Professional Documents
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Marc Sangnier
marc.sangnier@univ-amu.fr
1 Introduction
2 Public goods
3 Externalities
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Public Economics - Lecture 4: Public goods and externalities
Introduction
1 Introduction
2 Public goods
3 Externalities
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Public Economics - Lecture 4: Public goods and externalities
Introduction
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Public Economics - Lecture 4: Public goods and externalities
Public goods
1 Introduction
2 Public goods
Definitions
Canonical model and Samuelson rule
Decentralized private provision and Lindhal equilibrium
Voting on public good provision
Crowding out
Distortionary taxation
More on public goods
3 Externalities
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Definitions
N
X
xi ≤ X ,
i=1
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Definitions
x2
Pu
bl
x2 = X
ic
go
od
x 2 ivat
x1 = X
= eg
Pr
X
− od
x1
o
0 x1
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Definitions
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Definitions
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Definitions
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Definitions
Equilibrium production
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Canonical model and Samuelson rule
• N individuals, i = 1, . . . , N.
• Two goods: g and x .
• Individual i consumes good x in quantity xi .
PN
Total consumed quantity is i=1 xi = X.
• Individual i consumes good g in quantity gi .
PN
Total consumed quantity is i=1 gi = G.
• Utility of i is U i = U i (xi , gi ), with U i increasing in xi and gi .
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Canonical model and Samuelson rule
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Canonical model and Samuelson rule
∂U i
(
∂x = λ ∂F
∂x ,
∀i, ∂U i ∂F
∂g = λ ∂g .
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Canonical model and Samuelson rule
• This yields:
∂U i /∂g ∂F /∂g
∀i, i
= .
∂U /∂x ∂F /∂x
• Pareto allocations are such that the marginal rate of substitu-
tion of every individual is equal to the marginal rate of technical
substitution.
• From the first welfare theorem, we know that market equilib-
rium leads to such an allocation.
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Canonical model and Samuelson rule
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Canonical model and Samuelson rule
∂U i
(
∀i, = λ ∂F
∂x ,
PN ∂U i∂x ∂F
i=1 ∂g = λ ∂g .
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Canonical model and Samuelson rule
Samuelson rule
N
X ∂U i /∂g ∂F /∂g
= .
i=1
∂U i /∂x ∂F /∂x
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Canonical model and Samuelson rule
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Decentralized private provision and Lindhal equilibrium
Decentralized provision
• Assume each individual i uses its income yi to consume quantity
xi of private good and contribute to public good provision by
gi .
• Total quantity of public good is G = N
P
i=1 gi . Everyone enjoys
it.
• Each individual solves:
U i xi , N
P
max i=1 gi ,
s.t. xi + gi ≤ yi .
∂U i ∂U i ∂U i /∂g
∀i, = ⇔ = 1.
∂x ∂g ∂U i /∂x
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Decentralized private provision and Lindhal equilibrium
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Decentralized private provision and Lindhal equilibrium
Lindhal equilibrium
N
X
τi = 1;
i=1
G1 = . . . = GN.
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Decentralized private provision and Lindhal equilibrium
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Voting on public good provision
G
U i yi − ,G ,
N
• First order condition yields:
∂U i /∂U g 1
i x
= .
∂U /∂U N
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Voting on public good provision
1
MRSm = .
N
• Samuelson rule:
N PN i
i=1 MRS 1
X
i
MRS = 1 ⇔ = .
i=1
N N
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Voting on public good provision
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Voting on public good provision
Temporary conclusion
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Crowding out
Crowding out
Roberts, Russell D., 1984. “A Positive Model of Private Charity and Public
Transfers,” Journal of Political Economy, University of Chicago Press, vol. 92(1),
pages 136-48, February.
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Crowding out
Bergstrom, Theodore & Blume, Lawrence & Varian, Hal, 1986. “On the private
provision of public goods,” Journal of Public Economics, Elsevier, vol. 29(1), pages
25-49, February.
