Transcript for:
Externalities and Public Goods Lecture Notes

we're going to begin a chapter called externalities and public goods our results thus far have been very pro-market from what we've seen in class we've found that unregulated markets give us equilibrium stable prices and maximum economic surplus in reality there are times when unregulated markets do not maximize total surplus and that's what we're going to look at today that brings us this idea of externalities we start off with this basic premise i think we would all agree with our actions affect other people so think about something like smoking and if we are calculating the marginal cost of smoking you would say things like financial costs the amount you spend on cigarettes you also have health costs so you may have to spend extra on medical care you also may have a shorter life or be more likely to have health issues when you're older things like that those are all more different types of costs to you of smoking there's one other marginal cost we should think about which is second hand smoke secondhand smoke is not a cost that you pay that's the cost that everyone who's around you when you're smoking pays most people who are affected by second-hand smoke are not producers or consumers of cigarettes so if we're thinking about the market for cigarettes so far we would think about producers and consumers if we're calculating total surplus we would take the surplus of producers the profits they make from selling cigarettes we would take the surplus of consumers so the enjoyment they get from smoking minus their financial and health costs of smoking and we would add up producer surplus and consumer surplus and that would give us our total economic surplus that is sort of what we've done previously in this in this course now i want to think about is those second those people affected by secondhand smoke who are not producers or consumers of cigarettes again those people are not captured by our calculation of producer surplus plus consumer surplus and this leads us to this idea of an externality an externality is the benefit or cost received by someone not directly involved in the production or consumption of a good so for example the person affected by secondhand smoke so you're smoking someone next to you breathes it in doesn't and doesn't like it and there's some negative effects from breathing in secondhand smoke they are neither a producer or a consumer of a cigarette they are someone who is outside of that market another way of defining an externality is a side effect of an activity that affects bystanders whose interests weren't taken into account so there's an externality because you decided to smoke you're next to someone and you weren't really paying attention to their marginal cost when you decided to smoke externalities are why people hate rental scooters so i used to live in washington dc there's scooters everywhere people hate them why is that well because scooters impose externalities on people who aren't riding them if you're a pedestrian you're trying to walk down the sidewalk you have scooters buzzing by you most of the people who ride them it's their first or second time riding a scooter so they're bad at it somebody might bump into you um you kind of spend the whole time scared if you have a kid you gotta worry about your kids getting hit and similarly if you're a driver you're trying to drive on the road and these people on scooters sort of can't decide if they should be on the sidewalk or on the road some of them will be on the road and they'll tie up they'll slow down traffic they'll make it hard for you to turn etc and so if we think about it the people who want to ban scooters are typically bystanders right the people who want to get rid of scooters are not the people who use scooters they're not the companies that sell scooters right they both like scooters and want them to be there people who want to get rid of them are these pedestrians and drivers who don't use them and just have to deal with these externalities the picture i have is actually a sheriff's boat near portland and what they do is they have to fish all these scooters out of the river that people who don't like scooters um throw the scooters in the river these police fish them out so let's think of some other interesting negative externalities so the first one we want to talk about we call positional externalities these are things where the outcome depends on your relative performance so for example think about suvs if you have an suv your suv makes it more likely that if we crash it will be fatal to me so if we're both in small cars and we get a crash it won't be as big of a crash if we're both in large cars and we get in a crash they sort of will cancel each other out um and so we think that neither of us is more likely than the other to get killed however if i'm driving this little car you're driving an suv and if we crash your big car is much more likely to hurt me in my little car than i am in my small car to hurt you in your suv so you getting this bigger and heavier car puts a negative externality on me your decision to make to take steroids hurts my chance of winning again winning a race is based on relative performance and so if you decide to take steroids that doesn't just affect you that affects me who's trying to compete with you another place we see this is an arms race so if both of us want to have the toughest army then when you buy weapons i'm going to need to buy weapons to make sure that i became be remain as strong as you which leads you to buy weapons and so on and so what we're doing is imposing these negative externalities on each other leading us both to spend a huge amount of money on weapons another is the common resource problem and what we get there is there's some resource that we're both using and the more i take the less is left for you so the most common example of this is overfishing so there's some fixed amount of fish in the ocean and when i start catching them that means all the fish that i catch you cannot catch those fish so new fish that leaves none for me so we are imposing externalities on each other when we fish uh something similar is we can think of intergenerational externalities