Let us make an in-depth study of the externalities and public good. .. For private goods, the relationship between individual consumption xi and output X is. Public goods and externalities arise because of the failure of conditions 1 and 4 . a positive externality, the market will produce too little of it in relation. A PowerPoint on externalities and environmental economics, public (social) goods, and more.
As it turns out, one of the economics instructors' most commonly used examples of a public good that cannot be privately provided is not a good example at all. Other public goods problems can be solved by defining individual property rights in the appropriate economic resource.
Cleaning up a polluted lake, for instance, involves a free-rider problem if no one owns the lake. The benefits of a clean lake are enjoyed by many people, and no one can be charged for these benefits. Once there is an owner, however, that person can charge higher prices to fishermen, boaters, recreational users, and others who benefit from the lake.
Privately owned bodies of water are common in the British Isles, where, not surprisingly, lake owners maintain quality. Well-defined property rights can solve public goods problems in other environmental areas, such as land use and species preservation.
Externalities and Public Good (With Diagram)
The buffalo neared extinction and the cow did not because cows could be privately owned and husbanded for profit. Today, private property rights in elephants, whales, and other species could solve the tragedy of their near extinction. In Africa, for instance, elephant populations are growing in Zimbabwe, Malawi, Namibia, and Botswana, all of which allow commercial harvesting of elephants.
Since Zimbabwe's elephant population rose from 30, to almost 70, today, and Botswana's went from 20, to 68, On the other hand, in countries that ban elephant hunting—Kenya, Tanzania, and Uganda, for example—there is little incentive to breed elephants but great incentive to poach them.
In those countries elephants are disappearing. The result is that Kenya has only 16, elephants today versuswhen its government banned hunting. SinceTanzania's elephant herd has shrunk fromto 61,; Uganda's from 20, to only 1, Property rights are a less effective solution for environmental problems involving the air, however, because rights to the air cannot be defined and enforced easily.
It is hard to imagine, for instance, how market mechanisms alone could prevent depletion of the earth's ozone layer. In such cases economists recognize the likely necessity of a regulatory or governmental solution.
Contractual arrangements can sometimes be used to overcome other public goods and externalities problems. If the research and development activities of one firm benefit other firms in the same industry, these firms may pool their resources and agree to a joint project antitrust regulations permitting. Each firm will pay part of the cost, and the contributing firms will share the benefits.
In this context economists say that the externalities are "internalized. The costs of bargaining and striking an agreement may be very high. Some parties to the agreement may seek to hold out for a better deal, and the agreement may collapse. In other cases it is simply too costly to contact and deal with all the potential beneficiaries of an agreement. A factory, for instance, might find it impossible to negotiate directly with each affected citizen to decrease pollution.
An account of how externalities are generated and sustained is needed to complete a theory of them, since in its absence they cannot be explained. If externalities are pervasive in contemporary societies, as they are, then that requires explanation.
Naming is Power A valuable contribution of the technical literature on goods with public good characteristics has been to provide an analytical template through which different kinds of goods could be classified and, thus, the specific problems of provisioning and distribution in the different cases better approached.
In the case of such goods it is widely agreed that there is an externality aspect benefits that are at least partially non-rivalrous and an aspect relating to boundaries excludability. The development of this analytical framework and associated classification system came late. Much of the definition and analysis of specific cases developed only from the s .
Whereas in pure forms, private goods are both excludable and rivalrous, and public goods are neither, club goods are excludable but non-rivalrous and the commons are non-excludable but potentially rivalrous. Efficiency conditions and available management strategies can be influenced both by the type of the good within this classification scheme and its more specific additional traits for instance depletable but renewable goods such as fisheries stocks present different problems than ones that are non-depletable but expansible such as intellectual property.
The identification of these different conceptual categories has been useful as it has provided a basis for understanding better the specific difficulties that bringing about a desirable patent of provision in each case presents. Still, it is far from obvious that the work of constructing such a taxonomy is anything near complete.
Public goods are treated by MWG as a special case of externalities. However, this is far from obvious. Both Lindahl and Bowen identify the condition for optimal provision as being that the sum of marginal rates of substitution between a public and private good must equal their marginal rate of transformation.
Interestingly, and specifically unlike Samuelson, both Bowen and Lindahl viewed the problem of provision as having to be approached through political economy. Lindahl is concerned with the political equilibrium between two different classes possessing different views in regard to the net marginal benefit of tax-financed public good provision. Bowen is concerned with interpreting the aggregate consequences of multiple voters casting their ballots in accordance with the valuations they place on public goods.
First, the theory can be indeterminate, due to the possible presence of multiple equilibria in public goods provisioning modelsfor instance due to strategic complementarities giving rise to outcomes dependent on expectations. Even with identical agents, there can be asymmetrical efforts to provide public goods, determining for example upon prevailing mutual expectations on which, see Cornes and Sandlerop cit.
If the possibility of publicly spirited behavior is considered, including that which may be conditioned on similar behavior by othersa still larger role for such determinants is introduced. Second, the empirical record of the theory is mixed at best. Experimental studies of public goods provisioning find a wide range of results depending on many distinct factors including the population of experimental subjects for an early survey see Ledyard As is now well known, and made most famous by the work of Elinor Ostrom and her collaborators the extent of actual collective action in practical situations depends greatly upon institutional factors, and cooperation often appears to evolve in response to the specific locally experienced imperatives and difficulties, although it takes different forms in distinct social contexts.
On the margins of the world economy and society, the addressing of collective action problems is often a matter of survivaland not surprisingly solutions are sometimes found, despite enormous pressures.
