CHAPTER 4 by Fatin Farhanah https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x en-us 2020-11-09 06:30:14 UTC 2024-01-04 23:46:11 UTC hello@padlet.com CHAPTER 4 : MODELING MARKET FAILURE frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903031227 2020-11-09 06:40:50 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903031227 Environmental Pollution frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903041102 2020-11-09 06:45:18 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903041102 frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903043301
  • the result of an inefficient market condition. 
    • ]]>     2020-11-09 06:46:16 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903043301     frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903050843 2020-11-09 06:49:43 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903050843 (i) theory of public good frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903793162 environmental quality]]> 2020-11-09 11:58:47 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903793162 (i) theory of externalities frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903797560 good whose production or consumption generates environmental damage. ]]> 2020-11-09 12:01:04 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903797560 Environmental Quality frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903803051 2020-11-09 12:03:40 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903803051 frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903811460 2020-11-09 12:07:39 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903811460 1. Public Goods Approach frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903815203 2020-11-09 12:09:30 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903815203 frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903842487 2020-11-09 12:21:48 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903842487 frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903848742 2020-11-09 12:24:45 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903848742 (i) market supply & market demand frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903851499
  • market D for a public good is found by vertically summing individual demands.
  • but consumers are unwilling to reveal their WTP because they can share in consuming the public good even when purchased by someone else.
    • ]]>     2020-11-09 12:26:02 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903851499     (ii) combined demand of two consumers frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903856631
  • Result is that market demand is undefined. 
  • lack of awareness of environmental problems (i.e., imperfect information) exacerbates the problem.
  • allocative efficiency cannot be achieved without third-party intervention. 
    • ]]>     2020-11-09 12:28:15 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903856631     Solution to Public Goods (Gov Intervention) frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903900280
  • respond through direct provision of public goods.
  • use political procedures and voting rules.
    • ]]>     2020-11-09 12:45:50 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903900280     2. Externality Approach frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903909663 2020-11-09 12:49:36 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903909663 Environmental Problems frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903946952 (negative externality)]]> 2020-11-09 13:02:42 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903946952 frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903959735 2020-11-09 13:07:03 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903959735 frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903960608
  • a spillover effect associated with production or consumption that extends to a third party outside the market.
    • ]]>     2020-11-09 13:07:20 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/903960608     Relationship between Public Goods & Externalities frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904054080
  • If the externality affects a broad segment of society and if its effects are nonrival and nonexcludable, the externality is itself a public good.
  • If the externality affects a narrower group of individuals or firms, those effects are more properly modeled as an externality.
    • ]]>     2020-11-09 13:33:36 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904054080     (i) Negative Externality frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904070518
  • Assume the market is competitive 
  • Supply is the marginal private cost (MPC).
  •  Production generates pollution, modeled as a marginal external cost (MEC).
    • Problem: Producers (refineries) have no incentive to consider the externality.
    Result: Competitive solution is inefficient. 
    ]]>     2020-11-09 13:37:47 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904070518     frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904090552 (a) Finding Competitive Solution
     S: P = 10.0 + 0.075Q
     D: P = 42.0 - 0.125Q, where Q is thousands of barrels per day.
    Since S is MPC and D is MPB, rewrite as:
    MPC = 10.0 + 0.075Q
    MPB = 42.0 - 0.125Q

    Solution
     Set MPB = MPC
     42.0 - 0.125Q = 10.0 + 0.075Q 

    Solve: QC = 160 thousand PC = $22 per barrel 
    Analysis: 
    • This ignores external costs from contamination
    • Allocative efficiency requires P to equal all MC 
    • MPC undervalues opportunity costs of production; QC is too high; PC is too low 

    (b) Finding an Efficient Solution
    Let Marginal External Cost (MEC) = 0.05Q
    Marginal Social Cost (MSC) = MPC + MEC
    MSC = 10.0 + 0.075Q + 0.05Q
             = 10.0 + 0.125Q
    Marginal Social Benefit (MSB) = MPB + MEB
    Assuming no external benefits, MEB= 0, so MSB = MPB

    Solution
    Set MSC = MSB
    10.0 + 0.125Q = 42.0 - 0.125Q
    Solving: QE = 128 thousand PE = $26/barrel
    Observe: In the presence of an externality, market forces cannot determine an efficient outcome 


    ]]>     2020-11-09 13:42:08 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904090552     Observation frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904158224
  • QC is too high, i.e., overallocation of resources
  • PC is too low, since MEC is not captured by market transaction
    • ]]>     2020-11-09 13:57:30 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904158224     (a) Comparing the Equilibria (Using Mp and MEC) frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904165427 Competitive firm maximizes p where 
    • MPB = MPC, or where MPB - MPC = 0, or
    • Mp = 0
    (since MPB – MPC = Mp by definition)

