Shane Frederick (JEP, 2005) Cognitive Reflection & Decision Making

Transcription

1 Shane Frederick (JEP, 2005) Cognitive Reflection & Decision Making 1. A bat and a ball cost $1.10 in total. The bat cost $1.00 more than the ball. How much does the ball cost? cents 2. If it takes 5 machines 5 minutes to make 5 widgets, how long would take 100 machines to make 100 widgets? minutes. 3. In a lake, there is a patch of lily pads. Every day the patch doubles in size. If it takes 48 days for the patch to cover the entire lake, how long would it take the patch to cover half of the lake? days

2 Mean CRT Scores By Location MIT 2.18 UCSD (Econ 2) 1.84 Princeton 1.63 Carnegie Mellon 1.51 Harvard 1.43 Michigan (Ann Arbor) 1.18 Bowling Green U Michigan (Dearborn) 0.83 Michigan State U University of Toledo 0.57

3 Correlation of CRT Score with Midterm Score: 0.31 Correlation of Order Midterm handed in with Midterm Score: -0.05

4 Chapter 11: probs #1, #3, and #4, p. 298

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6 Chapter 11: Externalities and Property Rights A. External costs B. External benefits

7 Definitions The private benefits of an activity are the benefits that you personally receive The external benefits of an activity are positive consequences of that activity for others that you don t personally get compensated for By positive consequences we refer to something they would be willing to pay to receive if they needed to

8 Example: beekeeping Private benefits: sell honey

9 External benefits: many commercial crops (such as apples, oranges, alfalfa, almonds ) have higher yields when more bees are around

10 One colony (30,000 bees) might produce 80 pounds of honey, sell wholesale for $1.50/pound = $120/colony One colony could increase yield of apple orchard by up to several hundred dollars

11 Marginal costs and benefits for the beekeeper Value ($ per colony) external benefit of 10 th colony is $100 external benefit of 30 th colony is $50 private marginal cost 120 social demand private demand (total honey sales) Total bee colonies maintained

12 If beekeepers were not compensated for pollination services, the private outcome would be inefficient Value ($ per colony) external benefit of 30 th colony = $ social cost of 30 th colony = $ private marginal cost social demand private demand (total honey sales) social benefit of 30 th colony = $170 Total bee colonies maintained

13 It would be socially efficient if the beekeeper maintained 35 colonies Value ($ per colony) 120 area of this triangle is deadweight social loss if only have 30 colonies private marginal cost social demand private demand (total honey sales) Total bee colonies maintained

14 Summary of economics of external benefits: What suppliers take into account in making their decisions is private demand Social demand = private demand plus external marginal benefits What suppliers should take into account in making their decisions is social demand

15 When social demand > private demand, too little of the activity is undertaken and result is socially inefficient

16 A socially efficient allocation calls for setting marginal social benefit = marginal social cost If social MB > social MC, should have more of activity If social MB < social MC, should have less of activity

17 With perfect competition and no externalities, social MC = private MC and social MB = private MB This is why perfect competition with no externalities results in socially efficient allocation (= Adam Smith s invisible hand )

18 When there are external costs or benefits, maximization of private profit is not in the public s interest, and Adam Smith s invisible hand does not work correctly

19 Chapter 11: Externalities and Property Rights A. External costs B. External benefits C. Dealing with externalities 1. Negotiation and the Coase Theorem

20 Owner of apple orchard would gain $50 if beekeeper located another colony next to orchard. So why not offer to pay beekeeper $25?

21 Both orchard owner and beekeeper would be better off So why don t they make such arrangements?

22 Answer: they sometimes do!

23 At any number of colonies less than 35, there is a contract that would make both orchard owner and beekeeper better off Value ($ per colony) offer to pay $25 for colony gives orchard $25 more profit, beekeeper $25 more profit benefit to orchard is $ private marginal cost social demand private demand (total honey sales) Total bee colonies maintained

24 At any number of colonies less than 35, there is a contract that would make both orchard owner and beekeeper better off benefit to orchard is $40 Value ($ per colony) 120 contract to pay $25 for colony gives orchard $15 more profit, beekeeper $15 more profit private marginal cost beekeeper must be compensated at least $10 social demand private demand (total honey sales) Total bee colonies maintained

25 Coase Theorem: If people can negotiate with each other at no cost for side payments for externalities, the socially efficient outcome would emerge Ronald Coase

26 When such contracts are written, the external costs or benefits become private costs or benefits

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28 But for some kinds of externalities, such contracts are not feasible

29 Chapter 11: Externalities and Property Rights A. External costs B. External benefits C. Dealing with externalities 1. Negotiation and the Coase Theorem 2. Taxes on activities with negative externalities

30 Premise: the optimal amount of negative externalities is not zero Cost (cents per mile) social MC private MC demand 9 10 Total miles driven in San Diego per Year (billions of miles)

31 Suppose we put a tax of 3 cents per mile for every mile driven. Then the marginal private cost of driving an extra mile would be 33 cents rather than 30 cents.

