Economics Chapter 10 notes

Private goods, public goods and externalities

KT Private Good: A good, such as an orange that is excludable

and rival.

The owners of a private good can exercise private property

rights, preventing other people from using their private good.
This is also called excludability.

The second property is rivalry, e.g. sweet consumed, qualities

no longer available to ‘rival’

KT Public good: A good, such as a radio programme, that is

non-excludable and non-rival

Characteristics of a pubic good include non-ecludability and

non-rivalry or non-diminshiability. Leads to market failure.
Another eg is a light house

KT Free Rider: somebody who benefits from a good or service

without paying for it.

Market also likely to fail because the incentive funtion of prices

breaks down.

Other eg’s of public goods include national defence, police,

street lighting.

Goods and ‘Bads’

KT Good: yields utility, unlike a ‘bad’ which yields disutility.

Good provides benefit to those using it – increase economic

welfare.

Bad is oppositee of good eg disutility - reduce economic

welfare.

A public bad is something such as garbage, people are

prepared to pay for the removal of economic bads.
But rubbish can be dumped so provided by gov.
Dumping is an eg of free riding
Public Goods and Gov Goods

Markets may fail to provide public goods, so the gov may have
to at 0 price to the consumers.

To try to correct the market failure, the gov provide public

goods, which is the effect. Includes merit goods eg healthcare.

Externalities

KT Externality: a public good, in the case of an ecternal

benefit, or a public bad, in the case of an external cost, that is
dumped on third parties outside the market.

There is no market where it can be bought or sold – outside the

market – missing market

Has a free rider problem. The provider of something eg

beautiful view, cannot charge a price, and it is ruined by
negative externalities such as pollution

Negative Externalities – eg power station discharges pollution

Real costs not reflected – see fig 10.2 page 108

Positive Externalities – eg power station warming water for

fishes

Cannot charge for this – see fig 10.3 page 108

Different types of externalities

-pure production externalities
-mixed production externalities
-pure consumption externalities
-mixed consumption externalities

Using marginal analysis to analyse externalities

KT Margin: refers to the last unit undertaken of a activity

If one more unit of the activity is now added, the previous unit,
which, up to that point had been the marginal unit, can no
longer be classified in this way.
Marginal costs and marginal benefits

KT Marginal benefit: The benefit resulting from the last unit of

a good
Marginal Cost: the cost of the last unit of a good
Social cost: The total cost of an activity, including the external
cost as well as the private cost.

Social cost = private cost + external cost

Marginal private cost is the extra cost incurred by the power

station when producing the last unit of electricity.

Marginal external cost is the extra cost dumped on the wider

community when the power station produces the last unit of
electricity

Marginal social cost is the extra cost borne by everybody, as a

result of producing the last unit of electricity

Marginal social cost = marginal private cost + marginal

external cost

KT Private benefit maximization: occurs when Marginal private

cost = marginal private benefit
Social benefit: The total benefit of an activity, including the
external benefit as well as the private benefit
Social benefit maximization: occurs when Marginal social cost
= marginal social benefit

On a diagram, the MSC curve is positioned above the MPC

curve. The vertical distance between the two curves is the
marginal external cost (MEC) at each level of the production of
electricity.

The same is for MSP / MPB – MEB represents the difference

Government policies and externalities

Two ways gov can intevene:

-eliminate or reduce production of negative externalities such
as pollution and traffic congestion using quantity controls
-regulate prices of goods and acticities that yield external
benefits.
Chapter 11 Merit Goods and Demerit Goods

KT Demerit Good: A good, such as tobacco, for which the social

costs of consumption exceed the private costs.
Merit Good: a good such as healthcare, for which the social benefits
of consumption exceed the private benefits.

Consumption of externalities such as education or healthcare

produces positive externalities which benefit the whole community.
As a result, the benefit of consumption exceeds the private benefit
enjoyed by the consumption exceeds the private benefit enjoyed by
the consumer.

See fig 11.1 pg 119

The social costs to the whole community resulting form the

consumption of a demerit good such as tobacco or alcohol exceed
the private costs incurred by the consumer. The private cost can be
measured by the money cost of purchasing the good, together with
any health damage suffered by consuming the good.

Below is the argument about exclusive schooling

The argument concerning imperfect information is an

important one. Parents with relatively poor educational
qualifications may be unaware of the full longer-term benefits
that their children might derive from a proper education.
Because the knowledge of these private benefits is an ongoing
learning process, children themselves will tend to
underestimate the long term gains from a proper education.

Education is a long-term investment decision. The private

costs must be paid now but the private benefits (including
higher earnings potential over one’s working life) take time to
emerge.

Education should provide a number of external benefits that

might not be taken into account by the free market. These
include rising incomes and productivity for current and
future generations; an increase in the occupational
mobility of the labour force which should help to reduce
unemployment and therefore reduce welfare spending.

Increased spending on education should also provide a

stimulus for higher-level research which can add to the long
run trend rate of growth. Other external benefits might
include the encouragement of a more enlightened and
cultured society, less prone to political instabilities and one
which manages to achieve a greater degree of social cohesion.
Providing that the education system provides a sufficiently
good education across all regions and sections of society,
increased education and training spending should also open up
a higher level of equality of opportunity. The reality is of
course that there are very deep and wide variations in
educational performance and opportunities across the country.

KT Information Problem: occurs when people make wrong

decisions because they don’t possess or they ignore relevant
information.

For a merit good, the long-term private benefit of consumption

exceeds the short-term private benefit of consumption.

In the case of demerit goods, it is the long-run private costs

rather than the long-run private benefits that are significant. A
person who smoked may regret it later in life

KT Normative Statement: a statement of opinion based on a

value judgement.
Positive Statement A statement of fact, or one that can be
scientifically tested.

So why does the government provide merit goods and

services?

• To encourage consumption so that some of the positive

externalities associated with merit goods can be
achieved
• To overcome the information failures linked to merit
goods, not least when the longer-term private benefit of
consumption is greater than the shorter-term benefit of
consumption
• On grounds of equity – because the government believes
that consumption should not be based solely on the
grounds of ability to pay for a good or service

Private provision of a merit good such as healthcare may be

affected by moral hazard

Governments discourage consumption of demerit goods

through regulation and taxation.

Governments encourage consumption of merit goods through

state provision and subsidy.