and so if you're overfishing not only does that leave less for me because you took all the fish it also leaves less for our children to catch or the p or maybe just the people next summer who were fishing so intergenerational means you're not hurting necessarily someone one of your peers someone at the same time as you you're hurting someone in the future overspending my baby boomers leaves a debt for your generation so one generation increases the national debt and borrows a bunch of money and spends it on themselves well it's the next generation who's going to deal with all that debt and be paying more interest on it and not be able to spend as much money on themselves your depletion of ozone leaves a hole for the next generation so that's a general pollution issue is that a lot of a lot of pollution sort of has effects down the road so you pollute today it's not just hurting you and the people around you it's hurting the people later on externalities can also be good we call these positive externalities and that happens when you benefit from a good without consuming or selling it let's think of some example so let's say that you have flowers the farm next to you have bees you are going to get a positive externality from the farmer next to you owning bees because those bees are going to come over and pollinate your flowers and so even though you're not buying or selling the bees you benefit from the fact that your neighbor is in the bee business and it's producing bees another example is lojack lojec is a service where they put on your car this sort of transponder of some sort they hide it on the car so it can be in a lot of different spots and if your car gets stolen then you call lojack and they trace your car and they're able to find it well one thing that the economic research has shown is that lojack has positive externalities because if you if you're in a city that has a lot of people with low jack and i'm deciding whether or not to steal your car well i don't know if you're a car as low jack but i know that there are several cars around here that do your car might have it and so i decide not to steal it because i really don't want to steal a car that has low jack and so what that means is if everyone around me has low jack i benefit from it and so maybe i don't even feel like i need to buy it myself because i'm enjoying the fact that everyone else paid for it and so the potential car thieves are concerned with the car they steal having low jack here's some other interesting positive externalities so the first is called fiscal externalities so this is what happens when we have income taxes so when you're successful that's good for me because it leads you to pay higher taxes and i now can the government can spend those taxes potentially on things that benefit me another is network effects so when you buy an iphone you increase the market for iphone apps leading more to be developed benefiting other iphone owners right so you imagine if you're the first person to buy a new kind of cell phone well people are not going to want to develop apps for the cell phone that hardly anybody's using it takes a lot of resources to develop a good app you only go through a business you're only going to go through that effort if there's a lot of people using that kind of phone so when you buy that iphone you are benefiting everyone else who owns an iphone just a little bit by making the iphone that much more desirable for app makers next we have what we call thick market externalities so a thick market is a market that has many buyers and sellers which reduces trade costs so let's think about how a thick market can involve positive externalities well when you search hard for a job it makes it easier for firms to hire workers leading them to create more jobs so if i'm thinking about creating youtube about posting a new job or hiring someone new one of the things that's going to factor into my decision is all right so if i decide i want to expand my business hire someone how difficult is it going to be for me to find a worker and if there's not many people on the online job boards then it's going to be difficult for me to find someone however if i if you are someone who's searching hard for a job looking at all the online boards then i as a hirer will say oh these are really popular they lead to good matches for workers and jobs so i'm going to create another job and post it on this board uh similar ideas when you shop on something like facebook marketplace that leads sellers to put things on facebook marketplace instead of throwing them away right so if i'm getting ray if i have you know i'm cleaning out my garage i have an old lawnmower and one option is i don't know i don't want this lawnmower i'll just you know throw it away however if i hear about facebook marketplace and i hear about all my friends are using it a lot of people use it to buy used things instead in addition including lawn mowers well then i'll say oh okay well if a lot of people are using it then i'll put my lawnmower on there so the fact that you bought something on facebook marketplace led me to put my lawnmower on there which allowed someone else to get consumer surplus from buying my lawnmower allows me to get producer surplus from selling it instead of throwing it away it's another example of how we all benefit from thick markets we're going to continue discussing externalities and public goods what we want to think about now is taking the information we learned in our last lesson what is an externality what's a positive externality what's a negative externality and let's tie that into what we've learned about marginal benefits and marginal costs and what we've learned about supply and demand curves so first we're going to think about private and social marginal benefits and marginal costs so private marginal cost is the cost to the producer of an additional unit a private marginal benefit is the benefit to the consumer from an additional unit thus far in class we have only considered private marginal benefits and costs so we haven't called them private marginal costs and marginal benefits but that's what we've been talking about right anytime we talked about the marginal cost to a producer we thought about