l5 market failure
TRANSCRIPT
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Economic Welfare
p
qD = MPB = MSB
S = MPC = MSC
p*
q*
CS
PS
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Maximization of Net Social
BenefitsNSB = s = PB(q) + EB(q) PC(q) EC(q)NSB = SB - SCFOC
s / q = PB/ q + EB/ q - PC/ q - EC/ q = 0PB/ q + EB/ q = PC/ q + EC/ qMPB + MEB = MPC + MEC
MSB = MSC
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Net Social Benefits
p
qMPB
MSC
p*
q*
CS
PS
MPC
MSB
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MSC > MPC
p
qMPB = MSB
MPC
p*
q*
MSC
qo
poCS
PS
Deadweight loss
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MSB > MPB
p
qMPB
MPC = MSC
p*
q*
CS
PS MSB
qo
po
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POSSIBLE CAUSES OF
MARKET FAILURE
Thin Markets
A market is thin when there are not enoughtraders to allow it to operate or when it istoo costly to operate
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Monopoly
p
qD
S
p*
q*
CS
PS
MR
pm
qm
Deadweight loss
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Asymmetric Information
Lack of information about activitiesaffecting economic agents
Asymmetric information makes exchangethrough market mechanism quite difficult
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Common property resources andnonappropriable externality
Nonapproriability means that any oneagent's consumption of the externality(pollution) does not reduce the consumptionof that same externality by others.
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Negative Externalities
p
qMPB = MSB
MPC
p*
q*
MSC
qo
poCS
PS
Deadweight loss
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Positive Externalities
p
qMPB
MPC = MSC
p*
q*
CS
PS MSB
qo
po
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Nonconvexities in the operation of themarket or in the technological
interdependence
A nonconvexity in the market can be caused
by setup costs, e.g. bureaucracy. Anonconvexity in technology is when theproduction possibility fails to be
everywhere bowed out.
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Price Support
p
qD
S
p*
q*qo
ps
q
CS
PS
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Price Ceiling
p
qD
S
p*
q*
pc
qo q
PS
CS
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Quantity Control
p
qD
S
p*
q*qo
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The absence of Property Rights
property rights
The set of valid claims to a good or resourcethat permits use of that good or resourceand the transfer of its ownership throughsale
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Coase Theorem
Proper assignment of property rights to anygood, even if externalities are present, willallow bargaining between affected parties
such that an efficient solution can beobtained, regardless of which party isassigned those rights
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common property resources
Those resources for which property rightsare shared by some group of individuals
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Environmental Quality: APublic Good
public good
A commodity that is nonrival inconsumption and yields benefits that arenonexcludable
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nonrivalness
The characteristic of indivisible benefits of consumption such that one person'sconsumption of a good does not precludethat of another
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nonexcludability
The characteristic that makes it impossible(or prohibitively costly in a less strict sense)to prevent others from sharing in thebenefits of a good's consumption
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Individuals Demand P
Q
DADB
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Market Demand P
Q
DADB
DM
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Market Equilibrium? P
Q
DADB
DM
S
Q*
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Concept of external economies(diseconomies)
(Scitovsky, 1954)Readings\3. Environmental Externalities.pdf
Technological external economies
equilibrium theory: output decisions in oneindustry are co-determined by actions in otherindustries; these effects do not result from changesreflected in the product or factor prices.
http://readings/3.%20Environmental%20Externalities.pdfhttp://readings/3.%20Environmental%20Externalities.pdfhttp://readings/3.%20Environmental%20Externalities.pdfhttp://readings/3.%20Environmental%20Externalities.pdf -
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Pecuniary external economies
interdependence among producers through themarket mechanism, i.e. due to price effects.
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The Theory of Externality
An externality is a spillover effect associated witheither production or consumption of a good or
service that extends outside the market to somethird party other than the producer or consumer of that good or service. If the external effectgenerates costs to a third party, it is a negative
externality . If the external effect generatesbenefits to a third party, it is a positiveexternality .
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ENVIRONMENTAL
EXTERNALITIESReadings\3. Environmental Externalities.pdf Application of the concept of externalities to environmentalproblems
Externalities result from services (disservices) renderedfree (without compensation), and are a cause for divergencebetween private profit and social benefit
Externalities are a cause for the failure of perfectcompetition to lead to an optimum situation
http://readings/3.%20Environmental%20Externalities.pdfhttp://readings/3.%20Environmental%20Externalities.pdfhttp://readings/3.%20Environmental%20Externalities.pdfhttp://readings/3.%20Environmental%20Externalities.pdf -
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Environmental Externalities
Defined
non-market effects (+ve or -ve) which resultas a side-effect of economic activities of producers and consumers and which affectthe welfare or profit conditions of otherhouseholds through spill-overs via man'ssurroundings
Examples:
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Examples:
negative
air pollution from automobiles; water pollution from factories dumping wastes; logging without afforestation; stenches from chemical plants;
positive
benefits derived from proximity of a natural park; benefits from the beauty of a well-designed building in the
vicinity;
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Characteristics
Interdependency
No compensation
Unintended/incidental by-product [Mishan,1971]
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Classification
1. (Non)-Separability
2. (Non)-Reciprocity
3. (Infra)-Marginality
4. Potential (Ir)-Relevance
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Separability
C1 = C 1 (q1, q2) C2 = C 2 (q1, q2)
For individual firm's profit to be maximized,FOC:
pi = C i / qi
i = 1,2
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For social benefit to be optimized,
FOC: pi = C i / qi + C j / qi
i = 1,2; j = 1,2;
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Reciprocity
when 1 imposes an externality on 2 and viceversa
non-reciprocal (unidirectional): when 1imposes external effects on 2 but not vice
versa
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Marginal Effects
[Buchanan and Stubblebine]
decision of 1 at the margin always affect thewelfare position of the others
infra-marginal: marginal change in thedecisions of a polluter leads to a marginal
change in environmental quality withoutaffecting the welfare position of othereconomic subjects
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Potentially Relevant
when environmental spill-over generates desire onthe part of the damaged party to modify thebehaviour of the polluter through trade,persuasion, or collective actions
irrelevant, if externality exerts no such action
Infra-marginal externalities are, by definition,irrelevant.
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Pollution as an Externality
Problem
C f = Q2;
B = 12Q or P = 12;
E = 0.01Q 2;
Cw = 20 + 50E;
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NPB = = 12Q Q 2
MNPB = M = / Q = 12 2Q
At max NPB, MNPB = 0 or P = MC 12 2Q = 0; Q = 6
EC = 50E = 0.5Q 2
MEC = Q
At max NSB, MNPB = MEC 12 2Q = Q; 3Q = 12; Q = 4
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Alternatively,
Max NSB = s = 12Q Q2
0.5Q2
= 12Q 1.5Q 2
FOCs / Q = 12 3Q = 0
Q = 4
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MEC = Q
MNPB = 12 2Q
Q
MNPB, MEC
4 6
12
4
a
bc
d
e
a = 16b = 8
c = 8d = 4e = 6
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The End