Cost benefit analysis lecture 3 · Valuing impacts in the output markets - distorted markets · Valuing impacts in the input markets Distorted markets · Estimating the changes in surplus gets complicated if the market is distorted · Examples of market distortion: 1. Information asymmetry 2. Externalities 3. Public goods 4. Addictive goods (monopoly/oligopoly) 1. Information asymmetry . One side of the market knows more information than the other . Firms may know the true quality of the product which may be hidden from the consumers e.g., prescription drugs · Employees may know their true productivity/ability which may be hidden from the employers . This moves the market away from competitive equilibrium · Government intervention reducing information asymmetry may decrease the dead-weight loss · However, government intervention may be costly · Justified depending on the nature of the good - search goods e.g., notebook, umbrella - experience goods e.g. clothes, restaurants, hotels - post-experience goods e.g. surgeries, new medicines, automobiles Suppliers side - d0 full information, d1 without full information (diagram) demanded less with full information. How social surplus has changed = Producer surplus ADP0 vs AEP1 Consumer surplus P0DC vs imperfect information At point E consuming Q1 paying P1*Q1 - net benefit is equal to +P'CG - GEF; losing because of less information. DEF is the net loss of social surplus. Government provides information that can move from E to D, avoiding losses. 2. Externalities · Unintentional effect of production or consumption on third parties . There is no market for externalities · Negative externality generates social cost e.g., pollution caused by factories · Positive externality generates social benefit e.g., utility generated by neighbour's garden Negative externalities = supply curve without negative externalities is below supply curve with negative externalities. Price is P0 which is more expensive than P1 CS= P0DEp1 PS = p0DCEp1 > including social costs Deadweight loss as a result - not accounting for externalities.
3. Public goods · Goods that are shared with the entire population are public goods e.g. public statues, clean air, etc. · Non-excludable and Non-rivalrous · Compare with apples which is a private good . Publicness of a good cause market failure due to a free-rider problem . No incentives for firms to produce such goods, so usually supplied by the government Maximum willingness to pay - kinked demand curve - person 1 demand is 0 at Pa price above demand curve market demand is 0. (private good diagram) Quantity supplied Q*, Person 1 willing to pay p1 person 2 willing to pay p2 Vertical sum - kinked demand curve other way around, kink at P1 - after the kink person 2 will benefit and be more than satisfied, leaving person 1 just satisfied (public good diagram) if someone else pays you don't have to = free-rider 4. Addictive goods · Goods for which today's consumption increases the future consumption e.g., tobacco, gambling, sugar, etc. · Rational addiction: when consumers take "addiction" into account when making choices · When "addiction" is