32 Using a tax to correct a negative externality Cost (cents per mile) people would choose to drive 9 billion miles if there was a tax social MC = private MC (if there is tax) 3 /mile tax social MC private MC (if no tax) demand 9 10 Total miles driven in San Diego per Year (billions of miles)

33 Taxes discourage any economic activity. If there are no externalities, this would be a bad thing. If there are negative externalities, this could be a good thing.

34 Problem 1: The contribution to traffic congestion differs with time of day. At midnight, marginal congestion cost = 0. Solution: set a toll for use of the road that differs with time of day.

35 Problem 2: Different cars cause different levels of pollution. Older cars cause much more pollution than new. Solution: base tax on features of car.

36 Chapter 11: Externalities and Property Rights A. External costs B. External benefits C. Dealing with externalities 1. Negotiation and the Coase Theorem 2. Taxes on activities with negative externalities 3. Subsidies for activities with positive externalities

37 Using a subsidy to correct a positive externality $/unit set subsidy = external benefit people would choose socially desired quantity if there is a subsidy marginal cost social demand = private demand (if there is a subsidy) social demand external benefit private demand (if no subsidy) Quantity socially desired quantity privately chosen quantity

38 Subsidies encourage an economic activity. If the right amount of the activity is already being undertaken by private market, this would be a bad thing (cost to taxpayers exceeds benefit to consumers and producers). If too little of the activity is being undertaken by private market, this would be a good thing.

39 Examples of potentially useful subsidies: (1) Recycling aluminum cans private benefit: economic value of aluminum external benefit: reduce burden on landfills cash redemption value: increases private benefit of recycling

40 (2) Public transportation private benefit: save gas, car costs external benefit: reduce traffic congestion, pollution, cost of new roads government subsidy: decreases cost to user of public transportation

41 (3) Basic scientific research private benefit: researcher may enjoy, may obtain patent, university gains prestige and students external benefit: research may inspire other discoveries for which others receive patent public subsidy: increases private return to research

42 Chapter 11: Externalities and Property Rights C. Dealing with externalities 1. Negotiation and the Coase Theorem 2. Taxes on activities with negative externalities 3. Subsidies for activities with positive externalities 4. Direct government regulation

43 Government regulation can sometimes be interpreted as response to externalities Speed limits and traffic laws Tort liability system Laws and regulations on disposal of chemicals, batteries, oil, computers, Zoning laws Regulation of air and water pollution

44 Chapter 11: Externalities and Property Rights C. Dealing with externalities 1. Negotiation and the Coase Theorem 2. Taxes on activities with negative externalities 3. Subsidies for activities with positive externalities 4. Direct government regulation 5. Market-based solutions

45 Example: controlling air pollution from coalfired power plants Mt. Storm, W. Virginia

46 What can plant do to reduce SO2 emissions? 1) Use low-sulfur coal abundant supplies in Wyoming and Alaska many power plants in northeast big differences in transportation costs across facilities Healy, Alaska

47 What can plant do to reduce SO2 emissions? 2) Use coal scrubbers differ in cost and effectiveness

48 Conclusion: some plants can reduce SO2 emissions at much lower cost than others Economic efficiency calls for equalizing marginal cost of reducing SO2 emissions across all sources Mt. Storm, W. Virginia

49 How to do this? (1) detailed regulation, separate requirements for each facility (2) market-based solution

50 Example: Clean Air Act Amendments of 1990 Approach: Companies issued permits to emit SO2 One permit allows to emit one ton of SO2 per year Total permits issued achieves policy goal Companies could buy or sell permits from each other

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53 Results: Pollution reduced well below goal Cost was 30% lower than original EPA plan

54 Separate questions: (1) How much is public willing to pay to reduce air pollution? (2) Given a given goal of reducing air pollution, what is the least costly way of achieving it?

