Fluent Essays

Please write three, separate, 400 word essays that address the following concepts. Be sure to discuss the concepts themselves as well as the relationship between the concepts. You will want to include graphs, diagrams and figures to help illustrate key concepts. Please be sure to use other sources of information as needed. It is very important that you properly reference your sources of information. Cite your sources cannot be overemphasized. Always give credit where credit is due!a) Economic Efficiency and Marketsb) Externalities and Environmental Problemsc) Social Costs and Private Costs divegences_between_social_costs_and_private_cost.pdf economic_efficiency_and_markets.pdf the_economic_approach.pdf Unformatted Attachment Preview 8 On Divergences between Social Cost and Private Cost RALPH TURVEY Ralph Tmvey is Visiting Professor of Economics at the London School of Economics Ihe notion that the resource-allocation effocts of divergences between marginal social and private costs can be dealt with by imposing a tax or granting a subsidy equal to the difference now seems too simple a notion.. Three recent ruticles have shown us this First came Professor Coases Ihe Problem of Social Cost, then Davis and Whinstons Externalities, Welfare and the Themy of Games appeared, and, finally, Buchanan and Stubblebine have published their paper Externality 1 These ruticles have an aggregate length of eighty pages and are by no means easy to read The following attempt to synthesise and summarise the main ideas may therefore be useful. It is couched in terms of external diseconomies, i e an excess of social over private costs, and the reader is left to invert the f analysis himsel should he be interested in external economies. The scope of the following argument can usefully be indicated by f starting with a brief statement of its main conclusions. Ihe first is that i the party imposing external diseconomies and the paity suffering them are able and willing to negotiate to their mutual advantage, state intervention is unnecessary to secw·e optimum resource allocation. The second is that the imposition of a tax upon the patty imposing external diseconomies can On Divergences between Social Cost and Private Cost, by Ralph Turvey, from Economica (August 1963). Reprinted by permission. 1 .Joumal of Law and Economics Vol. lII, October, 1960, .Journal of Political Economy, June, 1962, end Economica. November, 1962, respectively [Professor Coases article is reprinted in this volume, Selection 7 .] 139 140 TURVEY be a very complicated matter, even in principle, so tha t the a priori pre­ scription of sueh a tax is unwise. To develop these and other points, let us begin by calling A the person, firm or group (of persons or firms) which imposes a diseconomy, and B the person, firm or group which suffers it. How much B suffers will in many cases depend not oniy upon the scale of As diseconomy-creating activity, but also upon the precise nature of As activity and upon Bs reaction to it. If A emits smoke, for example, Bs Joss will depend not only upon the quantity enutted but also upon the height of As chimney and upon the cost to B of installing air-conditioning, indoor clothes-dryers or other means of reducing the effect of the smoke. Thus to ascertain the optimum resource allocation will frequently require an investigation of the nature a nd costs both of alternative activities open to A and of the devices by which B can reduce the impact of each activity. The optimum invoives that kind and scale of As activity a nd that adjustme nt to it by B which maximises the algebraic sum of As gain and Bs loss as against the situatio n where A pursues no diseconomy-creating activity. Note that the optimum will frequently involve B suffering a Joss, both in total and at the margin. 2 If A and Bare firms, gain and loss can be measured in money terms as profit differences. (In considering a soe1al opl!mum, allowance has of course to be made for market imperfections.) Now assuming that they both seek to maximise profits, that they know about the available aJtema ­ l!ves and adjustme nts and that they are able and willing to negol!ate, they will achieve the opllmum without any government interference. They will internalize the externality by merger. 3 or they will ma ke an agreement whereby B pays A to modify the na ture or scale of its acl!vity. 4 Alter­ natively, 5 if the Jaw gives B nghts against A, A will pay B to accept the opl!mal amount of loss imposed by A. If A and B are people, their gam and loss must be measured as the amount of money they respecl!vely would pay to mdulge m and prevent As activity. It could also be measured as the amount of money they respectively would require to refram from and to endure As activity, which will be different unless the marginal utility of income is consta nt. We shall assume that it is constant for both A and B, which is reasonable when the payments do not bulk large in relation to their incomes. 6 Under this assumption, it makes no difference whether B pays A or, if the Jaw gives B rights against A, A compensates B. 2Bucbanan-Stubblebine, pp. 380-1. 