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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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16 References
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