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Crowding out
∂U i /∂g
= 1.
∂U i /∂x
• There exists a unique Nash equilibrium.
• Implicitly define G ∗ such as all individuals optimize given others’
choice.
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Crowding out
N
X
τi = T .
i=1
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Crowding out
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Crowding out
xi
xi∗
gi
τi gi
G−i G∗ G
Z−i
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Crowding out
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Crowding out
Kingma, Bruce Robert, 1989. “An Accurate Measurement of the Crowd-Out Effect,
Income Effect, and Price Effect for Charitable Contributions,” Journal of Political
Economy, University of Chicago Press, vol. 97(5), pages 1197-1207, October.
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Crowding out
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Crowding out
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Crowding out
Hungerman, Daniel M., 2005. “Are church and state substitutes? Evidence from the
1996 welfare reform,” Journal of Public Economics, Elsevier, vol. 89(11-12), pages
2245-2267, December.
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Crowding out
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Distortionary taxation
Distortionary taxation
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Distortionary taxation
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Distortionary taxation
c = wl (1 − τ ) − T .
l ∗ = w 1/k (1 − τ )1/k ,
G = wl ∗ τ + T .
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Distortionary taxation
l k+1
W = wl (1 − τ ) − T − k+1 + v (G)
l ∗k+1
= wl (1 − τ ) − T − k+1 + v (wl ∗ τ + T )
∗
∂v (G) ∗
(G ) = 1.
∂T
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Distortionary taxation
∂W
∂τ =0
⇔ ∂l
−wl + w (1 − τ ) ∂τ ∂l
− l k ∂τ + v 0 (G ∗ ) wl + v 0 (G ∗ ) w τ ∂τ
∂l
=0
⇔ 0 ∗ ∂l
v (G ) w τ ∂τ = 0
⇒ τ∗ = 0
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Distortionary taxation
l k+1
W = wl (1 − τ ) − k+1 + v (G)
l ∗k+1
= wl (1 − τ ) − k+1 + v (wl ∗ τ )
∗
∂W
∂τ =0
⇔ ∂l
−wl + w (1 − τn) ∂τ ∂l
− l k ∂τ 0 ∗ 0 ∗ ∂l
o+ v (G ) wl + v (G ) w τ ∂τ = 0
⇔ −wl + v 0 (G ∗ ) wl + w τ ∂τ
∂l
=0
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Public Economics - Lecture 4: Public goods and externalities
Public goods
Distortionary taxation
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Public Economics - Lecture 4: Public goods and externalities
Public goods
More on public goods
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Public Economics - Lecture 4: Public goods and externalities
Externalities
1 Introduction
2 Public goods
3 Externalities
Definition
A simple model with externalities
Correcting externalities
Price versus quantities
Empirical measurement
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Definition
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Definition
Examples
• Pollution.
• Smoking:
Direct externality from “pollution”. Indirect (medium-term) ex-
ternality from health care.
• Tragedy of the commons:
Common right to access a resource leads to over-exploitation
and not to social efficiency because everyone only takes its own
profit into account and not the reduction in resource’s avail-
ability imposed to others.
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Definition
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Public Economics - Lecture 4: Public goods and externalities
Externalities
A simple model with externalities
U = u(x ) + y − d × P(x ),
W = u(x ) + W − c(x ) − d × x .
• Let p be the market price of good x .
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Public Economics - Lecture 4: Public goods and externalities
Externalities
A simple model with externalities
Market equilibrium
• The firm chooses x in order to maximize:
px − c(x ).
• Supply of good x satisfies:
c 0 (x ) = p.
• The consumer maximizes her utility, taking the level of pollution
as given:
u(x ) + W − px .
• Demand of good x satisfies: u’(x)=p.
• At the market equilibrium:
u 0 (x ∗ ) = p ∗ = c 0 (x ∗ ).
