Cavid last 15 questions
1) What are the key facts about the size and growth of government and the distribution of
taxes and spending?
21) When can the private market solve the problem of externalities?
internalizing an externality refers to the process of making the party
responsible for the external cost or benefit bear the cost or benefit
themselves. In other words, it is a way of making sure that the cost or
benefit is taken into account when decisions are made. The goal of this
process is to ensure that the market can function properly and efficiently
by providing the right incentives for individuals to act in a socially
efficient manner.
To see how a market might compensate those affected by the
externality,let’s look at what would happen if the fishermen owned the
river in the steel plant example. They would march up to the steel plant
and demand an end to the sludge dumping that was hurting their
livelihood. They would have the right to do so because they have property
rights over the river; their ownership confers to them the ability to control
the use of the river.
Suppose for the moment that when this conversation takes place, there is
no pollution-control technology to reduce the sludge damage; the only
way to reduce sludge is to reduce production. So ending sludge dumping
would mean shutting down the steel plant. In this case, the steel plant
owner might propose a compromise: he would pay the fishermen $100 for
each unit of steel produced, so that they were fully compensated for the
damage to their fishing grounds. So long as the steel plant can make a
profit with this extra $100 payment per unit, then this is a better deal for
the plant than shutting down, and the fishermen are fully compensated
for the damage done to them.This type of resolution is called internalizing
the externality.
22) What are possible public-sector solutions to the problem of
externalities, and what are the advantages and disadvantages of each?
1)Corrective taxation
We have seen that the Coasian goal of “internalizing the externality” may
be difficult to achieve in practice in the private market. The government
can achieve this same outcome in a straightforward way, however, by
taxing the steel producer an amount MD (for the marginal damage of the
pollution) for each unit of steel produced.
Corrective taxes, also known as Pigouvian taxes, are tools designed to internalize negative
externalities, such as pollution, by aligning private costs with social costs. They promote
economic efficiency, encourage behavioral changes, and generate government revenue that can
fund public goods or cleaner alternatives. However, these taxes face challenges, including
difficulty in quantifying externalities, potential regressive effects on lower-income groups, and
administrative costs. While they incentivize innovation and align with the "polluter pays"
principle, they may lead to evasion, political resistance, or misuse of revenues. As standalone
measures, they might not fully address systemic issues, necessitating complementary policies
for maximum effectiveness.
2) Subsidies
Subsidies are a valuable tool for internalizing externalities, particularly positive ones, by
reducing costs and encouraging beneficial activities like renewable energy adoption, education,
or healthcare. They promote innovation, support emerging industries, and address market
failures, while also enhancing equity by making essential goods and services more accessible.
However, subsidies can distort market signals, lead to overproduction, and impose significant
fiscal costs. Challenges include targeting the right beneficiaries, avoiding dependency, and
preventing misuse or corruption. Poorly designed subsidies can have regressive effects or
unintended environmental consequences, and political resistance often makes removing them
difficult, highlighting the need for careful design and regular evaluation.
3) Regulations
Regulations offer a direct and enforceable way to address externalities by controlling harmful
activities, such as setting pollution limits or mandating safety standards, ensuring compliance
with social and environmental goals. They provide clarity and predictability, do not require
financial resources like taxes or subsidies, and guarantee public protection, particularly for health
and the environment. However, regulations can be inflexible, stifling innovation and increasing
compliance costs for businesses, especially smaller ones. Enforcement can be costly and
resource-intensive, and there is a risk of regulatory capture, where industries influence rules to
their advantage. Additionally, the one-size-fits-all approach may not work effectively in all
situations, and political resistance can delay implementation, reducing their overall effectiveness.
23) Give comprehensive information about negative externalities and explain it by using graphs
and examples.
So there are two types of negative externalities: Negative production externalities and negative
consumption externalities.
Negative production externality
When a firm’s production reduces the well-being of others who are not compensated by the firm.
The steel plant is not the only producer using the river, however. Farther
downstream is a traditional fishing area where fishermen catch fish for
sale to local restaurants. Since the steel plant has begun dumping sludge
into the river, the fishing has become much less profitable because there
are many fewer fish left alive to catch. This scenario is a classic example
of what we mean by an externality. The steel plant is exerting a negative
production externality on the fishermen because its production adversely
affects the well-being of the fishermen but the plant does not compensate
the fishermen for their loss.