the actual cost of producing a good we thought about the price the marginal benefit to a consumer we thought about how much you personally enjoyed drinking coffee or buying gasoline so what we're going to do now is expand away from just thinking about private marginal benefits and marginal costs so we'll think about an external marginal cost an external marginal cost is the cost of an additional unit of a good that is imposed on people other than the producer so pollution is an example so if i'm running a factory my private marginal costs are going to be things like how much i spend on raw materials and how much i pay my workers an external marginal cost is going to be the amount that every time i produce a widget how much pollution does that generate that's an external marginal cost because that's imposed on all the people who live near my factory so let's think about um sort of trying to do a gra i'll show a graph and see if that sort of gives us to the sense of why we should care about private versus social benefits and costs so here's an example let's say that i'm running my factory and i calculate the marginal benefit to me in the marginal cost of producing this good and so i'll say all right well i've determined that if i produce one more unit and sell it i'll sell it for three dollars which means so let's think about how we can use a graph uh let's think about how we can use a bar graph to illustrate the importance of considering both private and social marginal benefits and marginal costs i'm going to show a bar graph that makes it hopefully clear why we should think about both private and external marginal benefits and costs so let's say right now we're running a firm and we have calculated the marginal benefits and marginal costs of producing one more unit so we say i say okay i found that if i produce one more unit i'll be able to sell that unit for three dollars so that's my marginal benefit it's going to cost me two dollars to make that unit two dollars to make that unit so my marginal cost is two dollars okay well if i make one more unit i sell it for three it only cost me two to make marginal benefit is greater than marginal cost from what we've learned before about rational rules that means you should keep doing it we should do it more however let's suppose that me producing one more unit generates more pollution and so let's say that we've determined if we could actually sort of survey everyone who is going to be affected by this pollution they were all honest we would determine that it imposes a extra cost that's a dollar fifty on the other people who aren't involved in my company who are just the have the unfortunate luck of being downwind of where i'm polluting well this is our this is what we call the social marginal cost the social marginal cost is the total marginal cost that includes both private and external marginal costs and notice that if we care about social if we actually care about the social marginal cost and not just the private marginal cost what this is saying is that we should actually stop doing this and do it less right we should not produce one more unit and whatever we should actually produce fewer units and we should keep backing down our quantity until our social marginal cost is equal to our marginal benefit let's look at something similarly with external marginal benefits so we'll go back to the b and honey example so an external marginal benefit is the benefit of an additional unit of good that is imposed on people other than direct the direct consumer so again this is the idea of that my neighbor has honey bees they make honey i'm not buying their honey but i am benefiting from the fact that their bees fly over and pollinate my flowers so let's look at another comparison of marginal benefits and marginal cost so we start off if we're just looking at private marginal benefits and marginal costs what this is saying is the marginal cost of me producing one more thing of honey is two dollars i'm only able to sell it for a dollar fifty right two dollars in cost a dollar fifty in benefit okay well the margin private marginal benefit is less than the private marginal cost does that mean i should stop doing it should i be doing less of it should i have fewer bees the answer is if if all i care about is myself then that is what the rational rule will tell me however if i'm also concerned with external marginal benefits so if i care not just about the dollar fifty that i get from selling my honey but i also care about this one dollar benefit that my neighbor gets from having their flowers look extra pretty because they're more well pollinated well now i see that i have two dollars and fifty cents in benefits only two dollars in cost which means yes i should be producing that next thing of honey and more beyond that i see here is that social marginal benefit is equal to private marginal benefit plus external marginal benefit let's think about how supply and demand can be affected by externalities so first we'll look at an ex negative externality and we'll think about the market for gasoline the market for gasoline if we want to think about costs gasoline is something that has negative externalities right it leads to pollution so the marginal social cost of gasoline is equal to the marginal private cost plus the external cost notice that a supply curve from what we've done all a supply curve cares about is my marginal private cost right so that is the cost for me to produce one more gallon of gasoline so supply curve with marginal private cost again this is everything we've done in this course up to here that's the supply curve we've thought about however let's think about how there is some external cost and so that means that our marginal social cost curve is going to be shifted up and so we'll say that if i were to produce this many units it cost me about 350. however there is an extra cost and we'll call it two bucks of external cost and so the total cost for me to produce q units is the three dollars and fifty cents it cost me plus the two dollars it cost you to have to deal with this pollution meaning that the total the mark total marginal cost so the marginal social cost is equal to five dollars and fifty cents and so one way to think