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Economics 2151B - Lecture 24.docx

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Economics 2150A/B
Kristin Denniston

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Economics 2151B Monday April 7 Lecture 24 Chapter 17 – Coase Theorem (con’t) Homework 5 • Due Tuesday April 8 at midnight Final Exam • Sat. April 26 2pm • Room LH105 • Bring: o Calculator o #2 pencil o ID Coase Theorem (*an easy short answer question for the exam) • The government doesn’t need to get involved in solving the negative externality problem • Private parties can negotiate and reach a Pareto optimal solution • Conditions for this to be possible: 1. The cost of negotiation must be 0 (or extremely low) 2. Property rights need to be well-defined • Through bargaining, the private parties will reach a Pareto (economically efficient) outcome, and it will be the lowest-cost outcome • It doesn’t matter who has the property rights – the result will be the same *Know under what conditions it applies, and what the results are (private parties can solve the problem) Page 11, Chapter 17 notes Example: Farmer A has cattle that damage the crops of Farmer B. The damage to Farmer B is $4000 when the cattle get out. • Solution 1: Fence A’s property (costs $2000) • Solution 2: Fence B’s property (costs $3000) • The coase theorem says that in theory, if the costs of bargaining are 0 and property rights are well defined, than these farmers can find the Pareto optimal solution to solving the externality problem. • If nothing is done, they will cause $4000 of damage. • Two cases: o B has property rights  They would sue A for the damage to their property.  A would pay to fence their own property (it is cheaper than fencing B’s property, a cost of $2000) o A has property rights (and are allowed to let their cattle roam)  It won’t matter who has the property rights, the solution will be the same  B will offer to fence A’s property, because it is a lower cost solution for him than to pay the damage  B would not be willing to pay more than $3000 because he could fence his own property for $3000 and solve the problem that way (rather than incurring the damage of $4000) Define goods based on whether they are rival and excludable in consumption: • Rival = my consumption affects your consumption Excludable? Yes No Yes Private Goods Common Rival? Resources No Natural Monopoly Public Goods Goods: o Public Goods  Examples: • Defence • Lighthouse • Fireworks display • Mosquito spraying  Once the good is provided, we all benefit (you can’t exclude someone from benefitting)  The problem: They tend to not be provided privately in a free market o Private Goods  Examples: • Chocolate Bar • Cars o Common Resources  Examples: • Ocean fisheries (we don’t think about how our consumption affects other people’s consumption) o Public Goods  Excludable in consumption, but not rival  Examples: • Cable TV • Electricity  We can exclude you from consuming cable or hydro, but one person’s consumption does not affect someone else’s consumption Are these goods public goods? • Education? o No, it is rival in consumption o Having 50 people in a classroom has capacity constraints • Hockey arenas? o No – when one team has the arena, another team can’t play • These are private goods with positive externalities (that is why the government subsidizes them) • Pareto optimal - The government will provide these goods if the social marginal benefits are greater than the social marginal costs o To measure social marginal benefits, they vertically sum the willingness to pay for the public good for each member of society o SMB is sometimes referred to as the aggregate marginal welfare function (AMWF) Example 17.2: (*you won’t have a math problem like this on the exam. The purpose is to show what vertical summation is. You should know what vertical summation is.) • Consumer 1: P =160-Q • Consumer 2: P =2100-Q • Consumer 3: P =3140-Q • We vertically sum everyone’s WTP to get the aggregate marginal welfare function: o The demand function needs to be in the inverse form, and we are summing prices.  Summing horizontally means we are summing quantities (and the demand curve has to be quantities as a function of price) o AMWF = P = 340-Q o AMWF = P + 2 (103-Q) + (140-Q) = 240-2 o AMWF = P + 1 + P2= (30-Q)+(100-Q)+(140-Q) = 300-3Q • Say that MC = $180 o Therefore no one would be willing to pay this cost for the public good. But if the government stepped in, it would be socially optimal to provide this public good up until the point where marginal cost = marginal benefit • Optimal level is where SMB = SMC o 300-3Q = 180 o Q* = 40 Example 17.16: 3 option
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