- 1. Economic Analysis and Public Policy Session 1 Introduction
& Overview Christopher Grandy 6/13/11
2. 3. Purpose of the Course
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- Acquire a working knowledge of economic concepts important to
public policy analysis.
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- Explore the process and issues related to economic public
policy analysis.
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- Give you experience: Develop your own analysis of a public
policy issue of interest to you.
4. Course Overview Syllabus 5. Readings
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- Main Text: Weimer and Vining (WV)
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- Ronald Coase (Externalities)
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- Christopher Grandy (efficiency)
Readings on policy method assigned on: 6/13-14 Information
Gathering (Ch. 14) 6/21 Goals-Alternatives (Ch. 15) 6.
Assignments/Grades
- Project: Conduct a policy analysis on any issue (but approved
by me).
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- First Report due afternoon of June 16.
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- Second Report due afternoon of June 24.
7. Main Points for This Session
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- Nature of policy analysis
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- What does a policy analysis usually look like?
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- These are the SAME elements you should have in your
analysis.
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- Example of Outline of assignment
8. Main Elements of Policy Analysis
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- Description of the problem
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- Why is government policy necessary? How have private markets
failed?
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- History of past policy responses
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- Policy Goals: What should we be trying to achieve?
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- How do Alternatives compare with respect to goals?
9. Main Elements of Canadian Salmon Fishery Example
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- Description of the problem
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- Fish catches and stocks have declined. Incomes have fallen.
Threats of elimination of salmon in Canada.
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- Prior analysis indicates large potential net present value of
fishing.
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- Why is government policy necessary? How have private
arrangements/markets failed?
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- Open access to fishing areas and difficulty of excluding
participants.
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- Public Good problem: Over use of resource threatens
depletion
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- History of past policy responses
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- Early History: Brief, ineffective attempts to license
fishers.
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- Overcapitalization: Too many resources devoted to fishing.
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- Gradually restricting entry through licenses
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- Unsuccessful buy-back of licenses (led to further investment by
incumbents).
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- Suggested tax on salmon catch to lower return and reduce
overcapitalization.
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- Buy back and auction licenses.
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- Voluntary buy back of licenses.
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- Area licensingmethods of fishing confined to certain
areas.
10. Main Elements of Canadian Salmon Fishery Example
(continued)
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- Policy Goals: What should we be trying to achieve?
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- Efficient use of economic resources.
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- Policy Alternatives: What might we try?
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- Adopt Pearse Commission proposals
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- Buy-back of licenses to reduce capacity by 50%.
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- River-Specific Exclusive Ownership
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- Assign fishing rights to single owner for 25 years.
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- Compensate existing owners of fishing licenses.
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- Individual Transferable Quotas
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- Fishers allocated quotas as percentage of estimated total
catch.
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- May be transferred (sold) to others.
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- How do Alternatives compare with respect to goals?
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- Balancing effects on efficiency, fairness and political
feasibility: River-Specific Exclusive Ownership
11. Notes for Your Project
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- Limitations and Responses
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- Unless already familiar with issue, cannot do extensive
literature review.
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- Instead, identify potentially useful literature (list).
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- Unless already familiar with issue, cannot do extensive
history
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- Instead, outline major history as you understand it (perhaps as
summarized in a previous analysis (cite)).
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- Cannot gather data to do cost/benefit analysis
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- Instead, list the major components of costs and benefits and
indicate possible sources of data/information.
12. Policy Analysis Compared to Other Approaches
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- For comparison, consider possible approaches from other
analytical perspectives:
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- Development of concept of common resource problems
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- Outcome of public decision process as illustration of class
power.
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- Estimating the behavioral response to taxing fishing
licenses.
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- Surveying fishers about what compensation is considered
acceptable.
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- Defining societal goals for fishery (and other natural
resources?) and rules for achieving those goals. Sustainability
guidelines?
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- How to efficiently carry out the mandates of decision-makers
(e.g. the legislative process)Managing the process of moving to
exclusive river-specific ownership.
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- How to participate in, as well as support, the public
decision-making process and implement its outcomes.