about this is essentially what we've done is this should look very similar to a shift of a supply curve right usually talk about a supply curve shifting left and right here we show it's lift shifting up it's the same idea right i could have drawn this similarly with a left arrow now let's think about a positive externality we'll think of something like vaccines so when you get a vaccine it doesn't just benefit you it benefits other people because if you have you're vaccinated and you can't get the virus you then cannot spread it to other people so the market for vaccines the marginal social benefit is equal to the marginal private benefit plus the external benefit so the demand curve does not reflect all the benefits right if you're demand we usually you usually just think about your own demand curve which is at which you care about the marginal private benefit right so if you're at work you're deciding whether or not to get your free flu shot you might just think okay well am i someone who gets the flu am i concerned with getting the flu how much how do i feel about taking some time out of my lunch hour getting poked um and so that would be your marginal private benefit of getting a flu shot what the external benefit is is all those people who work with you who you potentially could infect with the with the flu so if there are external benefits now that means we would think about okay our external benefits should shift that demand curve up or to the right and so we get a marginal social benefit curve and so what that means is if we'll go back and first look at the um graph on the left so our marginal social cost curve what we can really call that is the social supply curve so again if we care about all of society that's what the supply curve should look like if all you care about is yourself that is what the private supply curve looks like and again that private supply curve is what we've seen all through the course up until now now we'll look for the at the positive externality graph so again if you care about not just yourself but also all the people you could potentially give the flu to then your demand curve looks like that the social your social the social demand looks like that that's the demand curve you care about everyone if you're only concerned about yourself you have that private demand curve down there again to summarize on the for negative externalities they shift the supply curve up and to the left positive x positive externalities shift the demand curve up and to the right so let's think about um how that will affect equilibrium so before we show just supply or just demand here we'll show supply with demand so i start off we have s sub p and d sub p that's the private supply private demand so that's again all the firm cares about is itself all the consumer cares about is itself now if we decide that we are going to care about negative externalities we're going to have that leftward shift of our supply curve and so we're saying here is if social benefits are considered we would expect higher prices and lower quantities why because we start off here we would move up to here and this is sort of we think about what's going on when you and we'll talk more about this in a little bit but if i was thinking about something like gasoline or cigarettes if i wanted to discourage people from smoking what we do is we make cigarettes more expensive prices are higher people respond to a change in price by reducing their quantity demanded that should say costs um so the last slide we looked at a graph of how supply shifts we looked at a graph of how demand shifts but we didn't look at supply and demand together that's what we're going to do here so first we'll think about negative externalities negative externalities as we saw shift social supply up and to the left so we have a leftward shift we've talked about leftward shifts of supply before so previously we would have a leftward shift in supply if it got more expensive for me to produce the good here we have a leftward shift of supply if we start caring about all the people who are affected by pollution so let's compare our equilibrium points so we start it off here started off here we moved up and to the left because our supply curve shift supply curve shifted and we wind up right here and if we compare the two if social costs are considered we would expect higher prices and lower quantities so let's think about the implications of this graph so solve the graph let's think about what it means if we factored in externalities quantity would be lower and what that means is that goods with negative externalities are over produced so something like pollution things products that produce a lot of pollution we're going to think that those are over produced because if i'm producing gasoline i'm not going to be thinking about the fact that gasoline causes a lot of pollution so we get too much gasoline the other thing we want to know note is that there is still a socially optimal quantity of pollution right so notice that we did not say oh if we care about social benefits and costs then the quantity produced is zero now if we go back here we're still even if we care about pollution we're still getting some amount of this product produced if there was no trade-off then we would say if there were no sort of benefits from gasoline we would say oh no pollution is best right all we care about is pollution we'll just minimize pollution make it zero however pollution is a byproduct of productive activity right so one way to have no pollution is to not have people going to work and not have factories producing anything but that's not what we want for an economy right we want people to be traveling we want people to be going into work we want factories to be making things and so what we instead we have is a trade-off right where there's a trade-off between useful gasoline so again that's gasoline that generates consumer and producer surplus versus harmful pollution which is something that negatively affects bystanders now we'll think about positive externalities on a supply and demand graph positive externalities shift social demand to the right so this is where we're saying that if i act if i'm just um this is where we're saying that