Negative consumption externality
When an individual’s consumption reduces the well-being of others who are not compensated by
the individual.
Usaqlar exampellara bir basa kitabdan baxmagi meslehet gorurem yoxsa anlamayacaqsiz.Seh.(123) baxin
Consider the case of cigarette smoke. In a
restaurant that allows smoking, your consumption of cigarettes may have a negative effect on my enjoyment of a
restaurant meal. Yet you do not in any way pay for this negative effect on me. This is an example of negative
consumption externality, whereby consumption of a good reduces the well-being of others, a loss for which they
are not compensated. When there is a negative consumption externality, SMB 5 PMB 2 MD, where MD is
the marginal damage done to others by your consumption of that unit. For example, if MD is 40¢ a pack, the
marginal damage done to others by your smoking is 40¢ for every pack you smoke.
24) Give comprehensive information about positive externalities and explain it by using
graphs and examples.
Positive production externality
externality When an individual’s consumption increases the well-being of others, but the
individual is not compensated by those others .
positive consumption externality
When an individual’s consumption increases the well-being of others, but the individual is not
compensated by those others.
Positive Consumption
Vaccinations:
An individual receiving a flu vaccine not only protects themselves from illness but also
contributes to herd immunity, reducing the spread of the virus in the community.
Positive Production
Clean Energy Production:
A company that produces solar panels generates renewable energy, helping to reduce
reliance on fossil fuels, lower carbon emissions, and contribute to a cleaner environment
for society.
25) Give comprehensive information about negative production externalities and explain it by
using graph and example.
23-cu sual cavabdi ele ahaha
31) Give extensive information about Corrective Taxation (Pigouvian Tax) by using the
graph.
We have seen that the Coasian goal of “internalizing the externality” may be difficult to achieve in practice in the
private market. The government can achieve this same outcome in a straightforward way, however, by taxing the
steel producer an amount MD (for the marginal damage of the pollution) for each unit of steel produced.
Corrective Taxation (Pigouvian Tax) is a market-based approach designed to address negative
externalities—unintended and harmful side effects of economic activities that affect third
parties, such as pollution, noise, or congestion. The concept was first introduced by British
economist Arthur Pigou in the early 20th century and is primarily used to "internalize"
externalities by making the price of the harmful activity reflect its social cost. By doing so,
corrective taxes aim to reduce undesirable behaviors, encourage more efficient resource
allocation, and achieve a socially optimal level of consumption or production.
32) How do we determine the optimal level of public goods?
The optimal level of public goods is the amount of a public good that should be provided to
maximize societal welfare, balancing the benefits of providing the good against the costs of
producing it. The key principle in determining the optimal level is that the marginal social
benefit (the additional benefit to society from consuming one more unit of the public good)
should equal the marginal cost of providing that additional unit.
Here's how we determine the optimal level of public goods:
1. Marginal Social Benefit (MSB)
The marginal social benefit (MSB) represents the additional benefit to society when an extra
unit of the public good is provided. This benefit is usually derived from the marginal rate of
substitution (MRS), which tells us how much individuals are willing to sacrifice private goods
(like money or time) for an additional unit of the public good.
For public goods, the MSB is the sum of the individual MRSs. Since public goods are
non-excludable and non-rivalrous, everyone in society can benefit from them, so the
benefit to society is the aggregate value individuals place on additional units of the
public good.
2. Marginal Cost (MC)
The marginal cost of providing a public good is the cost of producing one more unit of that
good. This includes the resources (such as labor, materials, and capital) needed to increase its
provision. For example, if the public good is national defense, the marginal cost would include
the cost of building more defense infrastructure or recruiting more personnel.
3. Optimal Provision Condition
The optimal level of a public good is achieved when the marginal social benefit (MSB) equals
the marginal cost (MC) of providing the good. Mathematically, this can be expressed as:
MSB=MC\text{MSB} = \text{MC}MSB=MC
This equality ensures that the resources allocated to providing the public good are used
efficiently. If the MSB is greater than the MC, it means society values the additional unit of the
good more than it costs to produce it, so more of the public good should be provided. If the MSB
is less than the MC, it means the cost of providing the public good outweighs the benefit, so less
of the good should be produced.
Kitabdan oxuyun yenede chatgtp daha yaxsi geldi anlamasaz yazin mene sexsiden.
33) When is the private sector likely to provide the optimal level of public goods?