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- Telling a good storyidentifying victims, heroes, and villains
in the public decision-making process.
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- Client-oriented assessment of problems and alternatives with
goal of coming to a reasoned recommendation.
13. A Second Example: Traffic Congestion in Khon Kaen
- Will use this topic as an example throughout the course.
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- Description of the problem
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- Why is government policy necessary? How have private
markets/arrangements failed?
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- History of past policy responses
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- Policy Goals: What should we be trying to achieve?
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- How do Alternatives compare with respect to goals?
14. Next Time
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- Competition & Economic Efficiency
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- Gathering Information for Policy Analysis
15. Economic Analysis and Public Policy Sessions 2 and 3
Competition & Efficiency Gathering Information Christopher
Grandy June 13-14, 2011 16. Main Points for These Two Sessions
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- Under certain assumptions, competitive markets lead to an
efficient allocation of resources, and
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- Competitive markets maximize social surplus (the sum of
consumer and producer surpluses).
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- Under these assumptions there is relativelylittlerole for
public policy to improve social welfare.
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- Several critiques of the efficiency of markets worth
consideringespecially coercive relationships.
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- Ideas for gathering information to do policy analysis.
17. Efficiency
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- Pareto Efficiency: An allocation isPareto Efficientif there is
no way to reallocate resources so as to make one person better off
without hurting another.
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- Better off means that the person would prefer the new
allocation to his/her existing allocation.
18. Illustration of Pareto Efficiency Person A Person B 0 0 Moo
Satay Pad Thai Set of Pareto Efficient Allocations 19. Competitive
Markets & Efficiency
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- Competitive Markets: People take prices as given (they do not
act as though they can affect prices).
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- Buying and selling in markets at these prices leads to Pareto
Efficient allocations of resources.
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- A price is a rate of exchange of one good in terms of another
(e.g. A price of 30 means you give up 30 baht in exchange for one
dish of pad thai. Or 5 for one moo satay. This implies a price of 6
(moo satay for pad thai), meaning that you give up 6 moo satay in
exchange for 1 pad thai).
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- Can think of a price as the slope of a line in our graphs.
20. Illustration of Competitive Markets & Pareto Efficiency
Person A Person B 0 0 Moo Satay Pad Thai 21. Bottom Line Because
each person is doing as well as s/he can (each is on the highest
indifference curve possible) GIVEN the starting position and the
price, there is NO role for policy in improving this allocation of
resources without hurting one of the participants. 22. Exercise
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- Read and discuss the instructions for your group, making sure
that everyone understands.
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- Do NOT reveal your instructions/information to the other
group.
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- Discuss possible trades, exchanges with the other group in an
attempt to better your position.
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- You may make more than one exchange.
23. Consumer Surplus
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- Useful for later discussion to express some of these ideas in
terms of supply and demand curves.
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- Look first at demand curvesa relationship between the price of
a good and the amount that consumers are willing to purchase.
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- Consumer surplus: The value that consumers place on a good in
excess of the price they pay for it. Can be represented as the area
between the demand curve and the equilibrium price.
24. Illustration of Consumer Surplus Price Quantity D P 0 Q 0
Consumer Surplus 25. Producer Surplus
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- On the producer side, the relationship between price and the
amount producers are willing to provide is summarized in the supply
curve. The supply curve can be thought of as the cost of providing
different amounts of the good.
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- Producer Surplus: The value that producers receive in excess of
their cost. This is the area above the supply curve but below the
price.
26. Illustration of Producer Surplus Price Quantity P 0 Q 0 S
Producer Surplus (also called rent) 27. Social Surplus
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- In a particular market, the sum of the two surpluses is called
the social surplus. It is a measure of the aggregate benefits to
individuals on both sides (buyers and sellers) of the market.
28. Illustration of Social Surplus Price Quantity D P 0 Q 0 S
29. Welfare Implications of aPrice Change
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- Either an increase or decrease in price will reduce both
consumer and producer surplus relative to an initial position.
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- The resulting change in social surplus provides a measure of
the gain or loss due to the change.
