Group 3 Written Report
THE ECONOMICS OF THE PUBLIC SECTOR
Externalities, Public Goods and Common
Resources
Members:
Cristal Jane Daria
Nathaniel Macasulay
John Lloyd Libutan
Jennifer Serban
Sarah Abellar
Externalities, Public Goods and Common Resources
Introduction
• Markets do not always operate perfectly due to factors like externalities,
public goods, and common resources. These factors cause market failures,
where the allocation of resources is inefficient. Understanding how these
elements affect market outcomes is crucial for implementing policies that
improve societal welfare.
Externalities and Market Outcomes
•Externalities are costs or benefits that affect third parties who are not
directly involved in the market transaction. These external effects can
lead to inefficient market outcomes because the true social costs or
benefits are not considered in private decision-making.
Two types of Externalities
✓Negative Externalities: These occur when the production or
consumption of a good imposes external costs on others. Examples
include pollution from factories, where the private cost is lower than the
social cost, leading to overproduction.
✓Positive Externalities: These happen when the production or
consumption of a good provides benefits to third parties. For instance,
when individuals get vaccinated, they help protect others by reducing the
spread of diseases. However, the market underinvests in such goods,
leading to underproduction.
Impact on Market Outcomes:
Negative externalities cause overproduction because producers do not
account for the external costs.
Positive externalities cause underproduction because consumers do not
receive all the benefits.
Real-life Examples of Externalities
Negative Externality:
Air Pollution Factories and vehicles emit pollutants into the air, causing
health problems for the public and environmental damage. The market
fails to account for these social costs because the price of goods and
services produced using polluting processes does not include the cost of
cleaning the air or addressing health issues.
Positive Externality: Vaccination When individuals get vaccinated, they
reduce the spread of diseases, benefiting others by contributing to herd
immunity. However, individuals may underinvest in vaccinations because
they do not fully capture the social benefits, leading to lower vaccination
rates than what is socially optimal. –
Negative Externality:
Plastic Waste Plastic products are convenient and cheap, but they result in
significant waste that harms marine life and ecosystems. The costs of
cleaning up plastic waste or addressing environmental damage are not
included in the price of plastic products, leading to overuse and
environmental harm.
Positive Externality:
Public Parks Well-maintained parks provide aesthetic value, improve air
quality, and encourage physical activity. While park visitors benefit
directly, surrounding residents and businesses also gain from higher
property values and a more pleasant environment.
Common resources are natural or man-made resources that are shared
by many people, but overuse can lead to their depletion. These resources
are rival, meaning that when one person uses them, less is available for
others. However, they are non-excludable, meaning it is difficult or
impossible to prevent people from using them, even if they don't pay for
them.
Definitions:
Rival: A resource is rival if one person’s use of it reduces the availability
for others. For example, if one fisherman catches a lot of fish, fewer fish
are left for others.
Non-rival: A resource is non-rival if one person’s use does not affect the
availability for others. An example is a streetlight—everyone can benefit
from it without reducing its usefulness to others.
Excludable: A resource is excludable if people can be prevented from
using it. For instance, movie theaters can exclude people by charging for
tickets.
Non-excludable: A resource is non-excludable if it is difficult to stop
people from using it. For example, no one can be easily excluded from
enjoying fresh air.
Examples of Common Resources
Fisheries: Fish in the ocean are common resources. They are rival (one
person catching fish leaves fewer for others) and non-excludable (it's hard
to stop people from fishing).
Forests: Trees used for timber are rival, as one person cutting down trees
reduces what's left, and non-excludable, since it's hard to stop people
from logging without regulations.
Clean Water: Access to clean water is a common resource. Overuse can
lead to shortages (rival), and without proper regulation, it’s difficult to stop
people from using it (non-excludable).
The Problem of Overuse
Because common resources are rival and non-excludable, they are often
overused or depleted—a situation known as the tragedy of the commons.
This happens when people act in their own interest, consuming too much
of the resource without considering its long-term availability.
Solutions:
•To manage common resources, governments or communities may need
to implement:
•Regulations to limit use (e.g., fishing quotas).
•Property rights to make resources excludable (e.g., assigning fishing
areas).
•Community management where local users agree on fair usage rules.
•Managing common resources is important to prevent depletion and
ensure they are available for future generations.
Public Goods and Free-Riders
Public goods are non-excludable and non-rivalrous, meaning that one
person's use of the good does not reduce its availability to others, and it is
difficult to prevent people from using the good even if they do not pay for
it.
Examples of Public Goods: National defense, street lighting, and clean
air.
The Free-Rider Problem arises when people benefit from a good without
contributing to its cost. For instance, individuals can enjoy the benefits of
a public park without paying taxes, which leads to underfunding or
deterioration of public goods.
Characteristics of Public Goods:
Non-excludable: Impossible to exclude people from using it.
Non-rivalrous: One person’s consumption does not reduce the availability
for others.
Externalities and Public Goods: Lecture Discussion
Both externalities and public goods are sources of market failure. Markets
do not efficiently allocate resources to deal with external costs (negative
externalities) or benefits (positive externalities), nor do they provide
adequate public goods due to the free-rider problem. Governments often
step in to correct these inefficiencies through taxes, subsidies, and
regulation, ensuring better resource allocation.
Examples:
Negative externality: Air pollution from vehicles.
Positive externality: Education.
Public good: National defense.
Common resource: Fisheries (where overuse, also known as the tragedy
of the commons, can occur because the resource is overexploited without
regulation).
Some people may free-ride because they genuinely can't afford to
contribute, especially for essential services like clean water, healthcare, or
public transportation. This makes the free-rider issue more complex
because it's not always about avoiding payment—sometimes it's about
affordability.
In these cases, government intervention is the key. For example:
Taxes help distribute the cost fairly, where those who can afford more
contribute more.
Subsidies or free services for low-income individuals ensure that everyone
can access important public goods without being left out, even if they
can’t pay.
So, while free-riding can be a problem, it's important to recognize why it
happens and address it in a way that balances fairness with accessibility.
1. How can governments address negative externalities like pollution?
Governments can fix negative externalities by making businesses or
people pay for the harm they cause. For pollution, they can:
•Impose taxes on polluting activities (e.g., carbon tax) to make polluters
pay for the damage.
•Set regulations to limit the amount of pollution allowed.
•Create tradable permits where companies can buy and sell the right to
pollute, encouraging overall reduction.
[Link] can we encourage investment in positive externalities?
Governments and organizations can promote activities with positive
externalities by:
•Providing subsidies (financial support) for things like education, clean
energy, or healthcare that benefit society.
•Offering tax breaks or rewards to businesses or people who engage in
beneficial activities.
•Raising awareness about the wider benefits, encouraging more
participation and investment.
[Link] to solve the free-rider problem for public goods? The free-rider
problem happens when people use a good without paying for it. Solutions
include:
•Government funding through taxes, ensuring everyone contributes to
public goods like roads or national defense.
•Charging user fees where possible, like for public parks or bridges.
•Private provision: Sometimes, companies or organizations may offer
public goods by including benefits or services that motivate people to
pay .