Usaqlar yene kitaba baxin(sehh.193) ordan oyrenin yazilasi hecne yoxdu anlamasaz sorusun
menden sexsiden
34) What kind of difficulties does a government face in providing the optimal level of public
goods? Support your idea by giving real examples.
Governments face several difficulties in providing the optimal level of public goods, which are
goods that are non-excludable and non-rivalrous, meaning that no one can be excluded from
using them and one person’s consumption does not reduce the availability for others. Some of
the main challenges include:
Free Rider Problem: Since public goods are non-excludable, individuals can benefit from them
without paying for them. This leads to the "free rider" problem, where people may refrain from
contributing to the funding of public goods, relying on others to bear the costs.
Example: National defense is a prime example. Everyone in a country benefits
from security, but if people do not pay taxes, they still enjoy the protection
provided by the government. This creates a situation where the government may
struggle to collect enough resources to fund adequate defense measures.
Under-provision of Goods: Governments might under-provide public goods because they may
lack the appropriate incentives to deliver them in sufficient quantities. This can result from
political pressures, limited budgets, or inefficient allocation of resources.
Example: Public health infrastructure, such as hospitals and medical research,
may not be fully funded or prioritized, leading to shortages in services, especially
in poorer regions or countries.
Budget Constraints: Governments have limited budgets and must make difficult choices about
how to allocate resources across various public goods and services. This can lead to a mismatch
between the demand for a good and the available funding.
Example: In many countries, public education is underfunded despite high
demand for better schooling, which leads to overcrowded classrooms, insufficient
materials, and lower quality education.
Inefficiency and Bureaucracy: Governments may face inefficiency in managing public goods
due to bureaucratic hurdles, corruption, or lack of expertise. This can prevent the effective
delivery of public services.
Example: Infrastructure projects like road building or public transport systems
can be delayed or poorly executed due to inefficiencies, mismanagement, or
corruption within government institutions.
35) When is private provision likely to overcome the free rider problem?
While the free rider problem clearly exists, there are also examples in which the private market
is able to overcome this problem to some extent. Under what circumstances are private-market
forces likely to solve the free rider problem, and under what circumstances are they not?
Some individuals Care More Than Others Private provision is particularly likely to surmount the
free rider problem when individuals are not identical and when some individuals have an
especially high demand for the public good. For example, let’s assume that Ben has more
income than Jerry, but total income between the two is the same as the previous example, so
that the social optimum for fireworks is the same as when their incomes are equal. As we show
mathematically in the appendix, in this case, Ben would provide more fireworks than Jerry: if
the income differential is large enough, the total number of privately provided fireworks rises
toward the socially optimal number of fireworks. We obtain a similar outcome if Ben and Jerry
have the same income, but Ben gets more enjoyment from fireworks; even though they are a
public good, Ben will still provide more of them.
The key intuition here is that the decision about how many fireworks to provide for any
individual is a function of the enjoyment that the individual gets from total fireworks, that is,
the net of their cost. If a person gets a lot of enjoyment or has a lot of money to finance the
fireworks, he will choose to purchase more fireworks, even though he is sharing the benefits
with others: as enjoyment net of costs gets very large for any one individual, the provision of
the public good starts to approximate private good provision.
altruism Another reason that private agents may provide more of a public good than our model
would predict is that the model assumes purely selfish utility-maximizing agents. In fact, there is
much evidence that individuals are altruistic—that is, they care about the outcomes of others as
well as themselves. If individuals are altruistic, they may be willing to contribute to a public
good even if the free rider problem suggests they should not. In terms of our model, this would
be equivalent to Ben caring not only about the costs of fireworks to himself, but the cost to
Jerry as well, so that he is willing to contribute more to lower Jerry’s burden.
What determines altruism? This is a very difficult question and has given rise to an entire field
of study of social capital, the value of altruistic and communal behavior in society. A central
finding of this field is that individuals are likely to be more altruistic when they are more
“trusting” of others.
36) Think about the rival and excludable properties of public goods. To what degree is radio
broadcasting a public good? To what degree is a highway a public good?