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- Useful in beginning to estimate the desirability of a policy
that leads to a change in price.
30. Illustration of Change in Social Surplus Due to Price
Reduction Price Quantity D P 0 Q 0 S P 1 Q 1 Loss in Social Surplus
(Mainly due to loss in producer surplus) 31. Point
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- With competitive markets, the equilibrium prices and quantities
tend to maximize social surplus.
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- That equilibrium is a Pareto Efficient point.
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- NOTE: There are many other Pareto Efficient points, but it will
generally be impossible to move from one to another without
reducing the welfare of at least one person.
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- Again, given the assumptions of a competitive market, there is
no role for policy to unambiguously improve the allocations of
goods and services.
32. Exercise: How would we use consumer/producer surplus to
analyze market for kai satay?
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- What is current price of kai satay?
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- At what price would no one purchase kai satay?
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- What is the cost of supplying kai satay?
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- At what price would no kai satay be supplied?
Price Quantity Demand Supply 33. Role for Government
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- Markets (or, more generally, private arrangements) cannot
function without some government (collective action) support:
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- If it is possible (or not too costly) to simply take property,
rather than trade for it, then markets will fail.
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- Agreements often separated by timetime of delivery of a good or
service may differ from time of payment. If people can violate
(renege) on agreements, then no contracts (arrangements/trades)
will be made.
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- Laws, police, courts are critical societal institutions that
allow markets to function.
34. Example: Traffic Congestion in Khon Kaen
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- Goal: To move people and goods efficiently to their
destinations.
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- For competitive markets (private arrangements) to appropriately
handle traffic:
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- Competitive markets in infrastructure
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- Develop additional infrastructure?
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- Could markets improve traffic?
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- Everyone with right to travel that can be traded?
35. Project: Gathering Information
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- Distinction between document research (literature review) and
field research (interviews, surveys, etc.)
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- For this course you will mainly rely on document research
rather than field research.
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- Use Ch. 14 to help guide you in looking for resources on
potential topics for your project.
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- Remember: Because of limited time, I do NOT require an
extensive literature review. However, try to identify 4-5 important
items that seem relevant to your project.
36. Next Time
37. Economic Analysis and Public Policy Sessions 4 and 5 Market
Failures I: Public Goods & Externalities Christopher Grandy
June 14-15, 2011 38. Main Points for These Sessions
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- One way to start to think about a policy issue is to ask: Why
doesnt the market allocate this good/service efficiently?
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- Notice that this assumes that markets are a good way to
allocate goods.
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- Two important reasons why markets fail to allocate resources
well:
39. Rivalry and Excludability
- Two characteristics of many goods and services that make them
well-suited to allocation by the market.
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- Rivalry: One persons consumption reduces the amount available
for another person to consume.
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- For example, clothing, housing, food, computers, and so
on.
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- Prevents possibility that a person consume a good that another
person pays for and consumes (free riding).
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- Excludability: Relatively easy to prevent someone from
consuming the good/service.
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- For example, attempting to take any of the items above from a
store without paying will lead to arrest.
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- Assures that a private supplier will be paid.
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- Note that this illustrates one role of government in supporting
the allocation of goods and services via the marketenforcing
property rights.
40. Public Goods Public Goods are those that lack either rivalry
(they are nonrivalrous) or excludability (they are nonexcludable)
or both. Consider these examples: 41. Public Goods: Type I Rivalry
& Nonexcludability
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- Fresh Water: We all need water to live, so there is potentially
a huge market for it.
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- Water is rivalrous: My consumption of a certain quantity of
water reduces the amount available for someone else to
consume.
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- Water flowing in a river or underground is nonexcludable: In
general, it is difficult or impossible to prevent someone from
consuming such water.
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- Leads to the overconsumption of waterthe concern that others
will use the water if you do not gives people little incentive to
conserve and there is insufficient investment in preserving the
available supply.