3Davis-Whinston, pp. 244, 252, 256; Coase, pp. 16-17. 4Coase, p. 6; Buchanan-Stubblebine agree, p. 383. 5See previous references. 6or. Mishan has exarmned the welfare cntenon for the case where the only variable 1s the scate of As activity, but where neither A nor B has a constant marginal utility of income. Cf. his paper Welfare Critena for External Effects, American Economic Review, Septem­ ber, 1961. On Divergences between Social Cost and Priva £ r- I 0 I I i. I I 141 te Cost I I I �\ R s Scale of As actiVity I £ 0 J L Scale of As activity II FIGURE 1. s, to ievy a tax on A which 1s not Whether A and B are persons or firm B may prevent optimal resource by n received as damages or compensatio nd do nego­ a ssuming that they can a allocation from bemg achieved-still As gain ises xim a m ch whi a lloc ation tiate. 7 The reason is that the resource tax less As less gain As es tnus max ch iess Bs toss may differ from that whi Bs toss. lly be presented diagrammaticaJly The pomts made so far can usefu two alternative activities, I and II, (Figure !). We assume that A has only are all contJ.nuousiy variable. Let us and.that their scaies and Bs iosses e in the nght-hand part of the dia­ temporarily disregard the dotted curv gives the totai gain to A. The area gram. The area under As curves then to B after he has made the best u nder Bs curves gives the total ioss This lS thus the direct loss as reduced adjustment possible to As acl!vity. ing that adjustment. by adjustment, plus the cost of mak if A were unhampered by restric­ and If A and B could not negotiate vity I at a scale of OR. A scale of tions of any sort, A would choose acti l product, but the optimum is socia OS would obviousiy give a larger 2 is greater than area i. Now B area e sinc OJ, e scal at II clearly activity lb-2a) to secure this result, while A will be prepared to pay up to (la+ (l+Ja-2-2a) to assure it. The will be prepared to accept down to m gain to be shared between them, difference lS (lb- I+ 2), the maximu and this is clearly positive. actual damages caused by either If A is liable to compensate B for ity II at scale OJ (i.e. the optimum activity I or II, he will choose activ e a net gain of 2. The result is the sam allocat10n), pay 2a to B and retain very is gam the of tion ribu dist gh the as when there is no such liability, thou 2a) to secure this result. Hence lb(la+ to up A pay will B different: the rmposition of a liability on A for whether or not we should advoc ate 7Buchanan-Stubblebine, pp. 381-3. 142 TURVEY damages caused is a matter of fairness, not of resource allocation. Our Judgment will presumably depend on such factors as who got there first, whether one of them IS a non-conformmg user (e.g. an establishment for the breeding of maggots on putrescible vegetable matter m a residential district), who is richer, and so on. Efficient resource allocation requires the lIIlposition ofa liability upon A only ifwe can show that inertia, obstinacy, etc. inhibit A and B from reaching a voluntary agreement. 8 We can now make the point implicit m Buchanan-Stubblebines argu­ ment, namely that there is a necessity for any impost levied on A to be paid to B when A and B are able to negotiate. Suppose that A is charged an amount equal to the ioss he imposes on B; subtracting this from his margmal gain curve in the nght-hand part of the diagram gives us the dotted line as his marginal net gain. If A moves to pomt J it will then pay B to mduce him to move back to position K (which IS sub-optimal) as it is this position which maximises the joint net gain to A and B together. There is a final point to be made about the case where A and B can negotiate. This is that if the externai diseconomies are reciprocal, so that each imposes a Joss upon the other, the problem is still more complicated. 9 We now turn to the case where A and B cannot negotiate, which in most cases will result from A and I or B bemg too large a group for the members to get together. Here there are certain benefits to be had from resource re-allocat10n which are not privately appropnable. Just as with collective goods, 10 therefore, there is thus a case for collective action to achieve optimum allocation. But all this means is that ifthe state can ascertain and enforce a move to the optimum position at a cost less than the gain to be had, and ifit can do this in a Way which does not have unfavourable effects upon income distribution, then it should take action. These two ifs are very important. The second is obvious and requires no elaboration. The first, however, deserves a few words. In order to ascertain the optimum type and scale of As activity, the authorities must estimate all of the curves 1n the diagrams. They must, in other words, list and evaluate all the alternatives open to A and examine their effects upon Band the adjusttnents B could make to reduce the loss suffered. When this 1s done, if it can be done, it is necessary to consider how to reach the optimum. Now, where the nature as well as the scale of As activity is variable, it may be necessary to control both, and this may require two controls, not one. Suppose, for instance, that in the diagram, both activi­ ties are the enuss1on of smoke: I from a low chimney and II from a tall chimney. To induce A to shift from emitting OR smoke from the low chinmey to ennttmg OJ smoke from the tall chimney, it will not suffice to 8 Cf. the comparable argument on pp. 94-8 of my The Economtcs of Real Property, 1957, about the externai economy to iandlords of tenants improvements. 