Microeconomics

Microeconomics

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Microeconomics

Question 1 a

Public Goods

Public goods are commodities that non-excludable and non-rival when it comes to consumption. Non-excludability in such products means that no one can stop the other person from using them. Conversely, non-rivalry means that consumption by one person cannot finish the product thus eliminating competition for it. In addition, adding another consumer to this good has no marginal cost even when such people are not paying to get it (Mankiw 2011, p. 218). An example of such a good is street lighting where no one can be excluded from using, as long as it is provided. Additionally, the use by an individual will not limit others from using such lighting. Other examples include air, knowledge and national security.

Private Goods

Private goods, in contrast, are those that are excludable or rival in terms of consumption. For such products, people can be excluded from using them. In addition, the use by an individual can finish the product and thus create competition. Private goods are those that can be traded within the market by any person. Upon purchasing, one can exclude any other person from access. A good example is a car. The owner has rights to limit people who can drive it. Rivalry occurs when an individual consumes such a good, and its availability to others is affected. In the example of a car, if only a few custom cars are manufactured, consumption by one individual will affect that of others. Additionally, to have a car, one has to pay for it (Mankiw 2011, p. 218).

Common Resources

            Common goods have one of the characteristics used in defining products. They have a high rivalry in nature but are not excludable. This is to mean that despite everyone having access to such goods, consumption by one individual could affect that of others. An example is fishing grounds. Every person is allowed to fish in the seas. However, too much fishing by one individual can reduce the fish stock. Reduction in stock of fish in the sea means that other anglers will have a limited supply (Mankiw 2011, p. 218).

Club Goods

Club goods are those that can be excludable, but have low rivalry in consumption. This is to mean that some people can be prevented from using such goods although one individual’s consumption does not affect others. An example is a community service such as cable television. Such a service is not available to everyone since people from other communities or areas have no access. However, the use by one person within the community will not affect its availability to other members because they can use it at the same time (Mankiw 2011, p. 219).

Each of these types of goods can be represented in a diagram as follows

Question 1 b

Externalities are defined as third party effects that arise from consumption and production of goods and services for which there is no suitable reimbursement made. Externalities occur outside of the market meaning that they affect people who are not involved directly in their production or consumption (Hirschey 2008, p. 419). This is also called the spillover effect. During production and consumption, a spillover benefit or cost can be created. Negative externalities deal with spillover costs that have to be paid for by the third parties. Negative externalities affect optimal price and quantity in the market. When externalities exist, two types of costs and benefits are created. These are private and social cost and benefits. Social costs are made up of private and external costs. Conversely, social benefits are made up of private and external benefits. When a negative externality is created, and the producer does not pay for it, marginal costs of manufacturing and supplying will be low. As a result, the quantity of such a commodity in the market will increase because the costs are felt by the society (Hirschey 2008, p. 419). Consequently, the cost for society is above the cost of production represented in the following diagram

From this diagram, one can realize the effect of negative externalities on the market. The red curve represents the social cost while the black curve represents the industry’s marginal cost curve. The optimal quantity is represented by Q¹. Because of the negative externality, quantity Q^* is produced instead of the optima one at Q1. There is increased production because firms do not incur extra cost of the externality as the society does. Because of this, the optimal price decreases while the marginal cost to society increases. The DWL represents the Dead Weight Loss that results from failing to meet the optimal production and price (Fundamentalfinance.com 2013). The optimum price and quantity is achieved when supply equals demand, meaning there is efficient production. This is also the competitive market price and quantity. An example of a negative externality is pollution of water from the firms. When private firms pollute the water, the society incurs costs of treating related diseases while the companies continue to profit at a lower expenditure.

Question 2

Part a

One real life example of a positive externality in production is beekeeping. Ed Lotterman in his article, Beekeeping Highlights Principle of Positive Externalities, explores the positive externality created by beekeeping. The article discusses benefits of commercial beekeeping to the society. He cites that despite the commercial honey production standing at $250 million that is less than 1% of the entire farming, bees are extremely important for crop production (Lotterman 2013). Although one might think that eliminating bees will have no significant effect on the agricultural industry, the truth is the opposite. Bees, whether domestic or wild, provide a great value to the society through pollination of crops, an action far more valuable than profit from direct sales. Pollination becomes a positive externality because those who are not involved in beekeeping and the society that feeds on agricultural products will benefit from pollination without having to pay any costs. Additionally, the honey market is efficient in a free market without government regulation where less honey is produced because beekeepers cannot harvest the full benefit of bees. Subsequently, this ensures that beekeeping does not create extra costs to the society like other industries.

Part b

Despite the positive externality created by both domestic and wild bees, a problem is facing this market. Over the last half century, colonies of bees have drastically reduced because of a combination of several factors that include pollution, farming with insecticides and changing weather conditions. Much of the problem comes from negative externalities created by other firms such as farmers using chemicals, pesticides, and companies that cause pollution. In addition, lack of regulation on such externalities is causing more problems since farmers have all the right to use pesticides for maximum profit.

Although the article does not provide a solution for this issue, it is evident that the government needs to impose an incentive that ensures private firms creating externalities that harm bees seek efficient production. Imposing a tax on the amount of pesticides produced, as well used in farms would ensure that manufacturers and farmers seek improved means of generating their products. A tax remedy would ensure that farmers and pesticide manufacturers paid for any negative externality they cause (Daly & Farley 2010, p. 188). For every amount of pesticide used, it goes to the rivers through run off. Tax would ensure that every pesticide used is paid for by the firms. This increases cost for private consumption and production, which raises price and subsequently reduces output, as well as demand for the good creating. This can be represented as shown below

http://www.economicshelp.org/marketfailure/tax-negative-externality.html

This diagram shows what happens after tax is imposed on negative externalities. S represents the private marginal cost while S2 represents social marginal cost. D represents social and private marginal benefits. P represents price. Before tax was imposed, the quantity of products demanded had been high at Q1. At the same quantity, social marginal cost was quite high compared to private marginal cost since it would be above P2. In addition, price of the product is low at P1. After tax is imposed, quantity demanded decreases to Q2 while price increases to P2. Social marginal cost reduces. The private marginal benefit reduces as the social marginal benefit increases. Therefore, imposing a tax on firms creating negative externalities ensures efficiency of the market. It causes a pivotal shift in the supply curve since the producers have to supply the same goods at a higher price. As tax increases cost, price increases and causes demand to reduce. As a result, the optimal quantity and price id reached.

Bibliography

Fundamentalfinance.com 2013 Negative Externality viewed August 21, 2013.http://economics.fundamentalfinance.com/negative-externality.php

Hirschey, M 2008, Managerial Economics, New York, Cengage Learning.

Lotterman, E 2013, Beekeeping highlights principle of ‘positive externalities, viewed on August 21, 2013, http://www.idahostatesman.com/2013/06/14/2615934/beekeeping-highlights-principle.html

Mankiw, N G 2011, Essentials of Economics, New York, Cengage Learning.

Daly, H E & Farley, J 2010, Ecological Economics, Second Edition: Principles and Applications, New York, Island Press.