42. Public Goods: Type I Rivalry & Nonexcludability Quantity
of Fresh Water Price of Fresh Water D MPC Includes the cost of
gathering and transporting the water and the reduction in stock of
water for this individual only. MSC Includes cost of gathering and
transporting, but also reflects reduction in stock of water
available to all. Q P P P Q S P S Socially optimal consumption
Equilibrium private consumption 43. Potential Policy Response
Public Goods: Type I Rivalry & Nonexcludability
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- Charge a per unit tax that equals the difference between MPC
and MSC.
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- This raises the MPC curve to coincide with the MSC curve.
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- Leads people to account for their effects on the total
supplyand so, to conserve.
D MPC MSC Q P P P Q S P S Tax 44. Type I Public Good (R, NE)
asPrisoners Dilemma
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- Two households sharing a single well.
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- If both cooperate and conserve water, then each gets 100 Utils
(measure of utility (happiness)).
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- If one conserves while other does not; conserver gets 80 Utils
and non-conserver gets 110 Utils.
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- If neither conserves, then each gets 90 Utils.
Household 1 Household 2 Conserve Conserve Do Not Conserve Do Not
Conserve 100 100 80 110 110 80 90 90 Do Not Conserve is a dominant
strategy for each player. Socially optimal result is Conserve. Nash
Equilibrium is Do Not Conserve. 45. Public Goods: Type II
Nonrivalry & Excludability
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- Consider a toll road (without congestion):
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- Nonrivalrous: In the absence of congestion, your consumption of
the road does not reduce the amount that is available for others to
consume.
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- Excludable: Access to the road only available if toll
paidpreventing consumption.
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- Because it doesnt cost any more to supply another person (no
congestion), the marginal price of the lecture should be zero. But
at that price no one would be willing to supply it.
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- If a positive price is charged, then there is underconsumption
of the roadanother traveler could use the road at no additional
cost.
46. Two Notes on Nonrivalry
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- Leads to a distinction between the cost of supplying an
additional person versus the cost of supplying an additional unit
of the good.
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- With a private good (rival and excludable), in order to supply
an additional person with the good, one must supply an additional
unit of the good.
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- With a nonrival good, the same quantity can supply many people.
So, an additional person can be supplied at no additional
cost.
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- Requires a different method of moving from individual to market
demand.
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- With a rival good, we sum over quantity
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- With a nonrival good, we sum over price
47. Market Demand forRival and Nonrival Goods Rivalrous Good Q P
D 1 D 2 D P Q Nonrival Good D 1 D 2 D Market Demand is
thehorizontalsum (over quantity) of individual demand Market Demand
is theverticalsum (over price) of individual demand 48. Public
Goods: Type II Nonrivalry & Excludability Toll Number of
Travelers D S When toll road is not congested, supply exceeds
demand at a zero price. Everyone can travel for free. But how is
the toll road paid for? Charge a toll and accept underconsumption?
Tax everyone & allow all to travel?0 49. Public Goods: Type II
Nonrivalry & Excludability w/ Congestion Toll Number of
Travelers D At some point, each additional traveler imposes costs
on others.A fee reflecting those costs may be appropriate. But this
does NOT solve the problem of how to pay for toll road itself. 0 S
P 0 50. Public Goods: Type III Nonrivalry &
Nonexcludability
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- Nonrivalrous: Ignoring congestion, one persons watching the
display does not reduce the amount available to others.
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- Nonexcludable: Cannot prevent someone from looking at the sky
and watching the display.
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- At a positive price, there is underconsumption.
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- Because of nonexcludability, no one is willing to supply the
good.
51. Public Goods: Type III Nonrivalry & Nonexcludability
Fireworks Price D 1 D 2 D 3 Total Demand Supply
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- Optimal provision of fireworks is at Q* where marginal cost
(supply) equals total demand.
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- If knew each persons individual demand, then could charge
individual prices.
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- Since we dont know individual demand, could tax to supply the
good.
