GPP 501 Microeconomic Analysis for Public Policy Fall 2017

Transcription

1 GPP 501 Microeconomic Analysis for Public Policy Fall 2017 Given by Kevin Milligan Vancouver School of Economics University of British Columbia Lecture October 17 th Externalities: Definitions and Examples GPP501: Lecture Oct 17 1 of 24

2 Agenda for today: 1. Definitions of externalities. 2. The Pigou analysis. 3. Examples. GPP501: Lecture Oct 17 2 of 24

3 What s an externality? Any ideas? What is an externality external to? GPP501: Lecture Oct 17 3 of 24

4 Definitions of externality James Meade (Nobel 1977): An external economy confers an appreciable benefit on some person(s) who are not fully consenting parties in the transaction. Can you think of an example? Is this a broad or narrow definition? GPP501: Lecture Oct 17 4 of 24

5 Definitions of externality Kenneth Arrow (Nobel 1972): An externality arises from the absence of a market for a good; the absence of a pricing mechanism. Can you think of an example? Is this a broad or narrow definition? Why might a market be missing? GPP501: Lecture Oct 17 5 of 24

6 Definitions of externality Kenneth Arrow (Nobel 1972): Why might markets be missing? Can property rights be defined and enforced? Can we exclude non-payers? Are transactions costs too great relative to the gains from trade? Illiquid / small market. Information asymmetries: adverse selection and moral hazard. GPP501: Lecture Oct 17 6 of 24

7 Definitions of externality James M. Buchanan (Nobel 1986): The utility of an individual is dependent up on the activities under his own control but also upon another single activity under the control of a second individual. Can you think of an example? Is this a broad or narrow definition? What s different about this definition? GPP501: Lecture Oct 17 7 of 24

8 Agenda for today: 1. Definitions of externalities. 2. The Pigou analysis. 3. Examples. GPP501: Lecture Oct 17 8 of 24

9 Pigou s analysis Arthur Cecil Pigou (UK, ) Pigou thought of externalities as a divergence between personal costs / benefits and social costs / benefits This could be either on the demand side or the supply side of the market. Could be either positive or negative. Used Alfred Marshall s supply and demand analysis to explore implications of externalities. GPP501: Lecture Oct 17 9 of 24

10 Remember market equilibrium: p Demand Supply This is what we saw before. What does this look like with an externality? p 0 For example, a positive consumption externality. Q 0 Q GPP501: Lecture Oct of 24

11 A positive consumption externality: p What happens with a positive consumption externality? P 2 Demand 1 Demand 2 Supply The original demand curve is Demand 1, which just accounts for one s own private benefit. P 1 If we considered the benefits for others, we d be willing to pay more for each level of consumption. Gives us Demand 2. Marginal Social Marginal Benefit Private Benefit Yields a higher equilibrium quantity; higher price Market Quantity Social optimum Q GPP501: Lecture Oct of 24

12 A negative production externality: p Supply 2 What happens with a negative production externality? P 2 P 1 Demand Marginal Social Cost Marginal Private Cost Supply 1 This increases costs borne by other firms. If we considered the costs for others, we d need a higher price for each level of production. Gives us Supply 2. Yields a lower equilibrium quantity; higher price. Market Quantity Social optimum Q GPP501: Lecture Oct of 24

13 Practice: Try the following on your own: Negative consumption externality o What s an example? Positive production externality o What s an example? GPP501: Lecture Oct of 24

14 Agenda for today: 1. Definitions of externalities. 2. The Pigou analysis. 3. Examples. GPP501: Lecture Oct of 24

15 Let s talk through three examples of externalities: Externalities are at the core of economic theories in many spheres. Jane Jacobs externalities : human capital spillovers. Collective action externalities : crime prevention. Peer effects : impact of a disruptive child in a classroom. GPP501: Lecture Oct of 24

16 Jane Jacobs Externalities: American-Canadian urban theorist ( ) The Death and Life of Great American Cities (1961) Saw dynamic cities as crucial for civilizational advance: Benefits from interactions with people depend on the type/frequency/diversity of people in your circle. Agglomeration; economic geography. The point of cities is multiplicity of choice Human capital spillovers. o Lucas; Romer New Growth Theory o Glaeser; Florida urban diversity GPP501: Lecture Oct of 24

17 Jane Jacobs Externalities: Example from Enrico Moretti (2004) Human Capital Externalities in Cities Take people in 282 cities in Account for individual education, race, citizenship, work experience. Look for the extra bonus you get on top of those factors for having higher percentage of college grads in city. Moretti has many papers on human capital externalities GPP501: Lecture Oct of 24

18 Collective Action Externalities: If an individual bears the cost for an action, but a group shares the benefit, individuals may each choose too little action. Applause. Protest. Crime prevention. Climate change. Many institutions, social norms, and human behaviours derive from a desire to overcome the collective action problem. GPP501: Lecture Oct of 24

19 Collective Action Externalities: Example: crime prevention. What is Lojack? A small radio transmitter hidden in the car. Helps to find and retrieve the car, locate chop-shops. First introduced in Massachusetts in 1986, since expanded to a number of markets. Typical coverage rate is less than 2 percent of registered vehicles. GPP501: Lecture Oct of 24

20 Collective Action Externalities: Ian Ayres and Steven Levitt 1998 QJE: Measuring Positive Externalities from Unobservable Victim Precaution: An Empirical Analysis of Lojack Compare jurisdictions that allowed Lojack vs those that didn t in the 80s/90s. What was car theft rate? GPP501: Lecture Oct of 24

21 Collective Action Externalities: Lojack Private Benefit/Cost Average loss without Lojack: $4K Average loss with Lojack: $1K (from damage) Difference $3k Probability of loss Private Benefit from Lojack 0.05 / year $150 per year. Social Benefit/Cost Cost of loss $4K Benefit from one Lojack: ~1/3 drop in probability of loss of car. External Dollar benefit: $1300 Social benefit compared to private benefit: $ $150 vs. $150 Therefore social benefit is 10x private benefit. Social benefit is 15 x cost. GPP501: Lecture Oct of 24

22 Peer Effect Externalities: Do peers have an effect on your behaviours? Provide information. Enforce conformity ( peer pressure ). Divert or attract common resources. Carrell and Hoekstra 2010 AEJ: Applied Economics Externalities in the Classroom: How Children Exposed to Domestic Violence Affect Everyone s Kids Take data on domestic violence cases; match to school data. Look at impact of a domestic violence case on school outcomes of a kid s peers. Do the troubles of one kid affect the classroom achievement/behaviour of others? What might be the mechanisms? GPP501: Lecture Oct of 24

23 Peer Effect Externalities: GPP501: Lecture Oct of 24

24 For next time: We will study solutions to the externality problem. Read Farrell (1987) Information and the Coase Theorem to prepare. GPP501: Lecture Oct of 24