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Economics and Society ECON 10040

Dr. Christopher Jepsen, D212 Part 4 – Externalities and Property Rights

Readings – Part 4
• McDowell et al. – Chapter 11

Equilibrium (Chapter 3)
• Supply = Demand Price • Intersection of supply and demand curves • MB = MC • Socially optimum outcome P* • No deadweight loss
Q*

S = MC

D = MB Quantity

Example – Chickens
• Suppose your neighbor is a morning person • He likes fresh eggs for his very early breakfast • He decides to raise chickens and sell the extra eggs

Chicken Example Continued • What does your neighbour care about? – Cost of raising chickens • Suppose you are not a morning person • Clucking wakes you up way too early! • Chickens create negative externality for you .

yet the first party neither bares the costs nor receives the benefits from doing so.Negative Externality • Book defines negative externality as “a cost of an activity that falls on people other than those who pursue the activity” • Another textbook: “Externalities arise whenever the actions of one party make another party worse or better off.” .

Production vs. Consumption • Production externality – external cost (benefit) created by producer • Consumption externality – external cost (benefit) is created by consumer • Which type is the chicken example? .

Marginal Damage • Marginal damage – additional cost above and beyond the private cost of each additional unit • What would you be willing to pay to make the clucking stop? .

Negative Production Externality • PMB = Private marginal benefit Price • SMB = Social marginal benefit • PMC= Private marginal cost P2 • SMC = Social marginal P1 cost • MD = marginal damage • SMC = PMC + MD This triangle is the deadweight loss SMC MD PMC D = SMB = PMB Qsoc Qpvt Quantity .

Having trades where SMC > SMB Price This triangle is the deadweight loss SMC MD Psoc Ppvt PMC D = SMB = PMB Qsoc Qpvt Quantity . Not having trades where SMB > SMC Or 2.Deadweight Loss (DWL) • DWL occurs when 1.

Types of Externalities • • • • Negative production externality Negative consumption externality Positive production externality Positive consumption externality .

Negative Consumption Externality Price This triangle is the deadweight loss Example: Smoking MD S = PMC = SMC D = PMB SMB Qsoc Qpvt Quantity .

Positive Consumption Externality Price This triangle is the deadweight loss Example: Landscaping MB S = PMC = SMC SMB D = PMB Qpvt Qsoc Quantity .

Positive Production Externality Example: Beekeeper Price This triangle is the deadweight loss PMC MB SMC D = SMB = PMB Qpvt Qsoc Quantity .

What is socially optimal Q? 4. What is the deadweight loss? 3. What type of externality is shown? 2.Practice Exam Questions 1. What Q will be produced? Price B SMC PMC A D = SMB = PMB C Q2 Q1 Quantity .

Solutions to Externalities • Government and private options exist • Examples: – Government regulation banning chickens in urban areas – Neighbour giving you free eggs to compensate for noise .

Government Solution • Regulation – no chickens in neighborhood DWL with ban Price DWL w/o regulation SMC MD PMC D = SMB = PMB Qsoc Qpvt Quantity .

More Government Solutions • Another option is to impose penalties / fines • Example – farmer pays penalties for every chicken that clucks before 8am • Will this work? • How much should fine be? .

Pigouvian Tax • Tax = MD • A tax moves production from Qpvt to Qsoc • But MD is hard to measure Price SMC MD PMC D = SMB = PMB Qsoc Qpvt Quantity .

Government Solutions • Government solutions also exist for positive externalities .

Positive Externality Solution (1) Price S = PMC = SMC MB • Give cash to everyone who receives flu shot • Cash = MB • Quantity increases from Qpvt to Qsoc SMB D = PMB Qpvt Qsoc Quantity .

Positive Externality Solution (2) Price S = PMC1 MB Subsidy PMC2 SMB D = PMB Q1 Q2 • Subsidize producers of flu shots • Subsidy = MB • Quantity increases from Qpvt to Qsoc Quantity .