55 Chapter 11: Externalities and Property Rights C. Dealing with externalities 1. Negotiation and the Coase Theorem 2. Taxes on activities with negative externalities 3. Subsidies for activities with positive externalities 4. Direct government regulation 5. Market-based solutions

56 Chapter 11: Externalities and Property Rights C. Dealing with externalities D. The tragedy of the commons Question: what difference does it make whether a resource in privately owned or publicly owned? 1. Outcome when resource is privately owned

57 Suppose I borrow money to buy a 500- pound calf for $500 After interest and other costs, say next year I ll owe $ At that point, can sell 2- year-old cow for $1/pound

58 Can graze these cows on a 10-acre pasture The more cows I put on this pasture, the less weight each one will gain

59 # of cows weight per cow after 1 year 1000 lbs. 900 lbs. 800 lbs. 700 lbs. lbs. 500 lbs.

60 # of cows weight/ cow Total pounds

61 # of cows weight/ cow Total pounds Q (lbs.)

62 # of cows weight/ cow Total pounds Q TC

63 # of cows weight/ cow Total pounds Q TC MC= TC/ Q /lb /lb $1.00/lb $1.33/lb $3.00/lb

64 Private owner would want to operate at point where MR (=$1.00/lb) is equal to MC # of cows weight/ cow Total pounds Q TC MC= TC/ Q /lb /lb $1.00/lb $1.33/lb $3.00/lb

65 Private owner would want to operate at point where MR (=$1.00/lb) is equal to MC # of cows weight/ cow Total pounds Q TC MC= TC/ Q /lb /lb $1.00/lb $1.33/lb $3.00/lb

66 Private owner would want to operate at point where MR (=$1.00/lb) is equal to MC # of cows weight/ cow Total pounds Q TC MC= TC/ Q /lb /lb $1.00/lb $1.33/lb $3.00/lb Income generated from the land is $ $1800 = $

67 Chapter 11: Externalities and Property Rights C. Dealing with externalities D. The tragedy of the commons 1. Outcome when resource is privately owned 2. Outcome when resource is publicly owned

68 Suppose now that nobody owns the land (= commons), and anybody who wants to can graze cows on it

69 # of cows weight per cow after 1 year 1000 lbs. 900 lbs. 800 lbs. 700 lbs. lbs. 500 lbs. Suppose there are already 3 cows and your neighbor considers adding 1 more. Your neighbor s private marginal cost = $ Your neighbor s private marginal benefit = $700

70 Conclusion: if not privately owned, people will graze a lot more cows

71 If not privately owned, people would graze 5 cows, even though social MC = $3.00/lb. and only sells for $1.00/lb. # of cows weight/ cow Total pounds Q TC MC= TC/ Q /lb /lb $1.00/lb $1.33/lb $3.00/lb Reason: part of social MC is that other cows are less well fed, and I don t personally pay for that cost

72 Tragedy of commons: If resource is not privately owned, it will be inefficiently overused. Lack of private property rights makes poor countries even poorer

73 When land becomes too overgrazed to support cows, people add goats Goats in Ethiopia

74 Why don t they establish property rights? 1) Culture may not have tradition of ownership 2) Antipathy to capitalism 3) Power struggle over who would own the asset if property rights were established

75 Does Anyone Own The Fish In the Sea? Nobody owns the fish in the sea

76 If I catch more fish with my little fishing boat there will be fewer fish left to replenish future stocks

77 Effect on my own future yield may be small But combined effect on all the other fishing boats may add up

78 Commercial Marine Fisheries Catch

79 Fisheries catches would be declining faster, were it not for the expansion of fishing into deeper areas and further offshore, especially in the Southern Hemisphere Decade 1950s 1960s 1970s 1980s 1990s

80 Here is an illustration of this expansion toward greater depth, especially in the Southern Hemisphere Mean depth of catch (m) m Latitude ,000 2,

81 Now consider that ecosystem fluxes move up trophic pyramids 4 Top predators Trophic level 3 2 Prey fish Zooplankton 10% 10% 1 Phytoplankton * *.... *..... *. *. *. *.. *. *. 10%

82 Moreover, this process, wherein fisheries catches are increasingly based on organisms low in the food web, now known as fishing down marine food webs, has been recently shown to be stronger & more widespread than originally thought TL of landings Northwest Atlantic TL of landings Northeast Atlantic Pauly et al. Science,

83 Conclusion: global overfishing is a tragedy of the commons