Public Goods - are non-excludable & non-rivalrous.
non-excludable - it is not possible to prevent people who have not paid for a good from using it.
non-rivalrous - consumption of the good by one person does not prevent others from also consuming it.
Free-riders are those who can use a good without paying for it.
Examples given: National Defense - it is not possible to exclude anyone within a country's borders while at the same time protecting those borders. Individuals are protected if they have paid or not.
Positive Consumption Externality: The type/name of the externality tells you what you need to do! Positive = Positive (duh!) (we want more of it) Consumption = Benefits = Demand (there will be two demand curves, MSB & MPB)
Positive = we want more
Consumption = benefits = demand
Triangle = DWL (dead weight loss) (points to society) & is between the two demand curves
SOQ = Socially Optimal Quantity or the quantity desired by society (Pos.= more quantity)
Underproduction = If we want more we must be underproducing the good. (duh!)
MSB = MSC, obviously where social benefits and costs equal, equilibrium quantity- Q*
Triangle - always points to society - to help you know which demand/cost curve is drawn above or below, know that the triangle always points to (MSB) society for a Positive Consumption Externality... Your going to say,, but Charles I could draw the curve pointing to the left and still have it between the curves,,, but then the triangles point would be pointing to an equilibrium of less production (we need more).
Subsidy has been granted, shifting supply right, lowering price.
Check your graph and make sure it is showing what you want,,, to get more consumption prices must go lower. (look above and you will see this is exactly what has happened, prices have decreased and quantity produced has risen.)
Positive Production Externality: The type/name of the externality tells you what you need to do! Positive = Positive (duh!) (we want more of it) Production = Production = Costs = Supply (there will be two supply curves, MSC & MPC)
Positive = we want more
Production = costs = supply
Triangle = DWL (dead weight loss) (points to society) & is between the two supply curves
SOQ = Socially Optimal Quantity or the quantity desired by society (Pos.= more quantity)
Underproduction = If we want more we must be underproducing the good. (duh!)
MSB = MSC, obviously where social benefits and costs equal, equilibrium quantity- Q*
CLG - always a correctly labelled graph
Triangle - always points to society - to help you know which supply/cost curve is drawn above or below, know that the triangle always points to (MSC) society for a Positive Production Externality... Your going to say,, but Charles I could draw the curve pointing to the left and still have it between the curves,,, but then the triangles point would be pointing to an equilibrium of less production (we need more).
Check your graph and make sure it is showing what you want,,, to get more production prices must go lower. (look above and you will see this is exactly what has happened, prices have increased and quantity produced has fallen.)
An example of a positive production externality would be a case of bee keepers producing honey next to an orchard. Bees help in the pollination of the orchard, causing a benefit (unpaid) to the orchard owner.
Demand in this instance, which always reflects the MPB of buyers of honey, and is identical to the MSB as no external effects of honey consumption are assumed. (D,MSB,MPB)
Supply of honey reflects the MPC of honey producers (costs paid, labour and bees). Since the honey producer's production process entails external benefits to apple growers in the form of pollination, it follows that the social costs of honey production are lower than the private costs that the beekeepers consider. The MSC of honey production are therefore lower than the MPC by the amount of the external benefit created. (Triangle points to Society = MSC) There is an underproduction of this good, so prices need to be lowered. This is normally done through the use of a subsidy granted to the producer. This decreases the costs of production increasing output levels. 2008 AP Microeconomics Exam
Answer (B) Subsidizing flu shots will lead to the socially efficient level of output. (socially efficient level = socially optimal quantity) Reffonomics, excellent website
Negative Consumption Externality: The name of the externality tells you what you need to do! Negative = Negative (duh!) (we want less of it) Consumption = Benefits = Demand (there will be two Demand curves, MSB & MPB)
Negative = we want less
Consumption = benefits = demand
Triangle = DWL (dead weight loss) (points to society) & is between the two demand curves
SOQ = Socially Optimal Quantity or the quantity desired by society (Neg.=less quantity)
Overproduction = If we want less we must be over producing the good (duh!)
MSB = MSC, obviously where social benefits and costs equal, equilibrium quantity- Q*
Triangle - always points to society - to help you know which demand/cost curve is drawn above or below, know that the triangle always points to (MSB) society for a Negative Consumption Externality... Your going to say,, but Charles, I could draw the curve pointing to the right and still have it between the curves,,, but then the triangles point will be pointing to an equilibrium of more production (we want less).
Indirect tax equal to the external costs of consumption is needed to decrease supply and to increase the price of the good.
Check your graph and make sure it is showing what you want,,, to get less production prices must go higher. (look above and you will see this is exactly what has happened, prices have increased (with the tax) and quantity produced has fallen.)
