🏙️Public Economics Unit 2 – Public Goods and Externalities

Key Concepts and Definitions

• Public goods non-excludable and non-rivalrous goods or services (national defense, public parks, lighthouses)
  • Non-excludable no one can be effectively excluded from using the good
  • Non-rivalrous consumption by one individual does not reduce availability to others
• Externalities costs or benefits that affect a party who did not choose to incur those costs or benefits
  • Positive externalities generate benefits for a third party (education, vaccination)
  • Negative externalities impose costs on a third party (pollution, noise)
• Free rider problem occurs when people take advantage of public goods without paying for them
• Tragedy of the commons overexploitation of shared resources when individuals act in their own self-interest
• Coase theorem suggests that private parties can find efficient solutions to externality problems through negotiation, given clearly defined property rights and low transaction costs

Types of Public Goods

• Pure public goods perfectly non-excludable and non-rivalrous (air, national defense)
• Impure public goods partially excludable or rivalrous (roads, public education)
  • Club goods excludable but non-rivalrous (cable television, private parks)
  • Common resources non-excludable but rivalrous (fishing grounds, timber)
• Local public goods benefits confined to a particular geographic area or community (fire protection, street lighting)
• Global public goods benefits extend across countries and generations (climate stability, scientific knowledge)
• Quasi-public goods provided by both the public and private sectors (healthcare, education)
• Merit goods deemed socially desirable and often subsidized by the government (museums, public libraries)

Characteristics of Externalities

• Externalities can be positive or negative, depending on whether they generate benefits or costs for third parties
• Marginal social benefit (MSB) the sum of private benefits and external benefits
  • Positive externalities MSB exceeds marginal private benefit (MPB)
• Marginal social cost (MSC) the sum of private costs and external costs
  • Negative externalities MSC exceeds marginal private cost (MPC)
• Externalities lead to market inefficiencies because market prices do not reflect the full social costs or benefits
• Externalities can occur in production (industrial pollution) or consumption (secondhand smoke)
• Externalities can be intertemporal, affecting future generations (climate change, deforestation)
• Network externalities the value of a product or service increases as more people use it (social media, telecommunications)

Market Failure and Inefficiency

• Market failure occurs when the allocation of goods and services is not efficient
  • Leads to overproduction or underproduction compared to the socially optimal level
• Public goods market failure undersupply due to free rider problem and lack of price signals
• Externalities market failure overproduction of negative externalities and underproduction of positive externalities
  • Divergence between marginal social cost (MSC) and marginal private cost (MPC)
  • Divergence between marginal social benefit (MSB) and marginal private benefit (MPB)
• Information asymmetries can also contribute to market failure (adverse selection, moral hazard)
• Market power and lack of competition can lead to inefficient outcomes (monopolies, oligopolies)

Government Intervention Strategies

• Pigouvian taxes and subsidies designed to correct externalities by aligning private and social costs/benefits
  • Taxes on negative externalities (carbon tax, congestion pricing)
  • Subsidies for positive externalities (education grants, renewable energy incentives)
• Regulation and standards set rules and requirements to control externalities (emission limits, building codes)
  • Command-and-control regulations specify allowable levels of pollution or resource use
  • Performance-based regulations set targets but allow flexibility in how to achieve them
• Government provision directly supplying public goods or services (national defense, public education)
• Public-private partnerships collaboration between government and private sector to provide public goods or services (infrastructure projects)
• Tradable permits establish a market for pollution rights or resource use (cap-and-trade systems)
• Coasian bargaining facilitating negotiation between parties to resolve externality problems

Cost-Benefit Analysis

• Cost-benefit analysis (CBA) systematic process of comparing the costs and benefits of a policy or project
  • Helps determine whether a policy or project is economically efficient and socially desirable
• Identify and quantify all relevant costs and benefits, including externalities
  • Direct costs and benefits (construction costs, revenue generated)
  • Indirect costs and benefits (environmental impacts, social welfare gains)
• Discount future costs and benefits to present value using an appropriate discount rate
• Calculate net present value (NPV) the difference between the present value of benefits and costs
  • Positive NPV indicates that the benefits outweigh the costs
• Sensitivity analysis tests the robustness of CBA results by varying key assumptions and parameters
• Distributional considerations examine how costs and benefits are distributed among different groups

Real-World Examples and Case Studies

• Environmental externalities climate change, air and water pollution, deforestation
  • Carbon taxes and cap-and-trade systems to reduce greenhouse gas emissions
  • Regulations on industrial waste and emissions (Clean Air Act, Clean Water Act)
• Transportation externalities traffic congestion, accidents, noise pollution
  • Congestion pricing and tolls to manage traffic and fund infrastructure
  • Public transportation subsidies to reduce reliance on private vehicles
• Education as a positive externality generates social benefits beyond individual returns
  • Public funding and subsidies for education (K-12, higher education)
  • Positive spillover effects on economic growth, crime reduction, and civic engagement
• Public health interventions vaccination programs, disease control, sanitation
  • Government-funded research and development of vaccines and treatments
  • Mandatory vaccination laws and public health campaigns to promote immunization
• Natural resource management common pool resources, renewable and non-renewable resources
  • Fishing quotas and licenses to prevent overfishing and ensure sustainable yields
  • Extraction taxes and royalties on non-renewable resources (oil, minerals) to fund public goods

Policy Implications and Debates

• Balancing efficiency and equity in addressing externalities and providing public goods
  • Distributional impacts of taxes, subsidies, and regulations on different income groups
  • Ensuring access to essential public goods and services for all citizens
• Political economy considerations the influence of interest groups, lobbying, and electoral incentives on policy decisions
• Federalism and the role of different levels of government (national, state, local) in addressing externalities and providing public goods
• International cooperation and coordination in managing global public goods and transboundary externalities
  • International environmental agreements (Paris Agreement, Montreal Protocol)
  • Multilateral institutions and initiatives (United Nations, World Bank)
• Limitations and challenges of government intervention informational constraints, administrative costs, unintended consequences
  • Government failure when intervention leads to inefficient or suboptimal outcomes
  • Importance of evidence-based policymaking and iterative policy design
• Market-based approaches vs. command-and-control regulations debate over the effectiveness and efficiency of different policy instruments
  • Role of property rights, markets, and incentives in addressing externalities
  • Balancing flexibility and predictability in policy design and implementation