9Davis-Whinston devote several pages of game theory to this problem. . IOBuchanan-Stubblebine, p, 383. On Divergences between Social Cost and Private Cost 143 levy a tax of PJ per um! of smoke. 11 If this alone were done, A would continue to use a low chimney, emitting slightiy less than OR smoke. It will also be necessary to regulate chimney heights. A tax would do the tnck alone oniy if it were proportioned to iosses imposed rather than to smoke emitted, and that would be very difficult. These complications show that m many cases the cost of achievmg optunum resource allocation may outweigh the _gam. If this is the case, a second-best solution may be appropriate. Thus a prohibition of all smoke emission would be better than OR smoke from a low chimney (since i is less than lb) and a requirement that all chimneys be tall would be better still (givmg a net gam of2 less 2b). Whether these requirements should be imposed on existing chimney-owners as well as on new ones then in­ troduces further complications relating to the short run and the iong run. There is no need to carry the exampie any further. It is now abundantiy clear that any general prescription of a tax to deal with external disecono­ mies 1s useless. Each case must be considered on its own and. there is no a priori reason to suppose that the imposition of a tax is better than alternative measures or indeed, that any measures at all are desirable unless we assume that information and administration are both costiess. 12 To sum up, then: when negotiation is possible, the case for government intervention is one ofjustice not of economic efficiency; when it is not, the theorist should be silent and call in the applied economist. 11Note how different PJ is from RT, the initial observable marginal external diseconomy. 12coase, pp. 18, .44. --·-!HIRD EDIIION ECONOMICS OF THE ENVIRONMENT Selected. Readings Edited by ROBERT DORFMAN NANCY S. DORFMAN W • W • NORTON & COMPANY New York London CHAPTER 4; CHAPTER4 ECONOMIC EFFICIENCY. AND MARKETS This chapter has several objectives. First JS to develop the notion of economic efficiency as an index for examining how an economy fundions and as a crite­ rion for Judging whether it is performmg as well as it nught. Economic effi­ Clency is a slmple idea but one that has much to recommend it as a criterion for evaluating the performance of an economic system or a part of that system, but it has to be used with care. A single firm or group of firms may be judged very efficient in thelr own limited way as long as they are keeping costs low and making a profit. Yet, to evaluate the socl/U performance of these firms, we must use the idea of econoJIUc efficiency ma wider sense. In this case it must include all the SOClal values and consequences of economic decisions, in particular envi­ ronmental consequences. It is important also to discuss the relationship between economic efficiency and economic equity. The second task is to address the question of whether a market system, left to itself, can produce results that are socially efficient. We will see that there are cases m which a system of private markets will not normally be able to bring about results that are efficient in this wider sense. This leads into the next chap· ter, where we will examine the policy question; that is, if the economy is not operating the way we want it to, especially m matters of environmental quality, what kind of public policy nught be used to correct the situation? Econon:uc efficiency is a criterion that can be applied at several levels: to input usage and to the determination of output levels. We ru:e going to concen­ trate in this chapter on the second of these because ultimately we want to apply the concept to the output of envlronmental quality. There are two questions of interest: (1) What quantity ought to be produced and (2) what quantity is produced in fact? The first question deals with the notion of efficiency, the sec­ ond with the way markets normally function. 