Lecture notes week 11

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Economics for Management Studies
Course Code
Gordon Cleveland

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Week 11ECMA04 Externalities and Public Goods When markets work well, they work very well Competitive markets (usually) allocate resources to deliver maximum Gain to Society! At competitive equilibrium, P = MC or the marginal benefit of additional output = marginal cost of additional output MARKET FAILURES But markets sometimes do not work well (i.e., markets fail) N when there is only a small number of producers (oligopoly) or only one producer (monopoly) N when a good (or service) has substantial external costs (external costs are ones that producers ignore in their decisionse.g., pollution) N when a good (or service) has substantial external benefits (external benefits are ones that consume ignore in their decisions to consumee.g., education) N when a good is a public good: i.e., (1) it is collectively consumed, and (2) consumers cannot be excluded from consuming the good (or service) N In all these cases, markets fail to work well, governments may need to correct what markets would naturally do! N Side note: Another form of failure that governments address is income distribution: governments redistribute income from rich to poor, or provide services for needy individuals. However this is an equityather than an efficiency issue Positive and Negative Externalities (also called external benefits and external costs) Goods or services that affect others (not just the direct consumer and producer) Positive: Negative: N education N pollution (e.g., greenhouse gas emissions) N beautiful garden N raising bees N second-hand smoke N noisy activities N raising well-educated children Problem: When there are external effects (i.e., externalities), markets do not receive the right signals about all the benefits and all the costs, and therefore make the wrong decisions. Consumers and producers do not face the correct incentives. They will consume andor produce too much or too little of the good. When small numbers of people are affected, private negotiations can solve the problem. When large numbers of people are affected, this is a form of market failure. A first look at the problem: However, this approach assumes production and pollution are inseparably linked. Better to develop a model that focuses on pollution reduction (abatement) itself. First, some background about GHGs as an introduction to discussing the Marginal Cost of Abatement and the Marginal Benefit of Abatement. Greenhouse Gas Emissions (GHG emissions) N The earths surface temperature has risen by a little less than 1 degree Celsius in the 20tury. Mostly (34) due to increasing burning of fossil fuels. Also deforestation anstagricultural practices. N Projected average temperature rise over the 21 century ranges from 1.1 6.4 degrees Celsius (U.N. Intergovernmental Panel on Climate Change) N Important GHGs: carbon dioxide, methane, nitrous oxide, ozone www.notesolution.com
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