if i'm deciding to get a vaccine i should not just be thinking about how much i benefit if i'm also thinking about how much other people benefit from me getting a flu shot then that's what what that's going to do is shift my demand for flu shots to the right so what does that mean is that if social benefits are considered we would expect higher prices and greater quantities so if you think about how many people in my office are getting vaccinated we were getting this many people now we're getting this many people and we also see a higher price which makes sense because now if i really care about my fellow workers i'd be willing to pay a little bit more for it and so maybe that's not just me paying it in money it's me paying it in being willing to to wait an extra five minutes in line to get it so i'm going to summarize this and then we'll talk about some some policy applica implications so one type of externality is a negative externality that happens when your actions harm others so what's the problem here well the supply curve understates marginal social cost right it gets marginal private cost does not think about marginal external costs so what is the implication we get over productions this is where we're getting too much gasoline an example pollutes polluters produce too many greenhouse gases other hand we can have positive externalities and this is when my actions help others so the demand curve understates marginal social benefits so my private demand curve doesn't think about how you benefit from me getting a flu shot this gives us an under production of that good too few flu shots and so that's the example is that if all i care about is myself and all anyone cares about is themselves then we're going to have not enough people getting a flu shot for goods with negative externalities up here we want quantity to be lower for goods with positive externalities we want quantity to be higher how do we make this happen that's what we're going to think about in our next lesson this is our third and final lesson on externalities and public goods so we're going to think about solving externalities and we say solving what i mean is at the end of our last class we said okay well when there are goods with negative externalities we wish there was less of them produced when there's goods with positive externalities we wish there were more of them produced right i wish there were more people getting a flu shot unless you less people using gasoline well instead of just wishing how do we actually make that happen the key is to internalize the externality here's what we mean by that we want to make the actions of buyers and sellers reflect everyone who benefits from the good and any everyone who is harmed by the good right so what we'd really like is for when you're deciding whether or not to get vaccinated for you to not just think about your own benefit but really think about how much everyone everyone around you benefits from you being vaccinated and this brings us this famous idea called the coast theorem what the coast theorem says is that if bargaining is costless then externality problems can be solved by private bargains and so let's see what so what we're thinking about here is all right maybe instead of me just sort of not really caring about my co-workers maybe there's some way that my co-workers can say hey let's make a deal i'll take you out to lunch if you go get a flu shot that's sort of the idea that we're thinking about and so let's put some numbers to it let's say that there is a cafe where outside it is someone who will frequently play music or sing and so these performers near a cafe generate effort extra traffic which increases their cafe's profits by 120 so the cafe benefits 120 because these performers are outside drawing a crowd however during the winter there's fewer people hanging out on the street or people are not as what people are just sort of trying to get from where they work to the subway station and people and people are not going to be as likely to linger and tip well the performers because they're not getting enough in tips for it to be worth it decide that they're not going to play anymore but the cafe still benefits that still benefits 120 when those performs they're even in the winter so the people who do go to the cafe maybe they'll stay longer because there's a performance going on outside so a private bargain would be the cafe pays these street performers 40 bucks to stay through the winter what that means is both the performers and the cafe are better off why is that well the performers are basically made square to where they would have been in the summer right so in the summer whatever i earn it's enough to keep me going in the winter i lose out on 40 bucks so i quit well let's get me back my other 40 and so i'm willing to keep going i'll basically the winter is as profitable for me as the summer the cafe is better off because their alternative was to not pay the performer lose out 120 in profits instead they pay the performer 40. get an extra 120 so even after paying the performers they're still eighty dollars better than if the performers weren't there so these we call them side payments so this is one um person paying another person who benefits or is hurt by an externality these side payments internalize the externality because what that means was the side payments allowed the performers to benefit from the externality that they gave to the cafe so the performers now maybe the performers don't actually care how many people go to the cafe but if the cafe pays them 40 then they'll say all right well now i do care about how well you do and if you are willing to pay me then i will keep going now that is no longer an extra an externality for me that is something i'm actually thinking about when i'm deciding whether or not to perform however there's some challenges to private bargaining so when bargaining is costly externality problems persist so let's say that it wasn't just one cafe that was benefiting but it was 25 cafes on the street in all these different places and they all get some amount of benefit from the performers well then what you'd have to do is sort of get try to get 25 cafes to agree how much are we each going to pay these