Econ 215

University of Wisconsin -Stout

Honors Econ 21 5 – Spring 201 7

Ferguson

Problem Set # 5 Externalities and Public Goods (The last one!  )

Due M ay 1 st at the start of class

1. Externalities:

a. Think of an example of a market with positive externali ties that isn’t one of

the ones we talked about in class and explain why it is an externality (who is

being positively affected and how)

b. Think of an example of a market with negative externalit ies that isn’t one of

the ones we talked about in class. (who is be ing negatively affected and how)

c. State the Coase Theorem and explain what it means for markets with

externalities.

2. Externalities and Surplus: The market demand curve for wind chimes is

P = 250 – 5Qd. The supply curve is P= 5Qs. My neighbor’s wi nd chimes keep

me up at night when it’s windy outside (always), and create a negative externality

for me. Suppose this NEGATIVE demand extern ality is equal to $200 for the

wind chimes.

a) What is the market equilibrium price and quantity (when the externa lity is

NOT taken into account)?

b) Consider the case when the externality is taken into account. What is the

socially optimal equilibrium price and quantity when this externality is

included?

c) Give some intuition in regular words (not econ -speak) to explai n any

difference in quantity you found between the equilibrium in (a) and in (b)

3. Read the attached articles about the case of firefighters in Tennessee who allowed

a house to burn (“ No Pay, no Spray ” and “ The Perils of Privatizing

Government ”). Discuss the problem faced by suppliers in the market for fire

protection, and whether it qualifies as a public good or not. Pick one of the other

markets discussed in the second article and discuss whether you think it is a

market with a public goods problem, and if the private market will be able to

achieve a socially optimal or efficient equilibrium or not.

4. Listen to the mp3 of an episode of the NPR show “This American Life” attached

on D2L or streaming for free here:

http://www.thisamer icanlife.org/radio -archives/episode/441/when -patents -attack

(It’s about 50 min long, so plan ahead). Expl ain the issue at hand here and a few

of the key details – how do patents relate to our discussions of property rights,

externalities, public good, et c? Why are “ideas” different than slices of pizza or

pairs of shoes, from a market standpoint? Do you think patents are good, bad,

good sometimes? Tell me your thoughts based on what we’ve learned so far .

No pay, no spray: Firefighters let home burn

Tennessee house in ashes after homeowner 'forgot' to pay $75 fee

msnbc.com updated 10/6/2010 12:48:23 PM ET 2010 -10-06T16:48:23

Firefighters in rural Tennessee let a home burn to the ground last week because the homeowner hadn't paid

a $75 fee.

Gene Cranick of Obion County and his family lost all of their possessions in the Sept. 29 fire, along with

three dogs and a cat. "They could have been saved if they had put water on it, but they didn't do it,"

Cranick told MSNBC's Keith Olbermann.

The fire sta rted when the Cranicks' grandson was burning trash near the family home. As it grew out of

control, the Cranicks called 911, but the fire department from the nearby city of South Fulton would not

respond. "We wasn't on their list," he said the operators to ld him.

Cranick, who lives outside the city limits, admits he "forgot" to pay the annual $75 fee. The county does

not have a county -wide firefighting service, but South Fulton offers fire coverage to rural residents for a

fee. Cranick says he told the operator he would pay whatever is necessary to have the fire put out. His offer

wasn't accepted, he said.

The fire fee policy dates back 20 or so years. "Anybody that's not inside the city limits of South Fulton, it's

a service we offer. Either they accept it or they don't," said South Fulton Mayor David Crocker. The fire

department's decision to let the home burn was "incredibly irresponsible," said the president of an

association representing firefighters.

"Professional, career firefig hters shouldn’t be forced to check a list before running out the door to see

which homeowners have paid up," Harold Schaitberger, International Association of Fire Fighters

president, said in a statement. "They get in their trucks and go."

Firefighters did eventually show up, but only to fight the fire on the neighboring property, whose owner

had paid the fee. "They put water out on the fence line out here. They never said nothing to me. Never

acknowledged. They stood out here and watched it burn," Cranick said.

South Fulton's mayor said that the fire department can't let homeowners pay the fee on the spot, because the

only people who would pay would be those whose homes are on fire.

Cranick, who is now living in a trailer on his property, says his insuran ce policy will help cover some of his

lost home. "Insurance is going to pay for what money I had on the policy, looks like. But like everything

else, I didn't have enough."

After the blaze, South Fulton police arrested one of Cranick's sons, Timothy Allen Cranick, on an

aggravated assault charge, according to WPSD -TV , an NBC station in Paducah, Ky. Police told WPSD that

the younger Cranick att acked Fire Chief David Wilds at the firehouse because he was upset his father's

house was allowed to burn.