In a variety of contexts, including the international political economy and business cartelscollective action problems are often at least partially overcome. The body of theory on public goods, although offering potential insights, is often undermined by a propensity to turn theoretical deduction into presumed fact. They wish to maximise their individual profits: Hence each sets L.
The equilibrium total labour input, L0, in Fig. This occurs because the wage-rate is low enough for an intersection to take place in the range of negative marginal products. The outcome, in this case, will be inefficient as long as the output of fish has a positive value and labour devoted to fishing has an opportunity cost.
In order to generalize this result, we have to make some assumptions about the marginal social value of fish and the marginal social cost of labour. We assume that these are, in fact, measured by the market prices offish p and labour Wrespectively. Hence net social benefit from fishing in the lake is: Free access always leads to overfishing if there are diminishing returns which means that the intersection of WL and pf L in the figure always occurs at a value of L greater than that at which their slopes are equal.
Such an agreement may not be very likely if there are a large number of individuals with fishing rights or if it is difficult to police such an agreement because breaking the agreement would be profitable.
Externalities and Public Good (With Diagram)
One solution could be to divide the lake among the individual fishermen and give each of them exclusive right to fish in that part of the lake. These rights will require policing and enforcing and this may be expensive. An alternative solution would be to vest ownership of the lake in the individual.
Since, on our assumptions, total profit from fish production from the lake is the net social benefit, maximisation of profit leads to efficient labour input. Unrestrictive access leads to intensive use, but it may also lead to other kinds of inefficiency because it weakens the incentive of individual decision-makers to invest in improvements to the productivity of the resource, or to pay regard to the possibility of extinction of the fish stock through overfishing.
Since a single individual cannot prevent others from using the resource; the benefits from investment or voluntary restraint will be spread over all other users. Hence, it will not pay any single decision-maker to undertake the investment, or to restrict his catch, even though the total benefits exceed the cost.
Even if the share of the benefits accruing to a single individual exceeds the cost of the investment, it may not be undertaken if each individual believes that he will benefit from the investment of other users.
- Public Goods and Externalities
- Externalities and Public Goods: Theory OR Society?
Because of non-excludability, investment by other users is a substitute for investment by any particular individual and if all individuals realize this, no investment may take place. The market fails in this case because no market can exist in the absence of well-defined and easily enforceable rights to exclude by any single individual. There is nothing which can be exchanged and no means which individuals can capture or be made to bear all the results of their actions.
The defining characteristic of a public good is that it is non-rival and non-exclusive: Consumption of it by one individual does not actually or potentially reduce the amount available to be consumed by another individual. Examples include radio and television broadcast and national defence. Any individual can listen to or watch the output of a broadcasting station, without preventing any other individual who possesses a radio or television receiver from consuming the same output.
Broadcasts are an example of an optional public good, in that, one can choose to consume any amount of output produced. Defence is a non- optional public good in that all inhabitants of the country consume the total quantity provided; and if one inhabitant is to be defended, all will be. For private goods, the relationship between individual consumption xi and output X is: We derive the necessary conditions for Pareto efficiency in a two-person, two-good economy.
The preferences of consumer i can be represented by the quasi-linear utility function: Notice that the assumption that preferences are representable by a quasi-linear utility function means that the marginal valuation of the public good is independent of the amount of the private good consumed.
The production possibilities for the economy are shown in Fig. We derive the efficiency conditions by maximising U1 subject to individual 2 at least getting a specified level of utility U2 and subject to the material balance constraints and technology. In such an economy, the feasible output combinations are those on or below PP and material balance constraints. Since consumer 1 is non-satiated, the constraint on U2 and the material balance constraint on the private good will bind as equalities in an efficient allocation.
The IC I2 in Fig Thus, since individual 1 will also be able to consume public good, his consumption bundle is x01, q0 when the public good output is q0. The curve g in Fig. Since the slope of g is the difference between the slope of PP and the slope of I2: Efficiency requires that the amount of the private good the individuals would be willing to give up to acquire an extra unit of the public good I.
MRS must be equal to the amount by which production of the private good must be reduced to raise the output of the public good by one unit MRTxq. A market economy is unlikely to satisfy the efficiency conditions for the supply of public good for two reasons First, many public goods are non-excludable.
For example, defence and police services. If it is impossible to exclude non-payers from consuming a public good, firms may not be able to collect revenue to cover the cost of producing the public good.
If there are free riders because they cannot be excluded, the price that firms charge for supplying a public good may not be an adequate measure of the marginal benefit of the good and there will be a less efficient supply of the good. Second reason is that the market may fail to provide an efficient amount of public goods even when they are excludable, arising from another characteristic of public goods: Suppose, a good is excludable, transferable, there are many consumers and producers and also low information costs.
In such a situation, if the good is private, the resulting market equilibrium allocation will be optimal. Competitive market economy ensures that all consumers pay the same price, which will be equal to the marginal cost of the good in each of the firms.
Consumers will compete for a given output of the good and no consumer will be offered or be able to force a sale at a price less than the market price. By contrast, if the good is public, even if excludable, the opportunity cost of a unit sold to one consumer is zero when output q is given.
Since the good is a public good, an additional unit consumed by one individual does not reduce the amount available for consumption by any other individual. This means that no consumer is competing against any other consumer for a particular unit. The consumer, and, thus, the market is not competitive, despite the large numbers of buyers and sellers.
If all consumers act in this way, the amount offered by consumers will be. In a competitive market for a private good, consumers realise that they cannot affect the market price and, hence, they adjust their consumption until their marginal valuation of the private good is equal to its price.