公共经济学课件

1Chapter1-IntroductionPublicEconomics2PublicFinanceDefinedPublicfinanceisaboutthetaxingandspendingactivitiesofthegovernment.Alsoknownas“publicsectoreconomics”or“publiceconomics.”Focusisonmicroeconomicfunctionsofgovernment–policesthataffectoverallunemploymentorpricelevelsareleftformacroeconomics.Scopeofpublicfinanceunclear–governmenthasroleinmanyactivities,butfocuswillbeontaxesandspending.3PublicFinanceandIdeologyHowshouldagovernmentfunctionineconomicsphere?Organicview–communitystressedaboveindividual.Goalsofsocietysetbythestate.Mechanisticview–governmentisacontrivancecreatedbyindividualstobetterachievetheirindividualgoals.Individual,notgroup,isatcenterstage.Thisistheviewpointtakeninthetextbook.4GovernmentataGlanceLegalframeworkFederalgovernmentNorealconstraintsonspendinginConstitutionTaxesmustcomeoriginateinHouseofRepresentatives.Equaltaxratesacrossstates.Incometaxcamefrom16thamendmenttoConstitution.CanrunbudgetdeficitsStateandlocalgovernmentCanimposespending/taxingrestrictionsonitself.Manystatescannotrunbudgetdeficits.5GovernmentataGlanceSizeofgovernment–howtomeasure?NumberofgovernmentemployeesAnnualexpendituresPurchasesofgoodsandservices,transfers,andinterestpaymentsUnifiedbudget–In2001,$1.6trillionspentatfederallevel,andanother$1.3trillionatstateandlocallevels.6GovernmentataGlanceThesenumbersignoreactivitiesthatdonothaveexplicitoutlays,butsubstantialeffectsonresourceallocation.Regulations,forexample.Conceivably,couldconstructa“regulatorybudget”toaccountforthesecosts,butdifficulttocompute.7GovernmentExpenditureSomenumbersAnnualexpenditureshavegrownbyafactorof290from1929-2001.Inflation,populationalsochanging.Real,per-capitaexpenditurestill10timesaslarge.AspercentageofGDP,governmentexpenditurewas9.6%in1929,and29.3%in2001.Table1.19GovernmentExpenditureUnitedStatesversusotherdevelopedcountries.U.S.publicsectorisquitesmallcomparedtoSwedenorFrance,andsmallerthanallthecountrieslisted.Althoughlarge,theU.S.governmentissmallinrelativeterms.Morerelianceonprivatesector.Table1.211GovernmentExpenditureIn1965NationaldefensealmosthalfoffederalexpenditureSocialsecuritysmall&Medicarenon-existentDebtpaymentsroughlyconstant.In2001Defensewaslessthanone-fifthSocialsecuritynowlargestspendingitem,Medicarelarge&growingFigure1.113GovernmentExpenditureMuchofthegovernmentbudgetconsistsofentitlementprograms–programswithcostsdeterminedbynumberofpeoplewhoqualify.SocialSecurity,Medicare,welfareThree-quartersofthefederalbudgetisrelativelyuncontrollable,becauseoftheseentitlements.14GovernmentExpenditureFederalgovernmentresponsibleforabout51%ofdirectexpenditure.Stategovernmentsresponsiblefor21%.Localgovernmentsresponsiblefor28%.State&localgovernmentsprimarilyresponsibleforpolice&fireprotection,education,transportation,andsomewelfareprograms.15GovernmentRevenuesFederaltaxesmainlyconsistofindividualincometaxes,payrolltaxes,andcorporatetaxes.Personalincometax46%ofcollections.State&localtaxesmainlyconsistofpropertytaxes,salestaxes,individualincometaxes,andgrantsfromfederalgovernment.Lessreliancenowonpropertytax,moreonincometax.16RecapofIntroductionPublicfinance,definitionViewsofgovernmentGovernmentexpenditureGovernmentrevenue17Chapter2–ToolsofPositiveAnalysisPublicEconomics18PolicyanalysisishardWhyisitsohardtotellwhat’sgoingonwithgovernmentactions?Considerloweringincometaxrates.Willloweringtaxesincreaseworkeffortandlaborsupply?Unlikethephysicalandnaturalsciences,difficulttoperformcarefullycontrolledexperimentsontheeconomy.Oftentimes,thereisno“controlgroup”or“comparisongroup”forapolicy.19AlternativestoanexperimentUseofstatisticaltoolstostudyimpactofpublicpolicies.Willusethedebateovertheeffectoftaxesonlaborsupplytoillustratehowpositiveanalysisisdoneinpublicfinance.20RoleofeconomictheoryConsideranalyzingTable2.1Asmarginaltaxrateshaveincreased,averageweeklyhourshavedecreasedfrom1955to2001.Canweconclusivelysaythattaxeshavedepressedlaborsupply?No.Nonlaborincomerose(dividends,interest)AttitudesmayhavechangedTable2.122RoleofeconomictheoryInreality,anunlimitednumberoffactorschangeovertime,andcouldaffectlaborsupply.Economictheoryhelpsisolateasmallsetofvariablesthatareimportantinfluencesonbehavior.23RoleofeconomictheoryTheorywouldsuggestthatpersonmaximizesutility--andwouldincludefactorsliketheperson’sownwagerate.Theoryisoftentoosimple–mayignoreimportantconsiderations.Butwholepointofmodelbuildingistoreduceaproblemtoitsessentials.24RoleofeconomictheoryInthislaborsupplycase,theafter-taxwagechangeswiththepolicy.Theorypredictsthattheeffectonhoursisambiguous.Thesubstitutioneffectpredictsthatasthewage(priceofleisure)falls,consumerssubstitutetowardleisure.Theincomeeffectsaysthatifleisureisanormalgood,consumersconsumelessofitasincomefalls.Onlyempiricalwork–analysisbasedonobservationasopposedtotheory–cananswerthisquestion.25MethodsofEmpiricalAnalysisTherearethreemainmethods:InterviewsExperimentsEconometricstudies26MethodsofEmpiricalAnalysisInterviewsMoststraightforwardwaytofindoutwhetherapolicywillaffectbehavioristoask.Reportersoftendothis.PitfallsofinterviewsThefactthatpeoplesaysomethingabouttheirbehaviordoesnotmakeittrue.Peoplemaybeembarrassedaboutthesubject,orhaveother“agendas.”27MethodsofEmpiricalAnalysisExperiments–Althoughdifficult,itisnotimpossibletorunpolicyexperiments.Requiresrandomassignment.PitfallsofexperimentsSelectionissues,evenifinitialrandomassignment.Subjectsknowtheyareinexperiment.Cost.28MethodsofEmpiricalAnalysisExperiments–someeconomictheoriesaretestinginlaboratorysettings,oftenwithcollegestudents.Similarapproachasusedbypsychologists.Usuallyofferdifferentrewards.Settingisartificial,however.Collegestudentsnotreallyrepresentativeofpopulationaswhole.29MethodsofEmpiricalAnalysisEconometrics–statisticalanalysisofdata.Effectsofpoliciesareinferredfromtheanalysisofobservedbehavior.30MethodsofEmpiricalAnalysisChoosespecificalgebraicformtosummarizetherelationship.Forinstance:WhereLishoursworked,wnisthenetwage,andA,X1,andX2areotherfactorsthataffectwork.α0-α4aretheparameters,andεisarandomerror.Figure2.132MethodsofEmpiricalAnalysisIgnoringalloftheotherfactorsexceptforthewagerate,thegoalistofitalinethroughthesedatapoints.Nostraightlinecanfitthroughthem,butthepurposeofmultipleregressionanalysisistofindtheparametersthathasthe“bestfit.”Theslopeofsucharegressionlinegivestheregressioncoefficientonthewagerate.33MethodsofEmpiricalAnalysisWhenα1=0,thenetwagehasnoimpactonhoursworked.Whenα1>0,thenetwageincreaseswork.Substitutioneffectdominates.Whenα1<0,thenetwagedecreaseswork.Incomeeffectdominates.Presenceofrandomerrorreflectsinfluencesonlaborsupplythatareunobservabletotheinvestigator.34MethodsofEmpiricalAnalysisInpractice,methoddoesnotalwaysleadtoconclusiveresults.Afterα1isestimated,itsreliabilitymustbeconsidered.Isit“close”tothetruth?Thestandarderrorindicateshowmuchtheestimatedparametercanvaryfromitstruevalue,andwhenthestandarderrorissmallinrelationtotheestimatedparameter,thecoefficientisstatisticallysignificant.35MethodsofEmpiricalAnalysisPitfallsofeconometricanalysisHeterogeneityacrossgroupsChangesinparametersovertimeOmittedvariablesbiasSomevariables,suchas“motivation,”areinherentlyunmeasurable.Reversecausality(simultaneity)Observedvariablesdon’talwayscorrespondtotheoryHoursofworkisnotthesameas“workeffort.”36RecapofToolsofPositiveAnalysisRoleofTheoryMethodsofempiricalanalysis37Chapter3-ToolsofNormativeAnalysisPublicEconomics38WelfareeconomicsNeedsystematicframeworktoassessthedesirabilityofvariousgovernmentactions.Welfareeconomicsisconcernedwiththesocialdesirabilityofalternativeeconomicstates.Distinguishescaseswhenprivatemarketsworkwellfromcaseswheregovernmentinterventionmaybewarranted.Reliesheavilyonbasicmicroeconomictools,particularlyindifferencecurves.39PureexchangeeconomyEconomywith2people(Adam&Eve)2commodities(Apples&Figs)Fixedsupplyofcommodities(e.g.,onadesertisland)AnEdgeworthBoxdepictsthedistributionofgoodsbetweenthetwopeople.Figure3.141PureexchangeeconomyEachpointintheboxinFigure3.1representsanallocationbetweenAdamandEve.Eachpointintheboxfullyexhauststheresourcesontheisland.AdamconsumeswhatEvedoesn’t.Adam’sconsumptionofapplesandfigsincreasesaswemovetowardthenortheastinthebox.Eve’sconsumptionofapplesandfigsincreasesaswemovetowardthesouthwestinthebox.Atpointvinthefigure,Adam’sallocationofapplesisOx,andoffigsisOu.EveconsumesO’vofapples,andO’woffigs.42PureexchangeeconomyAssumethatAdamandEveeachhaveconventionallyshapedindifferencecurves.Adam’shappinessincreasesasheconsumesmore;thereforehisutilityishigherforbundlestowardthenortheastintheEdgeworthBox.Wecanthereforedraw“standard”indifferencecurvesforAdaminthispicture.Adamwouldgetevenhigherutilitybymovingfurthertothenortheast,outsideoftheEdgeworthBox,butheisconstrainedbytheresourcesontheisland.43PureexchangeeconomySimilarly,Eve’shappinessincreasesassheconsumesmore;thereforeherutilityishigherforbundlestowardthesouthwestintheEdgeworthBox.Eve’sindifferencecurvesthereforeare“flippedaround.”HerutilityishigheronE3comparedE2orE1.Figure3.245PureexchangeeconomySupposesomearbitrarypointintheEdgeworthBoxisselected,forexamplepointginFigure3.3.ThisprovidesaninitialallocationofgoodstoAdamandEve,andthussomeinitiallevelofutility.Figure3.347PureexchangeeconomyWecannowposethefollowingquestion:IsitpossibletoreallocateapplesandfigsbetweenAdamandEvetomakeAdambetteroff,whileEveismadenoworseoff?AllocationhinFigure3.3isonepossibility.Weare“movingalong”Eve’sindifferencecurve,soherutilityremainsunchanged.Adam’sutilityclearlyincreases.Clearly,otherallocationsachievethissamegoal,suchasallocationp.Oncewereachallocationp,wecannotraiseAdam’sutilityanymore,whilekeepingEve’sutilityunchanged.48PureexchangeeconomyAnallocationisParetoefficientiftheonlywaytomakeonepersonbetteroffistomakeanotherpersonworseoff.Oftenusedasthestandardforevaluatingdesirabilityofanallocationofresources.Paretoinefficientallocationsarewasteful.AParetoimprovementisareallocationofresourcesthatmakesonepersonbetteroffwithoutmakinganyoneelseworseoff.Figure3.450PureexchangeeconomyManyallocationsareParetoefficient.Figure3.5illustratesthreeofthem--allocationsp,