these performers how much should we pay them during the winter you'd have to get all of them to agree and none of them to sort of back out and say well the other 19 of you are paying i'm not going to and so that is what we mean by costly bargaining costly bargaining this often occurs when there are many bystanders who benefit or harm and so we think about a negative externality how can we make sure that a polluter fairly compensates everyone who is negatively impacted right so if i'm polluting a town of 50 000 people there's going to be some people there who have asthma and they're very negatively impacted and they have to move there's going to be people who don't really who really they don't mind pollution so they're hardly negatively impacted at all but if we ask everyone everyone is going to say oh it has huge negative impacts i need to be paid lots of money and so that's another example where it's really challenging to try to strike a private bargain so let's think about another way that we can deal with this well let's get back to our original problem our problem is that people ignore external costs and benefits right that was what's leading us to this okay well maybe people ignore them however let's substitute an incentive that people don't that people ignore external costs so that's not really an incentive that you care about right it is not inducing you to act because you don't care about external costs or benefits with ones that people don't ignore which are taxes or subsidies right so even if i don't care at all about pollution if i don't care how much it bothers you to have to breathe in my dirty air i do care about money so even if people ignore external costs to bystanders they pay attention to prices so i'm going to pay attention to how much i have to pay if i pollute so for negative externalities we would think about implementing what we call a corrective tax equal to the external cost so what i want to do then is i'm going to put a tax on your on whatever you're producing that is equal to the amount of the external costs that you are putting on other people for positive externalities i would put in a corrective subsidy equal to the external benefit so this would be sort of someone paying me to get a flu shot the tax or subsidy leads people to act as if they internalize the externality right so i'm not acting i'm not getting my flu shot now because i all of a sudden care about my co-workers i'm getting my flu shot because my boss offered to pay me 10 to get it so one example of something like this is a carbon tax so the idea of a carbon tax is hey i don't care if i'm polluting there's also some intergenerational um externalities here right well i'll pollute i'll make the the earth just a little bit warmer but i'll be dead before it really matters well a carbon dioxide tax says well actually even if you don't care about other people you're going to care about the fact that we are taxing you forever for all the carbon you emit and because i put taxes on you for emitting carbon that will make you act think about it and try to come up with more energy efficient ways to do your business let's look at that on a graph so we're going to say that we have our we start off with a initial supply and demand curve notice the p subscripts here mean that we these are private costs and private benefits we're thinking about there's also three dollars in social costs and so this brings us the social supply curve looks like that notice it's shifted to the left and so what we want to do is get the equilibrium here's our initial equilibrium we wish there was some way we could get it up to here lower quantity produced well what we can do is implement a three dollar tax if my producing it is imposes a three dollar cost on everyone around me well if you make me pay a three dollar tax then i will behave as if i cared about you and your and the three dollars it cost you so ours so our social supply instead we think of that as a post-tax supply and this is called a corrective tax so if we this looks similar to in the when we talked about taxes before how a tax shifts supply to the left so what are some examples of corrective taxes well corrective taxes are any tax that we impose to fix negative externalities so cigarette taxes are designed to get people to smoke less right so we make tech we make cigarettes more expensive people aren't going to smoke as much and so as a result there's fewer people affected by secondhand smoke highway tolls reduce traffic congestion so if we are thinking about the negative externality that you impose on other people when you're driving well the way we could reduce that is make you act as if you were concerned with other people having to deal with your congestion so what that means is i'm going to charge you a little bit of money to drive on the road so you'll be a little bit less likely to drive on the road and that'll reduce the traffic lawsuits are in a way could be a corrective tax so what i mean here if you think about how a lot of communities you are required to deal with an icy sidewalk that's in front of your house so either salt it or shuffle it and if not what can hap potentially can happen is your neighbor or someone in your community is walking and they slip and fall and then they're able to suit you and essentially what that does is we have this externality which is me not taking care of my sidewalk hurts you when you try to go on a walk in the winter and the lawsuit is intended to internalize that right so even if i don't care at all if you fall what i do care about is not having to pay a lawsuit so i will shovel my driveway for that reason social norms can also act as a corrective tax so when you are done doing your grocery shopping you unload your shopping bags and you are getting ready to leave and you have the shopping cart well you just leaving the shopping cart there is what makes the most sense to you if all you care about is yourself right saves you from having to walk the car to the cart return and what do i care if it's going to be a pain for the next person who wants to park in the space or the next person who wants to go get a cart however one of the things that maybe keeps you from doing is what we call social norms that