 |  Principles of Microeconomics, 1st Canadian Edition Robert H. Frank,
Cornell University
Ben S. Bernanke,
Princeton University
Lars Osberg,
Dalhousie University
Melvin Cross,
Dalhousie University
Brian MacLean,
Laurentian University
Externalities and Property Rights
Graphing ExercisesExtending the Text Economic Naturalist 11.5 asks why the government subsidizes activities that generate positive externalities. The examples of such subsidies put forth in the text are planting of trees on hillsides and basic research. Trees on hillsides not only benefit the landowner but also benefit the entire community by minimizing erosion and the danger of mudslides. Basic research benefits the researcher directly and the larger community indirectly as the results of the research are developed into new ways of dealing with problems and into new products. Thinking of a government subsidy which may be a bit closer to your daily experience, we, as a society, believe very strongly that education of our members not only benefits them as individuals, but also benefits the society in general. One of the necessary conditions for a successful democracy is that the persons who vote have enough education to not be swayed by impossible promises, but be able to see through "pie-in-the-sky" campaigns. In addition to the civic benefits from individual education, a more educated work-force will not only earn a higher individual income, but the products produced will be more likely to use the minimum resources necessary. As a result of this recognition of the positive externalities associated with education we have a system of "free" public primary and secondary education. And as a general rule tuition and fees in universities cover only 25%-35% of the actual cost of operating the school. This subsidy is seldom questioned since the external benefits are so well recognized. |
| | 1. | Using the graph, show that if a positive external benefit of $10 accrues to each unit of output, ignoring this social benefit will result in the product being produced at a lower level than that which is socially desirable.
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| | 2. | Now, suppose the demand curve were more elastic, or price sensitive. How would the same $10 social benefit affect the desirable level of output?
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| | 3. | Using the same technique as above, explore the relationship between optimal output levels when social costs are and are not considered. How might your findings shed light on the relationship between the elasticity of demand and appropriate government policy to reduce negative externalities?
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| On Your Own: Other ways to use externalities to understand the world around us. Quite often we see individuals acting in ways which, in hindsight, are NOT in their individual best interests. Some years ago, in an effort to boost farm commodity prices, a small group of farmers in the US Midwest began a campaign to have each farmer reduce their output by 10% in order to drive up prices. In other words, they organized a nation-wide movement to shift the supply curve of farm commodities to the left by 10%. Since the demand for farm commodities is fairly inelastic the expected outcome, if everyone stuck together, would have been higher prices and higher revenue for all farmers. To begin your analysis, open a new window containing the interactive private/social marginal cost and demand model graph or, if the window is already open, click the Reset button. |
| | 4. | Do you suppose this endeavour worked?
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| | 5. | Using the graph, model the likely outcome from the farmer's quest above.
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| Question to Think About... We all want safer highways. It is well within our power to reduce highway deaths to a tiny fraction of the 40,000 or so that occur each year. What actions might accomplish the goal of reducing highway fatalities by 50%? Why do we not take the actions?
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2003 McGraw-Hill Higher Education