Basic Microeconomics by Professor R. Larry Reynolds, PhD - HTML preview

have “third-party” or “spillover” effects. There may be costs or benefits that

impact individuals who are not engaged in the actual use of the good. When

this happens it is called an externality. Externalities can be positive (a benefit

is conferred on a third party) or negative (a cost is imposed on individuals).

These externalities may occur in consumption (smoking a cigar can impose

costs on others) or production (producing paper generates air and/or water

pollution).

In some cases it is technically impossible to exclude (prevent an individual)

individuals from the consumption and benefits of a produced economic good.

These are called collective or public goods. National defense is an example

of a public good. In other cases it may be technically possible to exclude

283

15.4 Exclusivity

individuals from the benefits of a good but the cost of doing so makes it

impractical. These are often referred to as quasi-public goods.

There are also “fugitive or fugacious” goods. A fugitive good is one that is

owned by no one until some one “captures” it. The process of capture and use

of these goods imposes cost on others. These goods are called “common

property resources.”

15.5 “MARKET FAILURE” AND PROPERTY RIGHTS

W ith the presence of externalities, public or collective goods and

common property resources, the information generated by market

transactions may be distorted and incorrect signals result in misallocation of

resources.

15.5.1 EXTERNALITIES

E xternalities may be positive or negative.

POSITIVE EXTERNALITY

A positive externality exists when there

MC

are “Social Benefits” that result from a

C

market transaction or the use of a

M

and V*

good. In Figure X.B.1 a positive

BM V

MBP + MBS

externality is shown. Individual J

A

perceives the marginal costs of X as

MBP (to the

Individual)

MC and the marginal benefits as MBP.

To optimize the net benefits the

X

X*

Quan, X

individual would want X amount.

Figure X.B.1

However, there are other individuals

284

15.5.1 Externalities

who benefit from the J’s use of good X. The MB of others or society is MBS.

The marginal benefit to society is MBP + MBS. the optimal amount of good X is

X*, not X. In the case of a positive externality, market exchanges result in

less than the optimal amount of the good. One solution is to subsidize good X

by the amount V*-A.

NEGATIVE EXTERNALITY

A negative externality exists when an

MCP + MCS

alternative results in costs being

C

imposed on individuals who are not

MCP

d Mn

B a V*

involved with the transaction or use of

M V

the good. An individual who smokes a

A

cigarette in a restaurant has made a

MB

X**

X

Quan, X

decision to smoke based on the

Figure X.B.2

marginal benefits and marginal costs to

themselves. The second hand costs impose marginal costs on others. In

Figure X.B.2 the individual recognizes the costs and benefits to themselves as

MCP and MBP. Recognizing these costs and benefits, the individual will

maximize net benefits by consuming X amount of good X. Since the

consumption of good X imposes costs on others, the MPP + MPS reflects the

marginal costs to the individual and society. The optimal amount of the good

from a social perspective is X** rather than X. A negative externality results in

decisions to produce and consume more than the socially optimal amount of a

good. One solution is levy a tax of V*-A on good X.

285

15.5.2 Public or Collective Goods

15.5.2 PUBLIC OR COLLECTIVE GOODS

A public good has two important characteristics. First, it is technically

impossible to exclude any individual from consuming the good. Second, the

marginal cost of the additional consumer is zero.

The optimal result in a market is that the output occur at the level where

the MB = MC and the price should reflect both the MB and MC:

MB = P = MC

When the MC of another user is zero the optimal price is also zero. It is not

possible for a private provider to produce and offer a public good for

consumption (unless they are an altruistic philanthropist). National defense is

the primary example of a public good. A private market will not produce a

public good.

Since individual cannot be excluded and there is no reason for them to

contribute to the costs of production, they become “free riders.” In some

cases free riders can be encouraged to contribute through social mechanisms

such as feelings of philanthropy or guilt. In cases where a society decides to

undertake an alternative, and an individual prefers not to be a participant, the

individual may become a forced rider.

15.5.3 COMMON PROPERTY

A common property resource is a fugitive resource that is owned by the

individual who “captures” it. The use of a common property resource imposes

costs on others in the society. Buffalo, whales, “commons” and water quality

are examples of common property resources.

Garret Hardin’s article on the Tragedy of the Commons discusses the

tradition of a common pasture in villages. Each person can use the commons

286

15.5.3 Common Property

to graze their animal. Since no one owns the commons the incentive is to get

another animal to graze. Since everyone has the same incentive every one

takes more animals to graze and eventually the commons is overgrazed and

every one loses.

287

16 References

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Alphabetical Index

Abductive Reasoning..................................................................................................53

ALCOA......................................................................................................................256

Allocative efficiency............................................................................................91, 229

Anarchy.....................................................................................................................128

Antitrust....................................................................................................................119

Aristotle...........................................................................8, 10, 11, 45, 52, 73, 103, 288

Augustin....................................................................................................144, 163, 263

Austrian......................................................................................................116, 145-147

Average product.......................................................................................................205

Average revenue........................................................................................................191

Bacon..................................................................................................................52, 288

Bentham........................................................................83-85, 132, 142-144, 168, 288

Blackwell..........................................................................................................140, 292

Blaug..................................................................................................................50, 288

Boland......................................................................................................................288

Boorstin....................................................................................................................288

Booth..........................................................................................................................62

Boulding...................................................................................................................288

Braithwaite...............................................................................................................128

Bronowski..............................................................................................45, 46, 48, 288

Burke..................................................................................................................36, 288

Bynum......................................................................................................................289

Camus.........................................................................................................................98

Cantillon....................................................................................................................141

Capital..........................................................................................22, 30, 209, 210, 271

Capitalism..........................................................................................................68, 289

Cartesian.....................................................................................................................45

Census.......................................................................................................................277

Centrally planned.......................................................................................................39

Church........................................................................................................................111

Clark.........................................................................................................................269

Classical economics...........................................................................................140, 141

Claude........................................................................................................................116

Clayton......................................................................................................................119

Coase.......................................................................................................14, 69, 76, 289

Colbertism................................................................................................................140

Collective..................................................................................................................286

Command Economies...............................................................................................110

293

16 References