Examples: (drugs, alcohol, cigarettes) also known as demerit goods.
Negative Production Externality: The type/name of the externality tells you what you need to do! Negative = Negative (duh!) (we want less of it) Production = Production = Costs = Supply (there will be two supply curves, MSC & MPC)
Negative = we want less
Production = costs = supply
Triangle = DWL (dead weight loss) (points to society) & is between the two supply curves
SOQ = Socially Optimal Quantity or the quantity desired by society (Neg.=less quantity)
Overproduction = If we want less we must be over producing the good (duh!)
MSB = MSC, obviously where social benefits and costs equal, equilibrium quantity- Q*
CLG - always a correctly labelled graph
Triangle - always points to society - to help you know which supply/cost curve is drawn above or below, know that the triangle always points to (MSC) society for a Negative Production Externality... Your going to say,, but Charles I could draw the curve pointing to the right and still have it between the curves,,, but then the triangles point will be pointing to an equilibrium of more production (we need less).
Check your graph and make sure it is showing what you want,,, to get less production prices must go higher. (look above and you will see this is exactly what has happened, prices have increased and quantity produced has fallen.)
In the graph above the most used reason for a negative production externality to happen is due to pollution, (water, air, soil, road congestion). Pollution therefore harms society at some level, society being the injured third party. To correct for the cost of the pollution imposed on society an indirect tax equal to the size of the external cost (pollution harm to society) is imposed on the firm to make them pay for their pollution (to get them to internalize the cost they have placed upon society) The tax causes their production processes to become more expensive and they produce less (hopefully). Known as the "Polluter pays principle" designed and formulated by Pigou (1920) also known as a Pigovian tax,, a carbon tax is a Pigovian tax.
The government must estimate the harm done to society and propose an amount of tax that causes the firm to produce at the new lower level, Q*. That is difficult. Also, as you know now the PED of a good also effects the amount consumers or producers will assume of the tax.
Draw this graph about 50 times and explain to yourself what is happening.
Examples:
1995 AP Microeconomics Exam:
Answer (B) encourage firms to use the most efficient method to reduce pollution.
1995 AP Microeconomic Exam:
Answer (C) The private market price will be to low.
(notice in the graph at the top of the page the Price is low and then the SOQ (socially optimal quantity) is Q* produced with the higher Price.
2000 AP Microeconomics Exam:
Answer (C) society's marginal cost being higher than the firms marginal cost. (check out the graph above)
2000 AP Microeconomics Exam:
2005 AP Microeconomics Exam:
Answer (A) The price of cigarettes will be two low and the quantity sold will be to high. (overproduction)
2005 AP Microeconomics Exam:
Answer (B) The production or consumption of a good generates a negative externality.
2008 AP Microeconomics Exam:
Answer (B) Price will be less than the marginal social cost.
Welker on Negative Externalities of Production: Video
Market Failure: When market forces (demand and supply) alone fail to allocate scarce resources efficiently, either that to much or not enough of a good is produced or consumed.
Externality - When an economic activity creates benefits or imposes costs for third parties for which these do not pay for, or do not get compensated for, respectively.
An externality leads to a market failure as either more or less than the socially optimal amount is produced or consumed. Market forces alone fail to lead to an efficient resource allocation.
Externalities may arise in the production process, where they are known as production externalities, or in the consumption process, in which they are known as consumption externalities. If the impose costs on third parties they are considered negative externalities. In contrast, if they create benefits they are considered positive externalities.
MPC - Marginal Private Costs: defined as the costs of producing an extra unit of output. Include, wages costs of raw materials and other costs that the firm takes into consideration in its decision making process to produce. It follows that the supply curve reflects the MPC of a competitive firm. MSC - Marginal Social Costs: defined as the costs of producing an extra unit of output that are borne by society. They reflect the value of all resources that are sacrificed in the specific production process. This means that they include not just the labour and other resources that are sacrificed, the costs of which are taken into consideration by the firm, but also include any (External Costs) that are not considered by the the firms, like pollution.
MPB - Marginal Private Benefits: defined as the benefits the individual enjoys from the consumption of an extra unit of the good. The willingness of consumers to pay for an extra unit is determined by the extra benefit he enjoys from consuming that extra unit. The demand curve reflects the MPB enjoyed from consuming extra units of a good.
MSB - Marginal Social Benefits: benefits that society enjoys from each extra unit consumed. MSB includes the private benefits enjoyed by the individual but in addition any benefits others may enjoy as a result (External Benefits).
Reffonomics - Great website - Reffonomics
http://www.reffonomics.com/TRB/INPROGRESS/Microeconomicsindex1Externalities.html