Private Solutions • Consider again our chicken example • Suppose government does not intervene Price SMC MD PMC D = SMB = PMB Qsoc Qpvt Quantity .

Private Solutions Continued • How could you and your neighbour work out private solution? – What incentives could you provide? • Without tax. neighbour has little incentive to reduce production .

Private Solution – Pay (1) • You could pay your neighbour not to raise chickens • Scenario #1: – Neighbour’s benefit from chickens = €500 – Your cost from chickens = €800 • What should you do? .

Private Solution – Pay (2) • Scenario #2: – Neighbour’s benefit from chickens = €1000 – Your cost from chickens = €800 • What should you do? .

they can always arrive at efficient solutions to problems caused by these externalities.” .Coase Theorem • Ronald Coase (University of Chicago) won Nobel prize in 1991 • “If people can at no cost negotiate the purchase and sale of the right to perform activities that cause externalities.

your neighbour paying you is efficient . paying your neighbour is efficient • In scenario #2.Efficiency • Inefficient – can make one or more person better off without harming anyone • In scenario #1.

Property Rights • The allocation of property rights is important • Does your neighbour have the right to noisy chickens? • Do you have the right to peace and quiet? .

Book Example – A & F Gains to Abercrombie Gains to Fitch With filter €100 / day €100 / day Without filter €130 / day €50 / day • Abercrombie owns textile factory by river • Fitch is a fisherman on the river • Abercrombie pollutes river – Installing a filter would eliminate pollution .

#1 – A. Has Property Rights and Transactions are Very Costly Gains to Abercrombie Gains to Fitch With filter €100 / day €100 / day Without filter €130 / day €50 / day • What is the equilibrium? – No filter – Total output of €180 / day – Efficient? .

#2 – A. Has Property Rights and Transactions are Costless Gains to Abercrombie Gains to Fitch With filter €100 / day €100 / day Without filter €130 / day €50 / day • What is equilibrium? – Fitch pays Abercrombie to install filter – How much? – Efficient? .

#3a – Fitch Has Property Rights and Transactions are Very Costly Gains to Abercrombie Gains to Fitch With filter €100 / day €100 / day Without filter €130 / day €50 / day • What is the outcome now? .

#3b – Fitch Has Property Rights Gains to Abercrombie Gains to Fitch With filter €100 / day €100 / day Without filter €150 / day €70 / day • Assume transactions are costless • What is the outcome? – Who pays whom? – How much? – Efficient? .

Optimal Amount of Externalities • Suppose externality is pollution • Efficient amount is Qsoc • Q = 0 is not efficient Price This triangle is the deadweight loss SMC MD Psoc Ppvt PMC D = SMB = PMB Qsoc Qpvt Quantity .

Lack of Property Rights • What happens when property rights for valuable resources are not assigned? – Fish in Atlantic ocean – Wild animals in Africa • Usually. resource is overexploited and wasted .

opportunity costs not considered • Example of externality .Tragedy of the Commons • “The tendency for a resource that has no price to be used until its marginal benefit falls to zero.” • Without property rights.

7: Atlantic salmon stocks – EU Common Fisheries Policy – Stocks depleted – Why? .“Tragedy” Example – Irish Salmon • Example 11.

Tragedy of the Commons – Solutions? • EU now has strict quotas on fishing • Elephant poaching problem in Africa – Ivory is valuable resource – Some countries outlaw hunting – Others privatise ownership .

“Tragedy” Challenges • What to do when private ownership is impractical? – Timber on remote public land – Whales in international waters – Multinational environmental pollution .

What is equilibrium w/o transaction costs? . What is equilibrium with transactions costs? 2. What is equilibrium with transactions costs? 4. What is equilibrium w/o transaction costs? Suppose John has property rights 3.Practice Exam Questions Dog externality example With dog Without dog Gains to Bill €90 / day €130 / day Gains to John €100 / day €70 / day Suppose Bill has property rights 1.