WPSD -TV reported that Wilds was treated and released.

The perils of privatizing government

A Tennessee city's decision to let a home burn because of an unpaid fee illustrates one of the debates of this

election season: How much should government do?

By Karen Aho MSN Money 11/ 1/2010

By now, you've probably heard the story about the Tennessee man whose house was allowed to burn down

because he hadn't paid a $75 fire -protection fee.

The heart -ren ding image -- firefighters standing by as a family's home is reduced to ashes and four pets die -

- became instant fodder for a fierce election -year debate over what the government should and shouldn't be

doing with public dollars.

With the midterm electio ns looming and Tea Party candidates stumping for drastic cuts in government

spending, their foes held out the Tennessee fire as a glaring example of the perils of privatization. "This is

essentially the same as denying someone essential medical care becaus e he doesn't have insurance,"

economist Paul Krugman blogged for The New York Times. "So the question is, do you want to live in the

kind of society in which this happens?"

On the other side, most of the logic went this way: If the firefighters had saved the home anyway, who'd ever

pay the fee again? "I know that if I opted out of the program before, I would be more likely to opt -in now,"

Jonah Goldberg wrote on National Review Online . It's not as if people aren't aware of the potential problems

of privatization. After 9/11, the nation decided airport security couldn't be left in the hand s of poorly paid

private screeners. The high cost -- in dollars and human life -- of outsourcing operations to contractors in

Iraq and Afghanistan has been painfully clear for years.

But as the recession drags on and governments sink deeper into the red, it's easy to be swept up in the call

for government to do less. That's until a picture of what that might look like emerges: public firefighters, in

uniform and with hoses in hand, doing nothing.

The public -private debate

Privatization, broadly defined a s any transfer of a government service to a private company, is used at every

level of government and often with positive results. It can involve work contracted out but paid with city

dollars, or fees paid by the users of, say, a service or a roadway.

In the Tennessee fire, a city department responded to the call. But the home was outside the city, where

residents were required to pay a fee for service -- akin to a privatized model. Privatization is almost as old as

cities themselves. The ancient Greeks a nd Romans raised funds by auctioning off the right to serve the public

for a profit. Privatization in the U.S. is nothing new either, but it had been largely abandoned by the mid -

20th century in favor of a growing public sector. 4

"In the 19th century, New York City used to experiment with privatizing street cleanup. It was always cheaper

to privatize, but the streets didn't get clean," says Elliott D. Sclar, a professor of urban planning at Columbia

University and the author of " You Don't Always Get What You Pay For: The Economics of Privatization ."

"Finally, by the 1890s, they had thrown up their hands." The history of fire pro tection is similar. "In the 19th

century, cities used to burn down with private fire companies," Sclar says, so they went public.

The basic concept -- protecting the common good by protecting each individual -- has been applied to schools,

libraries, fire and police service, trash collection, transportation, infrastructure, health care, social services

and more. The success of these services is credited with laying the foundation for a prosperous American

middle class with an innovative industrial base.

But as the backlash against "big government" grew in the 1970s and '80s, privatization re -emerged. By 2007,

half of all local govern ments said they had considered privatizing some services, with nearly 90% citing cost -

cutting as the reason, according to the International City/County Management Association.

Name a public service today, and somewhere a private CEO is running it: prisons , schools, parks, trash

collection, welfare centers, mass transit. Proponents say the profit motive inspires companies to innovate,

streamline and cut costs. The Reason Foundation , a libertarian think tank, says privatiza tion typically reduces

costs between 5% and 20%.

A good chunk of those savings comes in the form of reduced labor costs. Today, 30% of public -sector workers

are unionized, typically receiving pensions, good health benefits and better -than -average pay. Jus t 7% of the

private sector is unionized. (Public -sector unions also tend to support Democrats -- another reason

privatization is a big issue for the largely Republican Tea Party movement.)

"Oftentimes it's about breaking unions," says Dean Baker, a co -dire ctor of the Center for Economic and

Policy Research , a progressive Washington, D.C., think tank. "Insofar as you can get a lower -cost work force,

you can get savings."

Cutting costs by driving down wages

Like many publ ic agencies, Jackson County, Ore., considered the bottom line when it tried to reopen its 15

library branches, shuttered after a loss of federal funds in 2007. While negotiating with the county workers

union, it put management of the libraries out for bid.

Library Systems & Services, the only private company to bid, won the contract with a bid that cut costs by

about 40% over what the union had proposed. With library hours reduced, the company rehired 70 of the 110

laid -off library members, at their same s alaries but with reduced benefits, says Amy Blossom, the manager

of the Ashland branch.

