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Chapter 3 summary
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Summary of 14 pages for the course EKN 310 at UP (Chapter 3 summary)
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Chapter 3Public goods and externalities
Private goods and the benchmark model:
Efficiency achieved in benchmark model because:
- Preferences for goods and services revealed by consumers → consumers are willing
to put a price on a product → tells producers the type and quantity of goods they
prefer.
- Competition amongst producers ensures minimum cost-model → producers
produce at the minimum turning point of the average cost curve.
- Perfect information ensures general equilibrium → everyone has all information on
market conditions.
Competitive markets → fail if there are no satisfactory mechanisms by means of which
consumers can reveal their preferences → existence of these mechanisms depends on
the nature or characteristics of goods and services.
Private good characteristics:
- Rivalry in consumption → one person’s consumption of a good reduces its
availability to other consumers → e.g nobody else can eat the same apple as you
did → nobody else benefits from your consumption.
- Excludability → consumption of a good is restricted to particular people (typically
those who pay the indicated price) → e.g apple cannot be eaten by anyone else
because it is your property, and you don’t have to share it.
Benefits of consuming private goods are restricted to individual who reveal their
preferences for good → rivalry and excludability of private goods force consumers to
reveal preferences → sets in motion the competitive processes that cause allocative
efficiency.
Price of takeaway coffee
S
Db
F G E
P
Db+j
Dj
B J Q
Quantity of takeaway coffees
Notes by Georgia Taylor EKN 310 1
, Graph analysis:
- Db and Dj → individual demand curve for two consumers.
o Assumptions of the bench-mark model in chapter 2 are used.
- Db+j → gives the market demand curve (sum of the individual quantities
demanded at each price)
- Market equilibrium at point E → market demand = market supply → yields a single
equilibrium at P
o Consumers cannot affect the equilibrium price they pay for their coffees →
therefore they are price takers.
- The graph highlights characteristics of private goods:
o Marginal utility (MU) = marginal cost (MC) for each consumer
o Area underneath demand curve gives total utility derived from consumption
and area under supply curve gives the sum of marginal costs of producing
each coffee.
o Therefore, at equilibrium price 0P → marginal utilities of the two consumers =
marginal cost QE
▪ This is a condition for the efficient supply of a private good.
o Price of a private good = marginal cost of that good
▪ This is the efficient pricing rule for private goods.
Pure public goods: definition:
Pure public goods/pure social goods → non-excludable and non-rival → e.g streetlights
(you cannot exclude person A from using the streetlight if they did not pay for it and the
same amount if light is provided to every person who uses it)
Non-rivalry in consumption has two important implications:
- One person’s consumption does not reduce the quantity available to other
consumers implies that marginal cost (the cost of admitting another user) is zero.
- It would be Pareto-inefficient to exclude anyone from consuming a non-rival good
→ even if it were feasible.
o Allowing person C to use the light will not detract from person A and B’s utility
from using the same light.
Non-excludability → it is impossible to exclude a person from consuming the goods → it is
not possible to assign specific property rights to public goods and enforce them → e.g
streetlights (you cannot exclude A from using the light if they have not paid for it).
Pure public goods → very few good qualify and pure public goods → e.g the army’s
protection becomes less effective as more people or larger areas need protection →
debatable if national defence is a fully non-rival at all levels of provision.
Few goods are classified as non-excludable → costly to place officers to chase non-
payers away from streetlights → new technologies may be developed that make
exclusion viable in financial terms → e.g a lighthouse sending an electrical signal to ships
that pay towards it, rather than having it in for every ship that passes
Notes by Georgia Taylor EKN 310 2
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