1. 30
CHAPTER
Government
And
Market Failure

2. PUBLIC GOODS
Rivalry & Excludability
(Chapter 5)
Private Goods
Divisibility
Demand Curve is Horizontal Summation
Public Goods
Indivisibility

3. DEMAND FOR A PUBLIC GOOD
Problems of Revealing Preferences
Adams’ Benson’s Collective
Willingness Willingness Willingness
Quantity to pay (price) to pay (price) to pay (price)
1 Exclusion Principle
does not apply

4. DEMAND FOR A PUBLIC GOOD
Problems of Revealing Preferences
Adams’ Benson’s Collective
Willingness Willingness Willingness
Quantity to pay (price) to pay (price) to pay (price)
1 $4 + $5 = $9

5. DEMAND FOR A PUBLIC GOOD
Problems of Revealing Preferences
Adams’ Benson’s Collective
Willingness Willingness Willingness
Quantity to pay (price) to pay (price) to pay (price)
1 $4 + $5 = $9
2 3 + 4 = 7

6. DEMAND FOR A PUBLIC GOOD
Problems of Revealing Preferences
Adams’ Benson’s Collective
Willingness Willingness Willingness
Quantity to pay (price) to pay (price) to pay (price)
1 $4 + $5 = $9
2 3 + 4 = 7
3 2 + 3 = 5

7. DEMAND FOR A PUBLIC GOOD
Problems of Revealing Preferences
Adams’ Benson’s Collective
Willingness Willingness Willingness
Quantity to pay (price) to pay (price) to pay (price)
1 $4 + $5 = $9
2 3 + 4 = 7
3 2 + 3 = 5
4 1 + 2 = 3

8. DEMAND FOR A PUBLIC GOOD
Problems of Revealing Preferences
Adams’ Benson’s Collective
Willingness Willingness Willingness
Quantity to pay (price) to pay (price) to pay (price)
1 $4 + $5 = $9
2 3 + 4 = 7
3 2 + 3 = 5
4 1 + 2 = 3
5 0 + 1 = 1

9. OPTIMAL AMOUNT OF A PUBLIC GOOD
P
$9
7
5 Adams’
willingness
3 to pay
1
D1
Q
0 1 2 3 4 5

10. OPTIMAL AMOUNT OF A PUBLIC GOOD
P
$9
7 Benson’s
willingness
to pay
5
3
D2
1
D1
Q
0 1 2 3 4 5

11. OPTIMAL AMOUNT OF A PUBLIC GOOD
P
When vertically
$9 added equals
collective
7 willingness
to pay
5
3
D2
1 DC
D1
Q
0 1 2 3 4 5

12. OPTIMAL AMOUNT OF A PUBLIC GOOD
P
$9 S
7
The public good’s
marginal cost
5
as shown by S
3
1 DC
Q
0 1 2 3 4 5

13. OPTIMAL AMOUNT OF A PUBLIC GOOD
P
$9 S
7 Yields the
optimum amount
of the public good
5
MB = MC
3
1 DC
Q
0 1 2 3 4 5

14. COST-BENEFIT ANALYSIS
Marginal Cost = Marginal Benefit Rule
Externalities
Spillover Costs
Overallocation
Spillover Benefits
Underallocation

15. SPILLOVER COSTS AND BENEFITS
P St
Spillover
costs
S
D
Overallocation
0 Q0 Qe Q

16. SPILLOVER COSTS AND BENEFITS
P St
Spillover
Benefits
Dt
D
Underallocation
0 Qe Q0 Q

17. SPILLOVER COSTS AND BENEFITS
Individual Bargaining –
Coase Theorem
Liability Rules and
Lawsuits
Government Intervention
Direct Controls
Specific Taxes
Subsidies and
Government Provision

18. CORRECTING SPILLOVER COSTS
P St
Spillover
costs
S
TAX
Overallocation
Corrected
D
0 Q0 Qe Q

19. CORRECTING SPILLOVER BENFITS
P
S
Spillover
Benefits
Dt
Underallocation D
0 Qe Q0 Q

20. CORRECTING SPILLOVER BENFITS
P Correcting by Subsidy to Consumers
S
Subsidy to
consumer
increases
demand
Dt
Underallocation D
Corrected
0 Qe Q0 Q

21. CORRECTING SPILLOVER BENFITS
P Correcting by Subsidy to Producers
Subsidy to St
producers
increases
supply
S’t
Underallocation
Corrected
D
0 Qe Q0 Q

22. A MARKET-BASED APPROACH
TO SPILLOVER COSTS
The Tragedy of the Commons
A Market for Externality Rights
•Operation of the Market
•Advantages
D 2004 S = Supply of
pollution
rights
Price per pollution right
$200
$100
D 2012
500 750 1000
Quantity of pollution rights

23. SOCIETY’S OPTIMAL AMOUNT
OF EXTERNALITY REDUCTION
Application of MC = MB
Rule
MC, MB Equilibrium
Optimal Reduction of an
Externality
Shifts in the Curves
Graphically…

24. SOCIETY’S OPTIMAL AMOUNT
OF EXTERNALITY REDUCTION
Society’s marginal benefit and marginal MC
cost of pollution abatement
Socially optimum
amount of
pollution
abatement
MB
0 Q1
Amount of pollution abatement

25. RECYCLING
Market for Recyclable
Inputs
Policy
•Demand Incentives
•Supply Incentives
Global Warming Theory

26. RECYCLING
Information Failures
Asymmetric Information
Inadequate information …
about sellers
about buyers
Moral Hazard Problem
Adverse Selection Problem
•Workplace Safety

27. cost-benefit analysis
marginal-cost – marginal-benefit rule
externalities
Coase theorem
tragedy of the commons
market for externality rights
optimal reduction of an externality
asymmetric information
moral hazard problem
adverse selection problem
Copyright McGraw-Hill/Irwin, 2005 BACK END

28. Public Choice Theory
And
The Economics of Taxation
Chapter 31