    Efficient firm produces where 
    • MSB = MSC or MPB + MEB = MPC + MEC
    • or MPB - MPC = MEC, if MEB = 0, so…
    • Mp = MEC

    Model 
    • Mp = MPB - MPC = (42 - 0.125Q) - (10 + 0.075Q) so
    • Mp = 32 - 0.2Q 
    • MEC = 0.05Q 

    Solution
    Competitive solution 
    • Set Mp = 0, or 32 - 0.2Q = 0, so QC = 160 
    • Find P by substituting into MPB or MPC (Using MPB, PC = 42 – 0.125(160) = 22)
    Efficient solution 
    • Set Mp = MEC, or 32 - 0.2Q = 0.05Q, so QE= 128
    • Find P by substituting into MPB or MPC (Using MPB, PE = 42 – 0.125(128) = 26)

    ]]>     2020-11-09 13:59:02 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904165427     frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904229936 2020-11-09 14:12:17 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904229936 frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904232413 2020-11-09 14:12:48 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904232413 frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904257577 Analysis
    QC = 160 thousand 
    • At this point, MEC = $8.00 per barrel (Note Mp ¹ MEC Þ not efficient)
    QE = 128 thousand
    • At this point, MEC = Mp = $6.40 per barrel 
    Efficiency would improve if output were restricted by 32 thousand (i.e., 160 - 128) 
    ]]>     2020-11-09 14:18:10 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904257577     (a) Measuring Society’s Net Gain (from restoring efficiency) frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904273924 As Q falls from 160 to 128: 
    • Refineries lose p measured as Mp (or excess of MPB over MPC) for each unit of Q contracted (Defines area WYZ)
    • Society gains accumulated reduction in MEC for each unit of Q contracted (Defines area WXYZ)
    • Net gain =Area WXYZ - Area WYZ =Area WXY 
    ]]>     2020-11-09 14:21:38 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904273924     frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904290819 2020-11-09 14:25:07 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904290819 Important Observations frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904300288
  • Both externality and public goods models show inefficiency of private market solution, i.e., market failure.
  • Underlying source of failure is absence of property rights.
    • ]]>     2020-11-09 14:27:05 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904300288     3. Absence of PropertyRights frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904307349 2020-11-09 14:28:28 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904307349 (i) Property Rights frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904310292 2020-11-09 14:29:03 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904310292 frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904319046
  • Valid claims to a good or resource that permit the use and transfer of ownership through sale. 
  • For environmental goods, it’s unclear who “owns” rights. 
  • Economics says it’s the absence of rights that matters, not who possesses them.
    • ]]>     2020-11-09 14:30:47 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904319046     (ii) Coase Theorem frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904324920 2020-11-09 14:32:00 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904324920 frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904328109  Proper assignment of property rights, even if externalities are present, will allow bargaining between parties such that efficient solution results, regardless of who holds rights.]]> 2020-11-09 14:32:39 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904328109 (iii) Building The Model frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904330494 2020-11-09 14:33:10 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904330494 frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904334333 Refineries use the river to release chemicals as an unintended by-product of production. 
    • Objective: to maximize p 

    Recreational users use the river for swimming and boating.
    • Objective: to maximize utility 
    ]]>     2020-11-09 14:33:54 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904334333     (a) Bargaining When Rights Belong to Refineries frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904343706 Recreational users are willing to pay (WTP) refineries for each unit of Q not produced
    • Will pay up to the negative effect on utility (MEC)

    Refineries are willing to accept payment not to produce
    • Will accept payment greater than their loss in profit from contracting production (Mp) 
    ]]>     2020-11-09 14:35:48 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904343706     (b) Bargaining When Rights Belong to Recreational Users frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904432930
  • Bargaining will proceed analogously
  • An efficient outcome can be realized without government intervention
  • Limitations of the Coase Theorem 
    • ]]>     2020-11-09 14:54:21 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904432930     Common Property Resources frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904454682
  • Common Property Resources are those for which property rights are shared.
  • Because property rights extend to more than one individual, they are not as clearly defined as for pure private goods.
  • Problem is that public access without any control leads to exploitation, which in turn generates a negative externality.
    • ]]>     2020-11-09 14:58:47 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904454682     Solution to Externalities (Government Intervention) frhnhrmlee https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904463122 Assigning property rights

    Set policy prescription, such as: 
    •  Set standards on pollution allowed 
    •  Tax polluter equal to MEC at QE 
    •  Establish a market and price for pollution 
    ]]>     2020-11-09 15:00:20 UTC https://padlet.com/frhnhrmlee/co3mu5ydfy382q9x/wish/904463122