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- But then some people will be unhappy
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- D1 doesnt want any of the good
Q* tax 52. Exercise
- Determine whether the following are public goods and, if so,
what kind [(R, NE), (NR, E), (NR, NE)]:
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- Information from an online search engine
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- Transportation on a train
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- Opihi (small, edible shellfish collected on the shore)
53. Example: Traffic Congestion
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- A congested road possibly the result of an initial Type III
public good (nonrival and nonexcludable).
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- A newly-built road likely to have enough capacity for all
current users. Thus, nonrival: one persons use of the road does not
reduce the amount available to another (measured in terms of
transit time).
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- With multiple, public accesses, the road is effectively
nonexcludabledifficult, or impossible, to prevent additional
travelers.
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- Over time, as population grows and/or economy develops, the
road becomes congested. Now the road is Type I (rival,
nonexcludable).
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- Converting the road to a toll road is one optionexcludability
can reduce congestion.
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- In New York City (Manhattan) 20 years ago, flat toll to drive
into city across George Washington Bridge.
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- Today, time-of-day pricing: $8 ( 240) during peak hours and $6
( 180) during non-peak hours.
54. Externalities
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- A divergence between private and social characteristics of a
market:
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- Anegativeexternality involves a divergence between private and
social cost. Implies overproduction of the good/service.
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- Pollution from a manufacturing facility.
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- Apositiveexternality involves a divergence between private and
social benefits. Implies underproduction of the good/service.
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- Educating children and socialization.
55. Negative Externality: Manufacturing w/ pollution side-effect
Quantity of Manufactured Goods Price Demand
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- MPC reflects only the costs recognized by the company. If the
company ignores pollution, then these costs will fall below
Marginal Social Cost.
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- Too much is produced if the firm utilizes MPC.
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- May force the firm (or consumers) to bear the cost by imposing
a tax on the manufactured good.
MPC (excluding costs of pollution) MSC (including costs of
pollution) Q p Q* 56. Positive Externality: Education Education P S
MPB MSB If parents only pay attention to the benefits to them of
educating their child, then they are on the Marginal Private
Benefit curve, and will choose education level E 0 . However, if
education has positive socialization effects (encouraging
cooperation, less violence, etc.), then there are benefits which
accrue to others. And MSB is the relevant curve. The optimal level
of education is then E*. The parents dont spend enough on education
at E 0 . May justify public subsidies for education. E 0 E* 57.
Externalities & the Coase Theorem
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- Ronald Coase won the Nobel Prize in Economics in 1991in part,
for work which has become known as the Coase Theorem.
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- Suppose that a farmer and a cattle rancher operate in close
proximity to one another so that occasionally straying cattle will
trample some of the crops.
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- This can be viewed as a negative externality between producers.
Traditionally this has been seen as a situation in which government
policy must address the issueperhaps by imposing a tax on cattle
production.
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- Coases insight: The farmer and the cattle rancher could
negotiate a solution(1) the farmer could pay the cattle rancher to
raise fewer cows, (2) the rancher could pay the farmer to plant
elsewhere, (3) the two could share the cost of a fence, etc.
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- Moreover, Coase argued that the pattern of planting and cattle
raising would be the same regardless of the solution negotiated.
Indeed, the pattern would be the same irrespective of whether the
farmer had the right to be free from cattle or the cattle rancher
had the right to allow foraging. The trick is that the two have an
incentive to maximize joint production.
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- Solution requires low transaction coststhe costs associated
with bargaining and coming to an agreement.
58. Exercise: Which of the following are externalities?
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- Neighbor paints house (nice color)
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- Neighbor allows tree to grow, obstructing view
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- To reduce global warming, national government joins
international treaty committing to end use of petroleum products by
2025.
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- New technology for making clothing puts professional tailors
out of business.
59. Example: Traffic Congestion
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- On a congested road, each additional traveler imposes an
external cost on the travelers behind.
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- Person decides whether to travel based on cost to
him/herincluding delays from congestion ahead.
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- But typically fails to see cost he/she imposes on those
behind.
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- Imposing a toll can internalize the negative externality.
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- Other negative externalities from traffic:
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- Air pollution in the local neighborhood.
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- CO2 emissionsglobal warming.
60. Next Time
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- Other Problems with Markets