basically you want to be a good citizen and you don't want to be the person who sort of you slide your card up onto the curb and everyone else just sort of glares at you right and so that's a corrective tax where you the tax that you pay if you do it is not financial it is the fact that you kind of feel bad about yourself and everyone's looking at you and judging at you and thinking about how selfish you are we can also have corrective subsidies remember those are intended to fix positive externalities and get us to do something more so there's were subsidies for hybrid cars so the government will pay you a little bit if you are willing to buy a hybrid car employers subsidize flu shots so a lot of places if you work they will offer a free flu shot during your lunch and so you don't have there's no financial cost to you we've talked a little before the idea of a warm warm glow when you do something nice so a warm glow from giving blood is like a corrective subsidy right so again i'm not getting paid cash to give blood but you know i get the the sticker the sticker here says be nice to me i gave blood today i uh get to you know hang out in the in the trailer afterwards eat a snack and think about what a nice thing i did and actually one argument against paying people to give blood is that the warm glow effect will go away so essentially it's the the sticker instead would be like you don't need to be that nice to me i gave blood in exchange for 10 bucks and so what they they've determined is basically it's not really worth it to give people 10 bucks because people are then just sort of thinking it as just another way to make money and you're not going to be thinking of it as like a nice thing to do another way of trying to fix externalities are using laws and rules so for example there are noise restrictions so there are certain times in neighborhoods when you are not allowed to make loud noises because being noisy that's a negative externality on your neighbors we have speed limits and drunk driving laws both of these are instances of you driving unsafely doesn't just hurt you it hurts the people you could potentially get in an accident with so there are negative externalities there so we make laws saying you can't do these things driving too fast and driving drunk because those impose externalities on other people also environmental standards so there are certain things that if you're starting a factory or there's all these rules you have to apply by because these are externalities that we don't want you to impose on other people laws are can often be a blunt one-size-fits-all instrument which is why economists often prefer the use of markets so we think about how there are lots of negative externalities from alcohol drunk driving like we talked about there's also people develop alcoholism a lot of crime occurs when people are drunk and so one solution would be to just ban the sale of alcohol and that's really not what most people want to do instead what what we do is we tax alcohol and so that hopefully on the margins gets a few gets people to drink a little bit less and also you can take um take the money and spend it on things like um alcohol cessation programs now we'll think about how managers can also use these rules to deal with externalities so uh companies will ban intra-office dating i have the clip from the office of the uh dinner party episode of the office which is the ultimate um explanation of why interoffice dating is bad employees must use antivirus software so again maybe i find the antivirus software kind of annoying and i have to update it and sometimes it keeps me from downloading something i want to but if i get a virus on my work computer that puts an externality on a lot of other people a lot of other people potentially are affected so company just makes a rule have to use our antivirus software corporate travel must book all trips that is because if i am going on a trip i don't it's not my money just spend as much money as it takes i want to get the best best flight fly first class stay in the nicest hotel and so on and that imposes an externality on my employer who's actually having to pay for it we also can see sometimes we use rules specifically to solve positional externalities and so we talked um so arms treaties when we were talking about what positional externalities are we had this idea that two countries will get into arms race so united states and the soviet union famously gotten these really expensive arms races during the cold war and so what you do as an arms treaty as you say listen we are both going to agree that we're not going to be producing a lot more weapons we are content that we have the you know we have enough weapons to each sort of threaten the other there's no point in both of us spending a lot of money so that is one example of a rule that solves this idea of both of us wanting to be best there's campaign spending limits so if i'm concerned that you're going to spend a lot of money and so i feel like i need to spend a lot of money we might set limits and saying you could only set spend some amount of money in an election sports anti-doping rules are all right well if i'm going to use steroids just because i feel like i have to keep up with you who's also using steroids instead we should just make rules and drug test people and so that nobody uses steroids and no one's getting that advantage we're going to move on and talk about public goods and so i'm going to start with a question how much did you pay the last time you saw fireworks and i'm going to guess that the answer is probably nothing and what we're going to do now is look at a couple of slides to think about why it is that you didn't have to pay for fireworks the last time you saw them so we're going to learn a couple of terms first term is a non-rival good a non-rival good is a good word consumption by one person does not diminish the amount available for someone else so something like netflix right if i'm watching a show on netflix that does not keep you from watching that show on netflix right netflix can show the same show to everyone and everyone in the country if it wants to and somebody that's a um pic a view of the river from michigan state campus me looking