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Today Review table on monopolistic competition Externalities—Ch. 30
Today
Review table on monopolistic competitionExternalities—Ch. 30
Table 1a
Perfect Comp Monopolistic Competition
Monopoly
Firms are price takers Firms are price makers
Firms are price makers
Choose q where P=MC Choose q where MR=MC
Choose q where MR=MC
In SR, P AVC in order to produce.
In SR, P AVC in order to produce.
In SR, P AVC in order to produce.
In LR, P ATC in order to produce.
In LR, P ATC in order to produce
In LR, P ATC in order to produce.
Firms face perfectly elastic demand for their product.
Firms face downward-sloping market demand.
Firms face downward-sloping market demand.
Table 1b
Perfect Comp Monopolistic Competition
Monopoly
No profits or losses in LR
No profits or losses in LR
May have profits in LR
No barriers to entry or exit
Barriers to Entry Barriers to Entry
Firms produce at lowest possible LRAC
Produce on downward-sloping portion of LRAC
May or may not produce at lowest possible LRAC
In LR equilibrium, P = MC
In LR equilibrium, P > MC
In LR equilibrium, P > MC
Table 1c
Perfect Comp Monopolistic Competition
Monopoly
No need for advertising, goods are homogeneous
Advertising may increase demand for product
Advertising may increase demand for product
Brand name is unimportant to consumers
Brand name is often very important
Only one brand to choose from
Externality
When an individual course of action affects others beyond the amount considered by that individual.
Negative externality
The individual course of action imposes costs on others.
Example: Bob’s smoking
Costs to Bob Cost of cigarettes Cost to own health Cost of keeping home and clothes clean
Costs to others from Bob’s smoking Health costs from second-hand smoke Cost of cleaning home, clothes Increased price of health insurance due to inclusion
of smokers in group rates.
Social Costs
The social cost of the activity is the private cost plus the external cost.
The social cost of one person smoking includes the costs to the smoker plus the costs to others.
Social Benefits
The social benefits are equal to the private benefits plus any external benefits.
Assume no external benefits from Bob smoking. Note: if there are external benefits, that is a
positive externality, see below.
Then the social benefits of Bob smoking are just the private benefits that Bob gets.
Marg.Ext. Cost
Costs versus Benefits$/Cigarette
Marginal Private Cost (to Bob)
Marginal Social Cost (to Bob & to others)
Marginal Benefit (Bob)
How much will Bob smoke?How much is optimal?
Bob’s choice versus society’s
Cigarettes/day
Marginal Private Cost
Marginal Social Cost
Marginal Benefit How can society get Bob (& others) to smoke less?
Bob’s choice
Optimalfor society
Social costs exceed benefits.
$/Cigarette
A Tax to Correct Negative Externalities
Society wants Bob to internalize the external costs of his smoking.
One way to do that is to tax cigarettes.The amount of the tax per cigarette should
equal the costs to others from Bob’s smoking.
Tax per cig.
A Tax on Cigarettes
Cigarettes/day
Marginal Private Cost
Marginal Social Cost =Marg. Private Cost + taxMarg. Private Cost + tax
Marginal Benefit
Use a tax to force Bob to pay the full costs of his smoking.
Bob’s choice if
taxed
Optimal
$/Cigarette
Pollution as a Negative Externality
Industrial production often creates pollution of air or water as a by-product.
Public policy options for dealing with pollution Ban pollution Tax pollution Establish maximum rates of pollution per firm Issue a limited number of permits to pollute, allow
them to be traded. (Used for CO2 in US)
The Tragedy of the Commons
Why is the copier always out of paper or in a paper jam?
“The Commons”
Historically, refers to common grazing land for a town.
In economics, refers to any situation in which a resource is used by many people, none of whom owns the resource.
What happened in “The Commons”?
The private cost of grazing your sheep in the commons was zero.
The social cost wasn’t, because once your sheep ate the grass, it wasn’t there for the next farmer.
The commons were routinely over-grazed, because nobody had an incentive to make sure the grass had time to grow back.
Current “Tragedies”
Fishing in the ocean There are no property rights to fishing grounds in
international waters. Fisherman have no incentive to let the population recover.
The shared copier The cost of fixing the paper jam is higher than the
benefits one person expects to get out it. Tendency to move on to another machine, or wait
until someone else fixes the problem.
Other Tragedies
Air Quality We drive our cars without regard to the marginal cost
to society of the air pollution. Gasoline taxes help.
Use of Outer Space Without some sort of controls, likely to see so much
debris and so many satellites that the use of space is impaired.
Public restrooms
Positive externality:
The individual course of action imposes benefits on others.
The social benefit of an activity is greater than the private benefit.
Examples of Positive Ext.
Education: Makes people better citizens. These benefits are in addition to the private benefits.
Attractive architecture, landscaping, etc. at your house increases the value of the neighbors’ houses.
Vaccinations: When one person is vaccinated, it helps the rest of us because we are less likely to catch the disease.
The Role of the Government & Externalities
Governments can use taxes to discourage activities with negative externalities.
They can use subsidies to encourage activities with positive externalities.
Government Regulation
Planning commissions or architectural review boards are used to create positive externalities rather than negative ones.
Commercial activities tend to be zoned separately from residential neighborhoods.
Property owners may be required to preserve historic buildings or to complement existing buildings.
Coming Up
Review for third midterm exam
Group Work-Externalities
List 3 examples of negative externalities (not already mentioned in class). How does society address each?
List 3 examples of positive externalities (not already mentioned in class). How does society address each?
Write out your answers.