66 ECONOMIC EFFICIENCY AND MARKETS 67 ECONOMIC EFFICIENCY In the preceding chapter we mlroduced two relationships, that between the quantity of output and willingness to pay, and that between output and mar­ ginal production costs. Neither of these two relationships, by itself, can tell us what the most desirable level of output is from societys standpomt. lb identify this output level, it is necessary to bring these two elements together. The cen­ tral idea of economic efficiency is that there should be a balance between the value of what is produced and the value of what is used up to produce it. In our terminology, there should be a balance between willingness to pay and the margmaJ costs of production. Efficiency JS a notion that has to have a reference point. lt JS critical to ask: efficient from the standpoint of whom? What 1s efficient for one person, in the sense of balancing costs and benefits, may not be effie1ent for somebody else. We want to have a concept of effie1ency that is applicable to the economy as a whole. This means that when referring to marginal costs, all the costs of producing the particular item m question must be included, no matter to who_m they accrue. When dealing with marginal willingness to pay, we must insist that this represents accurately all of the value that people in the society place on the item. This does not necessarily mean that all people will place the same value on all goods; it means only that there are no missmg sources of value. How do we irumtify the rate of output that is socially efficient? Suppose we focus on a particular type of output; in practice it could be refrigerators, auto­ mobiles, college educations, or a certam type of pollution-control equipment. Suppose that our item LS currently bemg produced at a particular rate, and we wish to know whether it would benefit society to have this output level mcreased by a small amount. To answer this requires comparmg the marginal willingness to pay for that extra output with the marginal opporton:ity costs of the output. If the former exceeds the latter, we would presumably want the extra output to be produced; otherwise we would not. This can be analyzed graphically by brmgtng together the two relationships discussed m the last chapter. Figure 4-1 shows the aggregate marginal willingness-to-pay curve (labeled MWTP) and the aggregate marginal cost curve (MC) for the good in question. The efficient level of production for this item is the quantity identified by the intersection of the two curves, labeled q in the figure. At this output level the costs of producing one more unit of this good are just exactly equal to the margmal value of it, as expressed by the marginal willingness-to-pay curve. This co=on value is p. The equality of marginal willingness to pay and margmal production cost is the test for determining if output ls at the socially efficient level. There ls another way of looking at this notion of effie1ency. When a rate of output is al the socially effiClent level, the net value, defined fill total willingness to pay minus tot.al costs, IS as large as possible. In fact, we can mellllure this net value on the diagram. At q we know that the total willingness to pay ls equal to an amount corresponding to the area under the margmal willingness-1:o­ pay curve from the origin up to q; this area consists of the sum of the three 68 SECTION TWO: , MC MWTP $ CHAPTER 4: ANALYTICAL TOOLS a q Quantity ot output FIGURE 4-1 The Socially Efficient Rate of Output. subareas: a + b + c. Total cost, however, consists of the area under the marginal cost curve, or area c. Thus, the surp lus is (a+ lJ + c) - c =::a+ b, which is the tri­ angular area enclosed by the marginal willingness-to-pay curve and the mar­ ginal cost curve. At any other quantity the corresponding value of total wilUngness to pay minus total production costs will be less than this area a + b. Lets be clear on what this graph is saying. We noted previously that the marginal willingness-to -pay curve is assumed to represent accurately all the benefits that people in our econo my actually experience when the good becomes available. The marginal production cost curve is assumed to contain all the true opportunity costs that are required to produce this good-no hid­ den or overlooked costs have been left out. Thus, the quantity qe is efficient because it produces a balance between the two sides-between the marginal worth of a good, as indicated by consumers; willingness to pay for it, and what it costs society to produce it, as measured by marginal costs. EFFICIENCY AND EQUITY t level when From the standpoint of society at large, production 1s at an efficren net benefits when IS, marginal benefits equal marginal production costs; that doesnt dis­ ncy Efficie . accrue s benefit are maxirn.Ized no matter to whom those net ered to consid is person one to s benefit tinguish among people. A dollar of net per­ one to s benefit of dollars d hundre One else. y be worth a dollar to anybod of one each to benefits of dollar one as same the worth be to ered son is consid ECONOMIC EFFICIENCY AND MARKETS 69 hundred people. In the real world, an outcome that benefits very rich people at the expense of poor people would be regard ed by most people as inequitable. This 1s sunply another way of saying that an outcome that IS efficient in this sense need not necessarily be equitable. Equity 1s tied closely to the distribution of wealth in a society. If this distri­ bution IS regarded as essentially fair, then Judgments about alternative output levels may justifiably be made using only the efficiency critermn. But if wealth is distributed unfairiy, the efficiency criterion by itself may be too narrow. Having said this, however, we have to recognize that in Judging economic out­ comes the relative e ... Purchase answer to see full attachment