To put the public goods and externalities problems in perspective, you may recall from Lecture Five that perfect competition provides an efficient allocation of society’s resources. However, you may also recall that when one or more of the assumptions of perfect competition are not met, a market failure results.
So far, we have examined the market failure of imperfect competition in our discussions of monopoly, monopolistic competition, and oligopoly. Now we turn to public goods and externalities—two market failures that provide the rationales for a large part of our government’s expenditure.
For example, each year the United States government spends almost $300 billion dollars on one public good alone: national defense; and this defense expenditure represents a full 15 percent of the total federal budget. At the same time, billions more are spent on other public goods ranging from parks, roads, and bridges to our criminal justice system, flood control programs, and even our lighthouses on the high seas. In this lecture, we will explain why it is the government rather than the private marketplace that has to provide for all these public goods.
Similarly, we shall see that the externalities market failure helps explain not only the existence of many of our environmental protection laws but also many government health services. In analyzing this important problem, we will want to come to understand the many different ways a government can address it—from liability rules, lawsuits and direct controls to the use of taxes to discourage “negative externalities” and subsidies to encourage “positive externalities.”
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McConnell &
Brue |
Samuelson &
Nordhaus 16th Edition |
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Complete textbook |
31, 32 |
30 |
18 |
28 |
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Microeconomic split |
17, 18 |
17 |
18 |
13 |
1) Introduction
2) Public Goods
a) Private versus Public Goods
¨ The Free Rider Problem
b) Economic Efficiency and Public Goods
¨ The Demand Curve for a Private Good
¨ The Demand Curve for a Public Good
¨ The Optimal Quantity of a Public Good
c) Benefit-Cost Analysis
¨ The Example of Flood Control
3) Negative and Positive Externalities
a) A Negative Externality Example
b) A Positive Externality Example
c) The Theory of Externalities
¨ Negative Externalities
¨ Positive Externalities
d) To Intervene or Not to Intervene, That is the Question
¨ The Coase Theorem
¨ Liability Rules and Lawsuits
¨ Direct Government Intervention
¨ Pigouvian Taxes
¨ Pigouvian Subsidies
4) A Summary
1. Name five ways in which government intervenes in the free market.
2. Contrast private versus public goods.
3. Describe the free rider problem. Provide several examples.
4. On what does the economic difference between public goods and private goods rest?
5. The market demand curve for private goods is what sum? How does this differ from the market demand for a public good.
6. Illustrate the optimal quantity of a public good.
7. What is the benefit-cost decision rule.?
8. The best way to make government more efficient is to always reduce government spending. Agree or disagree?
9. What is the idea behind externalities?
10. Provide a negative externality example. Illustrate the problem and indicate where equilibrium is in a free market. Is this optimal?
11. Provide a positive externality example. Illustrate the problem.
12. Explain the Coase Theorem and its implications for government intervention into the market.
13. What is the importance of assigning property rights in the Coase Theorem?
14. How might the Coase Theorem break down?
15. A second approach to internalizing externalities relies upon a legal framework of liability laws. Describe this framework.
16. Illustrate how direct controls can force new firms to incur costs associated with pollution control.
17. Explain and illustrate how Pigouvian taxes can be used to internalize externalities.
18. Illustrate how Pigovian subsidies can be used to internalize positive externalities.
19. Why does the U.S. provide free vaccines to children?