Radio broadcasting exhibits strong public good characteristics due to its non-rivalrous and non-
excludable nature. When a radio station broadcasts, one person’s act of listening does not
diminish the ability of others to listen, making it non-rivalrous. Additionally, traditional radio
broadcasts are non-excludable, as anyone with a receiver can tune in without paying. However,
subscription-based services like satellite radio introduce excludability, meaning not all forms of
radio broadcasting qualify as pure public goods. Highways, on the other hand, are only partially
public goods. They are non-rivalrous when traffic is light, as one additional car does not impede
others, but become rivalrous during congestion when additional vehicles reduce the quality of
the service. Similarly, highways are non-excludable if freely accessible, but toll roads and
restricted lanes impose excludability, limiting access to those who pay. Therefore, while
traditional radio broadcasting aligns more closely with the definition of a public good, highways
are better classified as common goods or club goods, depending on traffic conditions and
accessibility.
37) How do we appropriately measure the benefits of public projects? Support your idea by
giving relevant example.
Measuring the benefits associated with this project is more difficult than
measuring the costs because it is more difficult to use market values to place a
value on the benefits.
1)Valuing the saved time
The first benefit associated with this project is that both producers and consumers will save
travel time. For producers, we can value the time savings in a straightforward manner. The
benefits to producers arise from a reduction in the cost of supplying goods because it takes less
time to transport them.
The decreased costs lead to an increase in supply (a rightward shift in the supply curve), which
raises the total size of social surplus. This increase in social surplus is the benefit to society from
the lower cost of producing goods. It is much trickier to measure the benefits of time saved for
consumers:
Using Market-Based Measures to Value Time: Wages Suppose that we can show that the time
individuals save from driving faster is spent at work. Suppose, moreover, that there is a perfectly
competitive labor market that allows individuals to earn their hourly wage for each additional
hour spent at work. Under these assumptions, we would use drivers’ wages to value their time
savings. Opportunity cost is the value of the next best alternative use, and the next best
alternative use in this example is being at work. The value of time at work in a perfectly
competitive labor market is the wage rate that could be earned during that hour. The average
wage rate for workers in the
United States was $22.70 per hour in 2014.7
Using Survey-Based Measures to Value Time: Contingent Valuation
Before you took any economics, if I had asked you to figure out the value of time to someone,
how would you have proposed doing it? Most likely, you would have simply asked individuals
what time is worth to them! That is, you could ask, “How much would you pay to save five
minutes on your drive?” This approach is labeled by economists as contingent valuation, that is,
asking individuals to value an option they are not now choosing, do not have the opportunity to
choose, or is not yet available to them. The advantage of contingent valuation is that, in some
circumstances, it is the only feasible method for valuing a public good. Consider the difficulty of
valuing efforts to save a rare species of owl. There is no obvious market price that you can use
to value that species. But you can survey individuals and ask what it is worth to them to save
the species. These preferences can then be aggregated (added up) to form a value of efforts to
save the species. The problems with contingent valuation, however, are daunting, as reviewed
in the following Application.
Using Revealed Preference to Value Time The natural way for nonecon-
omists to value time is to ask individuals what their time is worth, but this approach runs into
the previously noted problems. The natural way for economists to value time is instead to use
revealed preference: let the actions of individuals reveal their valuation. The mantra of
economics is: people may lie, but their actions, which result from utility maximization, don’t!
Suppose we compare two identical houses, one of which is five minutes closer to the central
city where most commuters work. If individuals are willing to pay more for the closer home, this
implies that they value the time savings. We can therefore use the difference in sales prices
between the two homes to assign a value to saving five minutes of commuting. This comparison
provides a market-based valuation of their time that truthfully reveals the preferences of
individuals.
While appealing in theory, this approach also runs into problems in practice.
2) valuing saved lives
Returning to our highway example, the other major benefit of improving the turnpike is that
repairing the road will improve safety and save lives. Valuing human lives is the single most
difficult issue in cost-benefit analysis. Many would say that human life is priceless, that we
should pay any amount of money to save a life. By this argument, valuing life is a reprehensible
activity; there is no way to put a value on such a precious commodity.
Using Wages to Value a life As with valuing time, the market-based approach to valuing lives is
to use wages: life’s value is the present discounted value of the lifetime stream of earnings.
While this seems like a logical approach, it faces a number of problems. One major problem is
that using wages to value life doesn’t value any time that isn’t spent working.
Contingent Valuation The second approach to valuing a life uses contingent valuation. One way
to do this is to ask individuals what their lives are worth. This is obviously a difficult question to
answer. Thus, a more common approach is to ask about the valuation of things that change the
probability
of dying.
