MarketFailureWhenthemarketdoesnotefficientlyallocateresourcesMonopolyExternalitiesPublicgoodsImperfectInformationMarketFailureJustificationforgovernmentintervention?Necessary,butnotsufficientWhendecisionmakersdonotconsiderallcosts(orbenefits)oftheiractionsTwoviewsExternalitiesRonaldCoase(1910-2013)A.C.Pigou(1877-1959)PigouvianApproachSocialCost=PrivateCost+ExternalCostPriceofbeerHangoverDamagetoothersBoorishbehaviorDrinkingAlcoholCashmereExternalitiesPollutionFreeMarket:P1,Q1OptimalOutcome:P*,Q*cashmere$D1SprivateQ1P1P*Q*SsocialExternalcostHowcansocietyachievesocialoptimum?Imposetax=marginalexternalcostFreemarketoverproducesgoodsthatgenerateanegativeexternalityInternalizetheexternality!“Pigoutax”GettingaticketforexceedingthespeedlimitNotstudyingasmuchforyourecontestasyoushouldhavesoyougetalowergradethanyouwantAllowingyourcellphonetoringinclassGettingafluimmunizationshotWhichofthefollowingisanexampleofanegativeexternality?1ExternalitiesareduetoincompletepropertyrightsassignmentCoasianApproachMassiveCoalCoasianApproach

CoaseTheoremIfpropertyrightsarewell-definedandtransactionscostsarelowenough,thenprivatebargainingcanresultinanefficientoutcome.

CorollaryEfficiencydoesnotdependoninitialassignmentofpropertyrights.ExternalitiesareduetoincompletepropertyrightsassignmentPollutionRevisitedMassiveCoalCheshire,Ohiov.AEPAEPpaid$20milliontobuythe221-residenttownin2002Afactory'sproductionprocesscreatessludgethatpoursintoariver.Thissludgemakesitdifficulttofishintheriver,increasingthecostsofthelocalfishermenby$5000.Thefactorycaninstallawaterfiltersystemfor$4100,andthefishermencanutilizeaweightedfishingnetsystem(togetunderthesludge)for$3250.Bothsystemswouldremedythesludgedamagetothefishermen.Whatoutcomewouldyouexpectunderthefollowingconditions:Transactionscostslowandfactoryisnotliablefordamage?Transactionscostslowandfactoryisliablefordamage?Transactionscostshighandfactoryisliablefordamage?FactoryFilter:$4100Nets:$3250Damage:$5000Whichsystemisusedandwhopays?CharacteristicsofGoodsRivalNon-RivalExcludableNon-ExcludablePrivateGoodsCommonResourcesPublicGoodsClubGoodsNeighborhoodParkFundTakeoutasheetofpaperandtearitinto8smallsquares.Putyourinitialsoneachsquare.VCMGovernmentProvidedGoodsandServicesSchoolsRoadsPoliceCourtsFireDepartmentWaterLibraryHealthCareTransportationNationalDefenseSocialSecurityMedicarePostalServiceFBI,CIA,SEC,FTC,FCC,NSF,FDA,FDIC,HUD$680bPercapitaexpenditurePublicGoodsNon-rivalandNon-excludableSubjecttoa“free-rider”problemSocialOptimumOutputcanonlybeprovidedatonelevelforallMustfindsomewaytoaggregateindividualMBOptimumrequires:MSB=MSC012345Thetablebelowshowsthemarginalbenefitfromsubmarinesfortheonlytwocitizensofacountry.Submarinesareapublicgood.Ifsubmarinescost$145apiecetoproduce,whatistheefficientquantityofsubmarines?JacobMeiLiMarginalbenefit(dollarspersub)QuantityMarginalbenefit(dollarspersub)--0--10011507521005035025410050CommonResourcesNon-excludableRivalinconsumptionAfricanElephantFishBisonTrafficWi-Finetworks“Tragedyofthecommons”"WhywouldItoleratelivingorcoexistingwithanelephantthatissodestructive?"saysthevillagechief."Itdestroysourcrops,ourfields,ourtrees,ourenvironment.Itisbecauseofthevalueassociatedwiththeelephant

thatmakesuscoexistwithit."ApileofAmericanbisonskullsinthemid-1870s1980:1.3m1990:0.6mGlobalCaptureofAtlanticCod(tonnes)ClickerReviewEatingahamburgertosatisfyyourhungerSmokingacigaretteonadesertedislandAllowingyourcellphonetoringinclassGettingafluimmunizationshotWhichofthefollowingislikelytogenerateapositiveexternality?1ElizashouldpayLiting$400sothatshemaykeephercat.ElizashouldpayLiting$350topurchasehertissuesandallergymedication.LitingshouldpayEliza$325togivehercataway.Litingshouldmove.Eliza’scatcausesLitingtosneeze.Elizavaluesthecat’scompanionshipat$300peryear.ThecosttoLitingoftissuesandherallergymedicationis$350peryear.BasedontheCoaseTheorem,3$300,thebenefittothemiddlefamily$100,thebenefittothefamilythatvaluesittheleast$500,thebenefittothefamilythatvaluesitthemost.$1,500,thesumofthebenefitstoeachofthefivefamiliesAsmalltownoffivefamiliesisconsideringhavingafireworksdisplay.Thevalueofthedisplaytoeachfamilyis:$100fortheChens,$200fortheWangs,$300fortheAdairs,$400fortheGormans,and$500fortheJurgens.Thevalueofthepublicgoodisequalto4apurepublicgoodaprivategoodanimperfectpublicgoodbecauseofrivalryinconsumptionanimperfectprivategoodbecauseofnon-excludabilityMylesfindsthatwhenalotofpeopleareloggedontohiscollege'sInternetserver,ittakesmuchlongerforhimtodownloadhishomeworkassignmentsfromtheInternet.Accesstothecollegeserverisanexampleof5thecowisraisedindevelopedcountries,whiletheelephantlivesprimarilyinless-developedcountries.cowsareprivategoods,whileelephantstendtoroamfreelywithoutowners.cowsandelephantsarepublicgoods,butivoryisnonrival.ivoryisnonrivalandnonexclusive,butbeefisrivalandexclusiveThecommercialvalueofivoryisathreattotheelephant,butthe