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By
Karl E. Case,
Ray C. Fair &
Sharon M. Oster
2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster
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16
Externalities, Public
Goods, and Social Choice
Prepared by:
Fernando & Yvonn Quijano
2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster
Externalities, Public
Goods, and Social Choice
16
CHAPTER OUTLINE
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Other Externalities
Other examples of external effects are all around
us. When people drive their cars into the center of
the city at rush hour, they contribute to the
congestion and impose costs (in the form of lost
time and auto emissions) on others.
Clearly, the most significant and hotly debated
issue of externalities is global warming.
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Externalities
in athe
College
Dormitory
TheFIGURE
marginal16.2
benefits
to Harry exceed
marginal
costs he must bear to play his stereo system for a period of up to 8
hours. When the stereo is playing, a cost is being imposed on Jake.
When we add the costs borne by Harry to the damage costs imposed on Jake, we get the full cost of the stereo to the twoperson society made up of Harry and Jake.
Playing the stereo more than 5 hours is inefficient because the benefits to Harry are less than the social cost for every
hour above 5. If Harry considers only his private costs, he will play the stereo for too long a time from societys point of
view.
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Internalizing Externalities
Five approaches have been taken to solving the
problem of externalities:
(1)
(2)
(3)
(4)
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Firm A
Firm A
Firm B
Firm B
MC of reducing TC of reducing
Reduction of
MC of reducing
pollution for
pollution for
pollution by Firm B
pollution for
Firm A
Firm A
(in units of pollution)
Firm B
Firm B
TC of reducing
pollution for
Firm B
$ 5
$ 5
$ 8
12
14
22
21
23
45
12
33
35
80
17
50
50
130
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Samuelsons Theory
FIGURE 16.4 With Private Goods, Consumers Decide What Quantity to Buy; Market
Demand Is the Sum of Those Quantities at Each Price
At a price of $3, A buys 2 units and B buys 9 for a total of 11.
At a price of $1, A buys 9 units and B buys 13 for a total of 22.
We all buy the quantity of each private good that we want. Market demand is the horizontal sum of all
individual demand curves.
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Samuelsons Theory
FIGURE 16.5 With Public
Goods, There Is Only One
Level of Output and
Consumers Are Willing to
Pay Different Amounts for
Each Level
A is willing to pay $6 per unit for
X1 units of the public good. B is
willing to pay only $3 for X1 units.
Societyin this case A and Bis
willing to pay a total of $9 for X1
units of the good.
Because only one level of output
can be chosen for a public good,
we must add As contribution to
Bs to determine market demand.
This means adding demand
curves vertically.
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Samuelsons Theory
FIGURE 16.6 Optimal
Production of a Public Good
Optimal production of a public
good means producing as long
as societys total willingness to
pay per unit (DA+B) is greater than
the marginal cost of producing
the good.
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Samuelsons Theory
optimal level of provision for public goods The
level at which societys total willingness to pay per
unit is equal to the marginal cost of producing the
good.
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Mixed Goods
mixed goods Goods that are part public goods
and part private goods. Education is a key
example.
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Social Choice
social choice The problem of deciding what
society wants. The process of adding up individual
preferences to make a choice for society as a
whole.
The Voting Paradox
Impossibility theorem A proposition
demonstrated by Kenneth Arrow showing that no
system of aggregating individual preferences into
social decisions will always yield consistent,
nonarbitrary results.
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Social Choice
VP1
VP2
Dean
Resulta
A versus B
A wins: A > B
B versus C
B wins: B > C
C versus A
C wins: C > A
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Social Choice
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Social Choice
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Social Choice
Rent-Seeking Revisited
A monopolist would be willing to pay to prevent
competition from eroding its economic profits. Many
if not allindustries lobby for favorable
treatment, softer regulation, or antitrust exemption.
This, as you recall, is rent-seeking.
Theory may suggest that unregulated markets fail
to produce an efficient allocation of resources. This
should not lead you to the conclusion that
government involvement necessarily leads to
efficiency. There are reasons to believe that
government attempts to produce the right goods
and services in the right quantities efficiently may
fail.
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Coase theorem
market failure
drop-in-the-bucket problem
mixed goods
externality
nonexcludable
free-rider problem
nonrival in consumption
impossibility theorem
injunction
liability rules
logrolling
marginal damage cost (MDC)
marginal private cost (MPC)
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