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Public Economics - Lecture 4: Public goods and externalities
Externalities
A simple model with externalities
Social optimum
W = u(x ) + W − c(x ) − d × x .
u 0 (x̄ ) = c 0 (x̄ ) + d.
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Public Economics - Lecture 4: Public goods and externalities
Externalities
A simple model with externalities
p
Private marginal cost
Social marginal cost
p̄
p∗
Marginal damage
0 x̄ x∗ x
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Public Economics - Lecture 4: Public goods and externalities
Externalities
A simple model with externalities
• Starting from x ∗ :
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Correcting externalities
Correcting externalities
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Correcting externalities
Coasian solution
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Correcting externalities
Coase theorem
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Correcting externalities
Illustration
c 0 (x ) + α = p.
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Correcting externalities
• Consumers maximize:
u(x ) + W − px − dz + αz.
u 0 (x ) = p
d =α
c 0 (x ) + d = p = u 0 (x ) ⇔ x = x̄ .
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Correcting externalities
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Correcting externalities
Pigouvian taxation
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Correcting externalities
p
Private marginal cost +t
Social marginal cost
Private marginal cost
p̄
pt t
p∗
Marginal damage
0 x̄ xt x∗ x
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Correcting externalities
Regulation
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Correcting externalities
• Set a total cap for the negative externality and allow polluters
to trade permits to pollute.
• Initial allocation of permits thanks to some auction-based mech-
anism.
• Hybrid of pure regulation and Coasian mechanism.
• In equilibrium, polluters with largest marginal cost of reducing
pollution will buy permits to others; those with low marginal
cost to reduce pollution will do so.
• If total number of permits is sets to achieve social optimum,
both allocative and productive efficiency will be achieved.
• Dynamic incentives to innovate because each firm face its own
marginal cost of pollution.
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Price versus quantities
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Price versus quantities
Remarks:
• Any externality model can be mapped into a model of costs
and benefits of externality variation.
• The previous model had a constant social marginal benefit of
pollution reduction d.
• Marginal costs of pollution reduction is the loss in surplus from
producing less, i.e. u 0 (x ) − c 0 (x ).
• Here, we keep on not considering other methods to reduce pol-
lution such as changes in technology.
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Price versus quantities
T̄
T∗
MB(Q) MB 0 (Q)
0 Q∗ Q̄ Q
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Price versus quantities
• Both policies (tax T̄ and cap Q̄) move the economy to the
same situation.
• Both are equally inefficient with respect to social optimum
(Q ∗ , T ∗ ).
• With this source of uncertainty, both are equivalent.
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Price versus quantities
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Price versus quantities
e MC (Q)
MC 0 (Q)
T∗
T̄
MB(Q)
0 QT̄ Q∗ Q̄ Q
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Price versus quantities
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Empirical measurement
Empirical measurement
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Empirical measurement
Road-accident externality
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Empirical measurement
Aaron S. Edlin & Pinar Karaca-Mandic, 2006. “The Accident Externality from
Driving,” Journal of Political Economy, University of Chicago Press, vol. 114(5), pages
931-955, October.
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Empirical measurement
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Empirical measurement
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Empirical measurement
Brookshire, David S, et al, 1982. “Valuing Public Goods: A Comparison of Survey and
Hedonic Approaches,” American Economic Review, American Economic Association,
vol. 72(1), pages 165-77, March.
Pricei = α + βPollutioni + εi .
• Problems:
• Omitted variables bias: polluted areas worse on many dimension
beside pollution.
• Sorting: people with health problems avoid polluted neighbor-
hoods.
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Empirical measurement
Kenneth Y. Chay & Michael Greenstone, 2005. “Does Air Quality Matter? Evidence
from the Housing Market,” Journal of Political Economy, University of Chicago Press,
vol. 113(2), pages 376-424, April.
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Empirical measurement
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Empirical measurement
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Empirical measurement
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Empirical measurement
Contingent valuation
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Public Economics - Lecture 4: Public goods and externalities
Externalities
Empirical measurement
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End of lecture.