource

Nonrival Congestibleresource Purepublicgood

Wildernessarea

Rivalr :onea entsuseisattheex enseofanothers

Excludability:agentscanbepreventedfromusingthegood/service



5/27

Problemswith

the

provision

of

public

goods


NonExcludability:Excludabilityisneededtopricetagagood

NonRivalry:Anadditionalconsumercanenjoythegoodatnoextracostofprovision.

Efficientequilibriumwillnolongerbewhereindividualmarginalrateofsubstitution=priceratio=marginalrateoftransformationor

marginalwillingnesstopay=price=marginalcosts

Wegetbacktothisinamoment



6/27

Excursion:Aggregate

supply,

demand,

and

efficiency


Supplyanddemandcurvescanbeobtainedfromutilityandprofitmaximization.

Demand

corresponds

to

marginalwillingness

to

pay.

Aggregate

demand

given

byhorizontalaggregationofindividualdemandcurves. Su l corres ondstomar inalcostcurve.A re atesu l ivenb

horizontalaggregationofindividualsupplycurves.

(Net)Consumersurplus:areabetweendemandcurveandhorizontallinethroughthemarketprice.Measurefor(moneymetric)utilityofconsumers.

(Net)Producerssurplus:areabetweensupplycurveandhorizontallinethroughtheprice.Measureforprofit(revenueminuscosts)

,surplusismaximized.

Equilibriumgivenwheremarginalcostsequalmarginalbenefits



7/27

Demandfor

private

good


AssumeaconsumeriwithwillingnesstopayVi(xi)forconsumingquantityxi

Consumerfacespricepofthegood

Utilitymaximization: maxVi

(xi

)pxi

leadsto p=Vi(xi)



8/27

Demandfor

private

good


AssumeconsumeriwithwillingnesstopayVi(xi)forconsumingquantityxi

Consumerfacespricepatwhichonecanbuythegood

Utilitymaximization: maxVi xi pxi benefits costs

leadsto p=Vi(xi)

Remark:FormallythesettingcorrespondstoamoneymetricquasilinearutilityfunctionUi(xi,Mi)=Vi(xi)+Miwhichislinearinmoneyande.g.

concaveinxi

ThenthemarginalwillingnesstopayMWTPisthenegativeoftheMRSbetweenmoneyandgoodx

)($

iii

i

X XVX

U

MUMRSMWTP

Weknowthatinefficientequilibrium

$

i

i

M

ppp

MRS XX

y e nga sop= i xi



9/27

Demandfor

private

good


AssumeconsumeriwithwillingnesstopayVi(xi)forconsumingquantityxi


Utilitymaximization: maxVi(xi)pxi

leadsto p=Vi(xi)=MWTP

Demand correspondstomarginalwillingnesstopaycurve.

IfVi xi isconcavethenbydefinitionVi xi isfalling.Example:V1 x1 =x1 100x1

Grossconsumersurplusistheareaunderthedemandcurve.Netconsumersurplus.

Aggregatedemandgivenbyhorizontalaggregationofindividualdemandcurves.

= = 1 1 1 1 2 2 2 . 2



10/27


Supply ofprivate

goods

Wecanbreakdownprofitmaximizationinto

1. Minimizingcostsforagivenoutputbyoptimizinginputs

2. Maximizingprofitsbychoosingoptimaloutputlevel AssumeproducerjwithcostCj(xj)forsupplyingquantityxj

Producerfacespricepatwhichhecansellthegood

Profitmaximization:

maxpxjCj(xj)

p=Cj(xj)

Supplycorrespondstomarginalcostcurve. IncreasingifCj(xj)convex.

.

Example:C1(x1)=8+x12 , C2(x2)=0.5x2

2



11/27

Supplyof

public

goods


Assumin thatthe ublic oodG is riced ever thin asbefore.

Profitmaximization:maxp j j j

leadstop=C

j

(Gj

)

Supplycorrespondstomarginalcostcurve.

Aggregatesupplygivenbyhorizontalaggregationofindividualsupplycurves.



12/27

Demandfor

public

good


AssumeconsumeriwithwillingnesstopayVi(G)forconsumingquantityG

NotethatGnolon ercarriesanindex.Ever consumerconsumesalloftheGasthegoodisnonrival


ymax m za on:maxVi(G)pG

leadstop=Vi(G)

Individualdemandcorrespondsagaintomarginalwillingnesstopaycurve.

Socialdemandgivenbyverticalaggregationofindividualdemandcurves, .

Example:V1(G)=G(1000.5G) V2(G)=2G(1000.5G)



13/27

Optimalprovision

of

public

good


Aggregatemarginalwillingnesstopayshouldequalmarginalcostsofprovidingthepublicgood:

forallproducersj. TheproducedquantitiesG sumtothetotalamountof

)((G)Vi

i jj GC

publicgoodprovidedG: GGj

j

Ormoregeneralforthemarginalrateofsubstitutionbetweenprivateandpublicgoodsishastohold

withgoodprivate

MRS _

MRTMRSi

Thisrelationisknownasthe

Samuelsoncondition

_i



14/27

Optimalprovision ofpublicgoodsTheEconomicsofClimateChange C175

MRSA +MRSB =MWTPA +MWTPB

MC=MRT

=MWTPB

MRSA

=MWTPA

XX*



15/27

PublicgoodsIITheEconomicsofClimateChange C175

Withprivategood,eachindividualconsumesdifferentamount,butpayssameprice:equalmarginalvaluationbyeachindividual.

Withpublic

good,

each

individual

has

toconsume

sameamount,

but

marginalvaluationcandiffer:onlythesumofthemarginalvaluationshastoe ualthemar inalcost.

Publicgoodsarenonexcludable,sonolinkbetweenpaymentand

provision:public

goods

cannot

be

provided

bythe

market.

Governmentcanprovi epu icgoo an inanceitviataxes.Forefficientamountofpublicgooditneedstoknowmarginalwillingnesstopayforallindividuals.However

Nonexcludability givesconsumersincentiveto reerideandtounderstatetheirwillingnesstopay!



16/27

Lindahl markets


AssumethatanindividualmarketcanbeintroducedforeachconsumerofapublicgoodG

ThenthereareNconsumers,eachconsuminggoodGi,i=1,N atpricepG

i,i=1,N

DenotetheaggregatesupplyofthepublicgoodbyGanditspricebypG

ALindahl equilibriumasanallocationofgoods(includingG,Gi,i=1,N)andasetofprices(includingpGi,i=1,Nandaprice)suchthat

allfirmsmaximizetheirprofits,

allindividualsmaximizetheirutility(giventhebudgetconstraint),

allmarketsclearandforthepublicgooditholdsG=Giforall i=1,,N forthepriceofthepublicgoodholds:pG =ip

Gi .

Then(undersomeconditions)aLindahl equilibriumisParetoefficient

PrettymuchsaysthesamethingasourpictureandtheSamuelsonrule.

BecauseofnonexcludabilityandthedifficultiesofpricediscriminationLindahlmarketsgenerallystayatheoreticconstruct

Note:Excludabilitycanbenecessaryforanefficientmarketoutcome,eventhoughintheefficientmarketoutcome,in eneral,nobod willbeexcludedfromconsumin anonrivalgood!



17/27


18/27

ExternalitiesIITheEconomicsofClimateChange C175

x erna y c ass ca on ere nega ve ex erna es

Arising in Affecting Utility/production function

onsumpt on onsumpt on , ,

Consumption Production X(K,L,YA)

+ +

++

Production Consumption UA(XA,YA,X)

Production Production Y(K,L,X)

+ +

+ +



19/27

ExternalitiesIIITheEconomicsofClimateChange C175

Beneficial (positive) and harmful (negative) externalities

Effect on Originating in Originating in

others consumption production

infectious decease due to proximity to apiary

Adverse Noise pollution from Chemical factory discharge

water systems

GHG emissions can be in all 4 quadrants!!



20/27


Exampleofanexternality: Productiononconsumption



21/27

Exampleofanexternality:ProductiononproductionTheEconomicsofClimateChange C175

TwoproducersofgoodsXandY,withcosts2 2

,

E.g.twostylizedCalifornianfarms:awindmillfarmandawinery

100

XCX XXYCY

100

,

a ypeo ex erna y owe ace ere

LetpricesbepX=2andpY=3

X= x=

Y= Y= IsthataParetooptimum,i.e.efficient?



22/27

Exampleofanexternality:Production,InefficiencyTheEconomicsofClimateChange C175


,

LetpricesbepX=2andpY=3.100

XCX XXYCY

100

,

TryincreasingthenumberofwindmillsbyX=10

= =x

Y=150 Y=

Y=150?



23/27

Exampleofanexternality:Production,InefficiencyTheEconomicsofClimateChange C175


,

LetpricesbepX=2andpY=3.100

XCX XXYCY

100

,

OnlyifwecompensateproducerX,thewindmillfarmer!

amountofwine)fortheadditional10windmills

Mightsuchbargainingactuallytakeplace?

WillitleadtoParetooptimality? Whataretheobstacles?



24/27


25/27

ExternalitiesandPublicGoodsTheEconomicsofClimateChange C175

Anexternalityinvolvesagoodorbadwhoselevelenterstheutilityorproductionfunctionofseveralpeople/firms.

Thatimplieseffectivelyadegreeofnonrivalryandnonexcludability.

aspublicbads (goods)andviceversa



26/27

ClimateChangeandGHGsTheEconomicsofClimateChange C175

SowhatdoesthetheoryonpublicgoodsandexternalitiestellusaboutGHGemissions?

GHGsareapublicbad,mitigationisapublicgood.Thus

AcompetitivemarketequilibriumalonewillnotyieldaParetoo timal(efficient)allocation>Inprinciplewecanmakesomeindividualsbetterofwithoutmakinganyoneworseof

wanttofreeride

Becauseofnonrivalrythemarginalcostofmitigation(costoflast

mitigation(includingthebenefitsofavoidingclimatechangeimpactsinallcountries,industriesandforallindividuals)



27/27

ClimateChangeandGHGsTheEconomicsofClimateChange C175

AnotherwaytothinkaboutGHGemissions:

GHGemissionscausenegativeexternalitiesinproductionaswellasdirectlyonwelfare

Theseexternalitiesaffecteveryonearoundtheglobeandinparticularalsoindividualsnot etalive

HOW CANWE CORRECT FOR EXTERNALITIESAND PROVIDEPUBLIC GOODSATAN OPTIMAL LEVEL?

WHAT DIFFICULTIES DOWE FACE DEPENDING ON THECHOICE OF OUR INSTRUMENT(policymeasure)?


2 efficiency - market failure, public goods and externalities chapter 5

Documents