p1andp2.AmongtheseParetoefficientallocations,someprovideAdamwithhigherutilitythanothers,andtheoppositeonesprovideEvewithhigherutility.Figure3.552PureexchangeeconomyInfact,thereareawholesetofParetoefficientpointsintheEdgeworthBox.ThelocusofallthesetofParetoefficientpointsiscalledthecontractcurve.Figure3.7illustratesthecontractcurve.Figure3.754PureexchangeeconomyFigure3.7showsthateachoftheParetoefficientpointsiswhereanindifferencecurveofAdamistangenttoanindifferencecurveofEve.Mathematically,theslopesofAdam’sandEve’sindifferencecurvesareequal.The(absolutevalueof)slopeoftheindifferencecurveindicatestherateatwhichtheindividualiswillingtotradeonegoodforanother,knowasthemarginalrateofsubstitution(MRS).55PureexchangeeconomyParetoefficiencyrequires:56ProductioneconomyInpureexchangeeconomy,assumedsuppliesofcommoditieswerefixed.Nowconsiderscenariowherequantitiescanchange.Theproductionpossibilitiescurveshowsthemaximumquantityoffigsthatcanproducedwithanygivenquantityofapples.Figure3.858ProductioneconomyForappleproductiontobeincreased,figproductionmustnecessarilyfall.Themarginalrateoftransformation(MRT)ofapplesforfigs(MRTaf)showstherateatwhichtheeconomycantransformapplestofigleafs.Itistheabsolutevalueoftheslopeoftheproductionpossibilitiescurve.Themarginalrateoftransformationcanbewrittenintermsofmarginalcosts:59EfficiencywithvariableproductionWithvariableproduction,efficiencyrequires:Ifthiswerenotthecase,itispossibletomakeonepersonbetteroffwithanadjustmentproduction.Rewritingintermsofmarginalcosts,wethenhave:60FirstfundamentaltheoremofwelfareeconomicsAssumethatAllproducersandconsumersactasperfectcompetitors(e.g.,nomarketpower)AmarketexistsforeachandeverycommodityUndertheseassumptions,thefirstfundamentaltheoremofwelfareeconomicsstatesthataParetoefficientallocationwillemerge.Implication:Competitiveeconomyautomaticallyallocatesresourcesefficiently,withoutcentralplanning.Conclusion:Freeenterprisesystemsareamazinglyproductive.61SecondfundamentaltheoremofwelfareeconomicsNotethatParetoefficiency(andthefirstfundamentalwelfaretheorem)doesnotfairness.EitherthenortheastorsouthwestcorneroftheEdgeworthBoxisParetoefficient,butveryunequaldistribution.SocietymaycareaboutmorethanParetoefficiency.FromthecontractcurveintheEdgeworthBox,couldmapthederivetherelationshipbetweenAdam’sandEve’sutilities,ontheutilitiespossibilitiescurve.Figure3.1063SecondfundamentaltheoremofwelfareeconomicsThefrontieroftheutilitiespossibilitiescurveis,bydefinition,attainable.Similartoabudgetconstraint.Couldpostulateasocialwelfarefunction,whichembodiessociety’sviewsontherelativewell-beingofAdamandEve:Couldthenmaximizesociety’spreferences,ordemonstratethatsomePareto-inefficientbundlesarepreferredtosomePareto-efficientones.Figure3.1265SecondfundamentaltheoremofwelfareeconomicsThesecondfundamentaltheoremofwelfareeconomicsstatesthatsocietycanattainanyPareto-efficientallocationofresourcesbymakingasuitableassignmentofinitialendowmentsandthenallowingfreetrade.Noadjustmentstoprices.Issuesofefficiencyanddistributionalfairnesscanbeseparated.66MarketfailureTheoremswillbeviolatedwhentherearemarketfailuresMarketpower(monopoly)NonexistenceofmarketsInformationfailures(asymmetricinformation)ExternalitiesPublicgoods67EvaluatingpolicyWillthepolicyhavedesirabledistributionalconsequences?Willitenhanceefficiency?Canitbedoneatareasonablecost?68RecapofToolsofNormativeAnalysisWhatiswelfareeconomicsPureexchangeeconomyProductioneconomyFirstandsecondfundamentalwelfaretheorems69Chapter4-PublicGoodsPublicEconomics70PublicGoodsDefinedPurepublicgoodssharetwocharacteristicsNonrival–CostofanotherpersonconsumingthegoodiszeroNonexcludable–Veryexpensivetopreventothersfromconsumingthegood71ExamplesofpublicandprivategoodsPublicGoodsNationaldefenseHousecleaninginanapartmentwithmanyroommatesFireworksdisplayMusicfilesharingUncongestedfreewayPrivategoodsPizzaHealthcareCongestedfreewayPublichousing72ValuationofpublicgoodsEveryoneconsumessamequantityofpublicgoodMarginalbenefitofpublicgoodvariesbypersonInthehousecleaningexample,differentroommatesvaluethecleanapartmentdifferently.73ImpurepublicgoodsMostgoodsthatarethoughtofaspublicgoodsmaynotstrictlysatisfythenonrivalornonexcludableassumption.Ascenicviewisapublicgoodwithoutcongestion,butthequalitydiminishesasmorethenumberofsightseersincreases.Thus,ascenicviewbecomesrival.74PrivategoodscanbeprovidedbythepublicsectorThesearecalled“publiclyprovidedprivategoods.”Keycriteria:isthegoodrivalandexcludable?Publichousingisrival(onefamilyconsumesoneapartment)andexcludable(easytopreventconsumption).75EfficientprovisionofprivategoodsDerivationofaggregatedemandEachperson’sdemandcurverepresentsthewillingness-to-payforanadditionalunitofagood.Privategood:holdingPconstant,addtogetherindividualquantitiestogetQ.HorizontalsummationFigure4.177EquilibriuminprivategoodsmarketEquilibriumwheresupplycurveintersectsaggregatedemandcurve.Everyonepaysthesameprice,P.Individualsconsumedifferentquantities,Q.Paretoefficient.78EfficientprovisionofpublicgoodsConsiderafireworksdisplayasapublicgood–itisnonrivalandnonexcludable.Biggerdisplaysgivehigherbenefit.Publicgood:holdingQconstant,addtogetherindividualwillingness-to-paytogetP.Verticalsummation.Figure4.480EfficiencyinpublicgoodsmarketEveryoneconsumesthesamequantity,QIndividual’smarginalbenefitvaries.Efficiencyrequiresthatthesumofindividualmarginalbenefitsequalsthemarginalcost.81NumericalexampleConsider2individuals,AdamandEvewhohavethefollowinginversedemandcurves,andfaceamarginalcostcurvebelow.82Numericalexample,privategoodIfthegoodwasaprivategood,thentheaggregatedemandcurveis:Withaprivategood,everyonepaysthesameprice.83Numericalexample,privategoodInacompetitivemarket,P=MCApproximately133unitsoftheprivategoodareprovidedatapriceof$88.Adamconsumesaround22unitsandEveconsumesaround111units.84Numericalexample,publicgoodSupposeinsteadthatthegoodisapublicgood.Theaggregatedemandcurveis:Withapublicgood,everyoneconsumesthesamequantity.85Numericalexample,publicgoodEfficientprovisionwouldrequire:P=MCEfficientprovisionwouldimplythatAdam&Eveconsume138.46unitsofthepublicgood.Privatemarketmaynotarriveatthisallocation,however.86Efficientallocationsofpublicgoods:ProblemsAlthoughacompetitivemarketwillprovideprivategoodsefficiently,willthesamebetrueforpublicgoods?Peoplemayhaveincentivestohidetheirtruepreferencesforapublicgood.IfAdamcangetEvetopayforthepublicgood,hecanusehisincomeforotherpurposesandstillenjoythepublicgood.87Problems,continuedThisincentivetoletotherspayforthepublicgoodwhilestillenjoyingthebenefitsisknownasthe“freeriderproblem.”Theprivatemarketmaythereforefallshortofprovidingtheefficientamountofthepublicgood.88Problems,continuedThisincentivetofreerideoccursbecausethepublicgoodisnonrivalandnonexcludable.Apersongetstoconsumethegoodevenifhedoesnotpayforit.89Problems,continuedReturntothepublicgoodsnumericalexample.SupposeAdamchoosestofreeride,andEvethereforeprovidesheroptimalamount.Evechooses:AfterEvecontributes120unitsofthepublicgood,Adamdoesnotprovideanyadditionalcontributions,becausethemarginalbenefittoAdamofthe120thunitislessthanthemarginalcost.90SolutionstothefreeriderproblemGovernmentinterventioncanpotentiallyleadtoamoreefficientoutcome.Governmentcanusecoercivepowertoforcepeopletopayforpublicgoods,throughtaxation.Freeridingisnotafact,however.Thereareinstanceswhenindividualsdoactcollectivelywithoutcoercion.Laboratoryexperimentsoncollegestudentscontradictthenotionthatfreeridingwillleadtozerocontributionsforthepublicgood.Somesuggesttheresultsderivefroma“warmglow”ofgiving.91PrivatizationdebatePrivatizationmeanstakingservicesthataresuppliedbythegovernmentandturningthemovertotheprivatesectorforprovisionand/orproduction.Exampleswithcompetingpublic/privateprovisionincludepolicing,parks,andeventhejudicialsystem.92PrivateprovisionMixofprivateandpublicprovisiondependson:Relativewageandmaterialscosts:Whichsectorislessexpensive?Administrativecosts:Canthesefixedcostsbespreadoveralargegroupofpeople?Diversityoftastes.Privateprovisionismoreefficientwithdiversetastesbecausepeoplecantailortheirconsumptiontotheirowntastes.Distributionalissues.Notionsoffairnessmayrequirethatsomecommoditiesareavailabletoeveryone–suchaseducationorhealthcare.93PrivateproductionEvenifthereisagreementthatthepublicsectorshouldprovideagood,itisnotclearwhetherthepublicsectorshouldproduceit.Airportsecurityworkersareatimelyexample.Publicsectormanagersmaynothaveastrongincentivetocontrolcostsbecauseofthelackofprofitmotiveorfearsoftakeoversorbankruptcy.Qualityofpublicservicesmaybehigher,however.Thisismorerelevantwhencontractsareincomplete.94EducationprovisionGovernmentspendsapproximately$400billiononeducationannually.Whysuchextensiveintervention?Educationprimarilyaprivategood.Someefficiencyconcerns–socialization,politicalstability.Equityconcerns–accesstoeducationincreasessocialmobility.Elementaryandsecondaryeducationissubsidized,compulsory,andproducedbythegovernment.Thiscannotberationalizedonefficiencygroundsalone.95Whatdoexpendituresforpubliceducationaccomplish?Educationalinputsincludeteacher/pupilratio,teachereducation,experience,andsalary,andexpendituresperpupil.Educationaloutputsincludetestscores,attendancerecords,dropoutrates,andlabormarketoutcomes.Hanushek(2002)findsvirtuallynocorrespondencebetweeninputsandoutputs,thoughthisconclusioniscontroversial.Oneespeciallynoteworthyresultisthatoverwideranges,classsizedoesnotaffecteducationaloutcomes.96RecapofpublicgoodsPublicgooddefinitionDerivationofaggregatedemandcurvesInefficientprovisionofpublicgoodsFreeriderproblemPublicversusprivateprovisionEducation97Chapter5-ExternalitiesPublicEconomics98ExternalityDefinedAnexternalityispresentwhentheactivityofoneentity(personorfirm)directlyaffectsthewelfareofanotherentityinawaythatisoutsidethemarketmechanism.Negativeexternality:Theseactivitiesimposedamagesonothers.Positiveexternality:Theseactivitiesbenefitsonothers.99ExamplesofExternalitiesNegativeExternalitiesPollutionCellphonesinamovietheaterCongestionontheinternetDrinkinganddrivingStudentcheatingthatchangesthegradecurveThe“Club”anti-theftdeviseforautomobiles.PositiveExternalitiesResearch&developmentVaccinationsAneighbor’snicelandscapeStudentsaskinggoodquestionsinclassThe“LoJack”anti-theftdeviseforautomobilesNotConsideredExternalitiesLandpricesrisinginurbanarea.Knownas“pecuniary”externalities.100NatureofExternalitiesArisebecausethereisnomarketpriceattachedtotheactivity.Canbeproducedbypeopleorfirms.Canbepositiveornegative.Publicgoodsarespecialcase.Positiveexternality’sfulleffectsarefeltbyeveryoneintheeconomy.101GraphicalAnalysis:NegativeExternalitiesForsimplicity,assumethatasteelfirmdumpspollutionintoariverthatharmsafisherydownstream.Competitivemarkets,firmsmaximizeprofitsNotethatsteelfirmonlycare’saboutitsownprofits,notthefishery’sFisheryonlycaresaboutitsprofits,notthesteelfirm’s.102GraphicalAnalysis,continuedMB=marginalbenefittosteelfirmMPC=marginalprivatecosttosteelfirmMD=marginaldamagetofisheryMSC=MPC+MD=marginalsocialcostFigure5.1104GraphicalAnalysis,continuedFromfigure5.1,asusual,thesteelfirmmaximizesprofitsatMB=MPC.ThisquantityisdenotedasQ1inthefigure.SocialwelfareismaximizedatMB=MSC,whichisdenotedasQ*inthefigure.105GraphicalAnalysis,ImplicationsResult1:Q1>Q*Steelfirmprivatelyproduces“toomuch”steel,becauseitdoesnotaccountforthedamagestothefishery.Result2:Fishery’spreferredamountis0.Fishery’sdamagesareminimizedatMD=0.Result3:Q*isnotthepreferredquantityforeitherparty,butisthebestcompromisebetweenfisheryandsteelfirm.Result4:Sociallyefficientlevelentailssomepollution.Zeropollutionisnotsociallydesirable.Figure5.2107GraphicalAnalysis,IntuitionInFigure5.2,losstosteelfirmofmovingtoQ*isshadedtriangledcg.ThisistheareabetweentheMBandMPCcurvegoingfromQ1toQ*.Fisherygainsbyanamountabfe.ThisistheareaundertheMDcurvegoingfromQ1toQ*.Byconstruction,thisequalsareacdhg.Differencebetweenfishery’sgainandsteelfirm’slossistheefficiencylossfromproducingQ1insteadofQ*.108NumericalExample:NegativeExternalitiesAssumethesteelfirmfacesthefollowingMBandMPCcurves:AssumethefisheryfacesthefollowingMDcurve:109NumericalExample,continuedThesteelfirmthereforechoosesQ1:ThesociallyefficientamountisinsteadQ*:110NumericalExample,continuedThedeadweightlossofsteelfirmchoosingQ1=140iscalculatedasthetrianglebetweentheMBandMSCcurvesfromQ1toQ*.InFigure5.2,thiscorrespondstoareadhg.111NumericalExample,continuedBymovingtoQ*thesteelfirmlosesprofitsequaltothetrianglebetweentheMBandMPCcurvefromQ1toQ*.BymovingtoQ*thefisheryreducesitsdamagesbyanamountequaltothetrapezoidundertheMDcurvefromQ1toQ*.112Calculatinggains&lossesraisespracticalquestionsWhatactivitiesproducepollutants?Withacidrainitisnotknownhowmuchisassociatedwithfactoryproductionversusnaturalactivitieslike