Revealed Preference As with valuing time savings, the method preferred
by economists for valuing life is to use revealed preferences. For example, we can value life by
estimating how much individuals are willing to pay for something that reduces their odds of
dying. Suppose that a passenger air bag could be added to a new car for $350, and there is a 1
in 10,000 chance that it would save the life of the car passenger. This implies that the value of
lives to individuals who buy airbags is at least $3.5 million.
Alternatively, we can value life by estimating how much individuals must be paid to take risky
jobs that raise their chance of dying. Suppose that we compare two jobs, one of which has a 1%
higher risk of death each year (e.g., a coal miner versus a cashier in a retail store). Suppose
further that the riskier job pays $30,000 more each year. This $30,000 is called a compensating
differential. In this example, individuals must be compensated by $30,000 to take this 1%
increased risk of dying, so that their lives are valued at $3 million ($30,000/0.01).
38) How do we appropriately measure the costs of public projects? Support your idea by
giving relevant example.
example
Suppose that you are again working for your state government but that
instead of working on health and human services issues, you are running the
highway department. Your state turnpike is in poor shape, with large potholes
and crumbling shoulders that slow down traffic and pose an accident risk.
You have been charged by the governor with the task of considering whether
the state should invest in repairing this road.3
As shown in Table 8-1, making the improvements will require the following
inputs:
■■ 1 million bags of asphalt.
■■ 1 million hours of construction labor (500 workers for 2,000 hours each).
■■ $10 million per year in the future for maintenance costs.
There are two main benefits to these road improvements:
■■ Driving time for producers (trucks) and consumers will be reduced by
500,000 hours per year.
■■ The road will be safer, resulting in five fewer fatalities per year.
Measuring the current costs
The first goal of the cost-benefit analysis is to measure the cost of this public
good. It seems an easy task: add up what the government pays for all the inputs just listed to
obtain the cost. This method represents the cash-flow accounting approach to costs that is used
by accountants.
Imperfect Markets Suppose, however, that construction jobs pay much more than the next best
job. For example, perhaps state law mandates a minimum wage of $20/hour for construction
workers, while the market wage is $10/hour for all other workers.Because the construction
wage is higher than other wages, there will be some workers who would happily work in
construction but cannot find jobs, so they must instead work for $10/hour elsewhere. In that
case, the opportunity cost for a new project such as this one is the next best alternative for the
workers who join the project, which is the $10 they could have earned elsewhere. Therefore,
the opportunity cost for the 1 million hours of labor is $10 million. How can this be, when the
government actually spends $20 million to hire these workers? The cash cost to the government
for labor consists of two components: the opportunity cost of the resource (labor) plus the
transfer of rents, which are payments to the resource deliverer (the worker) beyond those
required to obtain the resource. The opportunity cost of one hour of labor is only $10 per hour
because that is what workers could earn elsewhere. Thus, by paying them $20 per hour, we are
transferring an extra $10 per hour to them. This is not a cost to society; it is simply a transfer
from one party (the government) to another (construction workers).
Measuring Future Costs The last cost is maintenance, which involves both materials and labor.
The analysis for those materials and labor is the same as we have pursued thus far. But there is
a new wrinkle as well because we need to combine a future stream of costs (maintenance) with
the one-time costs associated with construction. To do this, we compare the present discounted
value (PDV) of these costs, as reviewed in Chapter 4. A dollar tomorrow is worth less than a
dollar today because I could put the dollar in a bank today, earn interest, and have more money
tomorrow. So a dollar today is worth (1+ r) times as much as a dollar tomorrow, where r is the
interest rate that I could earn in the bank. As a result, future maintenance costs must be
discounted to compare them to today’s construction costs.
39) What are the best methods for dealing with difficult-to-measure costs and benefits, such
as the value of time and of human life?
37’ci sualin 2’ci hissesi
40) How do we compare costs and benefits to evaluate the optimality of public projects?
Table 8-4 shows the comparison of the costs and benefits of the turnpike renovation project.
The present value of the costs of this project is $253 million.
The benefits are 500,000 reduced hours of driving time and five reduced fatalities per year. The
time savings from this project is most appropriately valued by the revealed preference valuation
of time, which is $22.70/hour. The life savings is most appropriately valued by the revealed
preference value of life, which averages $9.6 million. The present discounted value of costs for
this renovation project is $253 million, while the PDV of benefits for this project is $848.6
million. Because benefits exceed costs by $595.6 million, the project should clearly be
undertaken.
