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Public Goods and Common Resources

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Excludable

-> A good if a person can be prevented from using it.

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Rival in consumption

-> A good if one person’s use of it diminishes others’ use.

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Private goods

-> excludable, rival in consumption

-> e.g. a dinner at a restaurant, a grocery shopping

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Public goods

-> not excludable, not rival

-> e.g. national defense, public education

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Common resources

-> rival but not excludable

-> e.g. fish in the ocean, forests, water or the atmosphere

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Natural monopolies

-> excludable but not rival

-> e.g. cable TV, telecommunications, Oil and Gas

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tend to be under-provided

people do not have to pay to use them

they have an incentive to free ride

firms have no incentive to provide them

the government provides public goods, using cost-benefit analysis to determine how much to provide

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tend to be over-consumed

people can use common resources without paying, so they tend to overuse them

cannot prevent free riders from using

little incentive for firms to provide

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The Tragedy of the Commons

a parable that illustrates why common resources get used more than is socially desirable

the tragedy is due to an externality: people neglect this external cost, resulting in overuse of the land

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Policy to Prevent Overconsumption

Regulate use of the resource

Impose a corrective tax to internalize the externality

Auction off permits allowing use of the resource

If the resource is land, convert to a private good by dividing and selling parcels to individuals

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The Markets for the Factors of Production

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Inputs used to produce goods and services

Including Labor, Land and Capital

These factors play a crucial role in the production process and are supplied by households to firms.

The supply and demand of factors of production create a separate market.

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The value of the Marginal Product of Labor

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The value of the Marginal Product of Labor

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The labor market is governed by supply and demand from households and firms.

Labor demand is derived from the demand for goods and services.

Influenced by the value of the marginal product of labor.

Firms hire labor based on the value of the marginal product and the market wage.

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The supply of labor depends on wages and alternative opportunities.

Wages and alternative opportunities influence the decision to supply labor.

Immigration and changes in job opportunities can also impact the supply of labor.

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Describes the relationship between inputs used and the output of goods.

Becomes flatter as the quantity of inputs increases.

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The additional increase in output from an additional unit of labor.

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The decrease in marginal product as the quantity of inputs increases.

production function

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The value of the marginal product of labor (VMPL) is the product of the marginal product of labor and the price of the output.

VMPL measures the additional benefit of hiring an additional unit of labor.

VMPL decreases as the quantity of labor increases.

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Wages in the labor market adjust to balance the supply and demand for labor.

Determined by the value of the VMPL.

Changes in the supply or demand for labor will change the equilibrium wage and the corresponding value of the marginal product.

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The marginal product of labor:

MPL =∆Q/∆L

∆Q = change in output

∆L = change in labor

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VMPL=value of the marginal product of labor
= P x MPL

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Marginal Cost(MC)

MC = W/MPL

W: Wage

MPL: Marginal Product of Labor

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Theory of consumer choice

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Externalities

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The impact of someone's actions on another person without any compensation.

can be negative or positive, depending on whether impact on bystander is adverse or beneficial.

Buyers and sellers who only think about their own interests ignore the additional costs or benefits of their actions, so the result in the market is not efficient.

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"Governments can sometimesimprove market outcomes."
=>In presence of externalities, public policy can improve efficiency.

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Buying more of one good leaves
less income to buy other goods.

Working more hours means more income and more consumption, but less leisure time.

Reducing saving allows more consumption today but reduces future consumption.

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the limit on the consumption bundles that a consumer can afford

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The slope of the budget constraint equals

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The slope of the budget constraint equals

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the rate at which A
can trade product 1 for product 2

the opportunity cost of product 1 in terms of product 2

the relative price of product 1:

P of p1 : P of p2

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shows consumption bundles that give the consumer the same level of satisfaction

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the rate at which a consumer
is willing to trade one good for another

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MRS = slope of indifference curve

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A fall in the price of P1 has two effects on
A's optimal consumption of both goods.

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A fall in P1 boosts the purchasing power of A's income, allows him to buy more P1and more P2

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A fall in Pp1 makes Pp2 more expensive relative to p1, causes A to buy fewer p2& more p1.

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Welfare economics studies how the allocation of resources affects economic well-being.

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Example: cigarette-seller and buyer

affected: everybody around buyer

social cost > private cost

=>social cost bigger than supply=>tax=externality

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Example: vaccine

firework...

affected : neighbor or everybody around buyer

social benefit > private benefit

=>social benefit higher than demand

=>subsidy=externality

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altering incentives so that people take account of the external effects of their actions

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If negative externality:

-market quantity larger than socially desirable

If positive externality:

-market quantity smaller than socially desirable

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To remedy the problem, “internalize the externality”

=>tax goods with negative externalities

=>subsidize goods with positive externalities

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=>regulate behavior directly

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=>provide incentives so that private decision-makers will choose to solve the problem on their own.

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=>A tax that encourages individuals to consider the societal costs that result from a negative externality.

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The ideal corrective tax = external cost

For activities with positive externalities,
ideal corrective subsidy = external benefit

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Other taxes and subsidies distort incentives and move economy away from the social optimum.

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Other taxes and subsidies distort incentives and move economy away from the social optimum.

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Align private incentives with society’s interests

Make private decision-makers take into account the external costs and benefits of their actions

Move economy toward a more efficient allocation of resources.

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A tradable pollution permits system reduces pollution at lower cost than regulation.

Firms with low cost of reducing pollution sell whatever permits they can.

Firms with high cost of reducing pollution buy permits.

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=>Pollution reduction is concentrated among those firms with lowest costs.

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Moral codes and social sanctions

Charities

Contracts between market participants and the affected bystanders

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If private parties can negotiate without any costs, they can solve the problem of externalities by themselves.

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Objections to the Economic Analysis of Pollution

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Objections to the Economic Analysis of Pollution

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Some politicians and environmentalists believe that it is wrong to allow individuals to pay for the right to pollute, as they argue that the environment should not be assigned a monetary value.

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Corrective Taxes vs. Tradable Pollution Permits

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Corrective Taxes vs. Tradable Pollution Permits

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As pollution costs rise, firms pollute less.

A tax or tradable permits system can reduce pollution by increasing the cost of polluting. When policymakers are uncertain about the demand for pollution, a permits system is more precise in achieving pollution reduction goals.