at that river and enjoying the beautiful view is not going to prevent you from looking at the red cedar river and thinking oh that's really pretty right next we have what we call a non-excludable good a non-excludable good is a good people cannot easily be prevented from consuming even if they did not pay for it so something like road traffic so if we don't have a toll road instead just think about the road to your house in your neighborhood anyone can use that road there's not really a way for me to keep you from using the road in my neighborhood and another one is something we talked about already which is fishing in public waters right it's not easy for me to keep you from fishing in the ocean um maybe in like a smaller lake we can have some rules and game wardens and police come monitor whether whether you're um you know abiding by the the limit of how many fish you can catch but in larger bodies of water there's just not a really feasible thing and so these are both non-excludable goods where i can't keep you from consuming it and or public then this brings us to the term public good public goods are goods that are both non-rival and non-excludable and so we'll think about peop things like fireworks national defense and clean air so why is that well these are all things where we can't prevent people from using them but one person using them doesn't diminish the amount available for someone else right so if you're an american citizen there's no way for me to say all right my national defense we're going to prevent we're going to protect me from a war but not from you national defense is something all of us benefit from and you being made safe by national defense does not make me any less safe there's you getting a benefit of it does not diminish my benefit from it and so what we're going to do you think about an unregulated market will likely not yield the optimal outcome right so there's not really a good way for the non-regulated market to yield the optimal amount of national defense right that is something that the government provides for this reason and so going back to our question about pub about fireworks well if you did let's think about why are fireworks free why is there not a free market for fireworks why does not the market just solve the fact that uh people like fireworks they cost some money to produce but maybe people just pay for private fireworks shows well if you didn't watch would there be more fireworks for someone else no fireworks are a non-rival good me looking up in the sky and seeing the fireworks does not prevent you from doing that could your town keep you from watching them there was some way that i could say oh you did not pay your taxes this year you are not allowed to watch the fireworks no there's not a way to do that if you could see them from your house or you can see them from the street there's not a way to exclude people from those so fireworks are not excludable so fireworks are non-rival and non-excludable fireworks are a type of public good this brings us to a concept what we call the free rider problem and so to illustrate that let's think about a lighthouse so if you don't know what a lighthouse is a lighthouse is a tower like that that's located at the coast of some body of water and it is there so that if you're a ship driving it at night and you don't know where to go you see the lighthouse and the lighthouse helps you navigate to a safe port well very few lighthouses were privately owned i say were because they don't remain lighthouses anymore because you know boats have gps and things like that why which of the following best explains this so why is it that very few lighthouses are privately is it because the startup costs for building a lighthouse are too high because the marginal benefits of safe travel are smaller than the marginal cost of earning a lighthouse or because there is not an effective way of ensuring only paying customers are able to use the lighthouse the answer here is c there is not an effective way of ensuring only paying customers are able to use the lighthouse because again the light's there the light is on anyone on the boat is able anyone in a boat can look at the light and use it to get to shore lighthouses are an example of a public good so they're non-rival one sailor using a lighthouse for navigation does not prevent other sailors from using it and they're not excludable there's no way to prevent a sailor from using a lighthouse the whole point of the lighthouse is that the light is always on when a good is non-excludable people often choose to consume without pain this is the free rider problem right so even if the lighthouse has a sign like hey give us 10 bucks for the for the fact that you got here safely there's no way to force people there's presumably no way to force people to pay because again you could just say oh i didn't use your lighthouse i just got here on my own this makes it difficult for private companies to profitably provide the good here's another example this is the microwave from when i was in the community microwave from when i was in graduate school and as you can see it was really gross and so if i were to clean the microwave other graduate students would benefit from my effort however i do not use the microwave frequently enough for it to be worth my time additionally i know that even if i clean up the mess someone else will make it messy again so we have a free rider here where we're all kind of hoping to free ride off someone else cleaning the microwave which means that there's nobody is cleaning it because again it's not worth any one person's time to pay the time cost of cleaning the microwave so how do we solve the free rider problem well one option is the government provides and that's you that's often why we call them public goods they're usually goods that are provided to the public by the government so if we need a lighthouse we'd expect the government to pay to fund this lighthouse governments pay to provide fireworks or we can try to develop technologies to control access best example there are toll roads right so instead of just saying up there's nothing we can do people are going to use these roads we put in barriers and make people pay to use the roads you