An analysis by the Oregon State Library found that while overall library staffing in Jackson was reduced by

36%, the number of librarians was reduced by 52% and the nu mber of those with advanced degrees --

common for the position -- by 57%. This net result -- lowered compensation overall and fewer benefits -- is

typical with privatization, according to the American Federation of State, County and Municipal Employees,

a union.

"It's certainly been one of the factors in the growing inequality" between rich and poor that led to the

recession, Baker says. "You get rid of those jobs, you put more downward pressure on the wages of other

jobs."

Critics also say there's no guar antee that work will be done less expensively, or better, with privatization. In

fact, the accounting books at private companies often remain closed. Jackson County, while happy with

Library Systems & Services, has no idea exactly how the company is spendi ng tax dollars. (The company

declined to comment for this story.) 5

That veil of secrecy can be costly. Consider the case of New York City's hiring of computer consultant

Science Applications International for a project called CityTime. After more than a dec ade, there's no end in

sight, and the New York Daily News reported recently that more than 400 c onsultants on the project have

billed the city an average of $400,000 a year. The city's controller is looking into why a project that was

supposed to cost $68 million has cost more than $700 million, the newspaper reports.

Asked to comment for this story , Science Applications provided written statement saying: "CityTime is

working now for 73,000 employees with a 99.9 percent accuracy rate and SAIC is eager to have the system

up and running in the remaining agencies once those agencies give us the green li ght. We believe CityTime

brings a great value and savings to New York City taxpayers and we are pleased to help ensure its

completion."

Ironically, the project was for equipment to prevent time -clock abuses by city employees.

Privatization "is a very mixe d bag. Just because something is done in the private sector doesn't mean it's done

more cheaply," says Baker, particularly once you factor in "highly paid executives."

"A government that's incompetent to deliver a service is not going to be any more compe tent to monitor a

contractor," Sclar adds.

Get rid of government?

Even when privatizing services does save money, the question remains: How far do we want to go?

Privatization purists say taxpayer dollars should never help pay for programs that would no t turn a profit in

the private sector or where there's a private alternative. Some Tea Party candidates have gone as far as calling

for privatization of Social Security and Medicare, the nation's biggest social programs.

Take Amtrak. Experts think half of its routes would be profitable if run by private companies, says Chris

Edwards, an economist and the editor of Downsizing the Federal Government , an online guide of the

libertarian Cato Institute. The routes that wouldn't be profitable -- largely in rural areas and outside the

Northeast -- "don't make any sense and shouldn't be run," he says.

"I don't think anything should be off limits," he says . He'd like to see the Federal Aviation Administration --

essentially the police of the skies -- privatized, along with airports. The media and federal accounting office

could monitor operations, but ultimately customers would drive performance. If Dulles International Airport

in the Washington, D.C., area hired a lousy security company, passengers would be more likely to use nearby

Reagan National Airport instead, Edwards says.

Another area ripe for privatization: highways and toll lanes, something that's already being done in some

areas. Let private companies raise capital and charge fees, and if you can't pay, slum it on the public

pavement.

Life in second class

But how much of this would the public stand for? Sure, we'll accept first class in the skies . In fact, bizarre

pricing gaps among travelers make flying affordable for the average Joes in the sardine cabin (see " The

secrets behind cr azy air -travel prices ").

But should there be two classes of airport security, two classes of fire protection, two classes of public safety?

And what happens when those paying to drive on private roads get tired of paying a gas tax to support public

roads? It can be annoying to pay both, Edwards concedes.

When Sclar, whose work takes him around the globe, lectures on privatization, he shows slides of what he

calls "the transportation of the rich in São Paulo, Brazil, and the United States." 6

The first slide shows a helicopter, the safe mode of transport in Brazil, where public services have been

heavily privatized and public areas are often unsafe. The second shows a New York City taxi -- a very

democratic mode of transportation.

"When you don't have good municipal services, societies break down," Sclar says. "The social costs of that

can be enormous over time."

So when do you let it burn?

The Tennessee fire has helped put the high -level debate into perspective. When city offici als ordered the

firefighters of South Fulton, Tenn., not to put out Gene Cranick's fire, their reasons made good business

sense: If you provide a service for free, no one will pay.

But was it the right decision for a community? As Cranick mourned his los ses, strangers across the country

called him a freeloader, an ingrate and a jerk. Firefighters from other departments said that the South Fulton

officers should be ashamed of themselves. After the fire, one of Cranick's relatives went to the fire station

and reportedly assaulted the chief.

Even privatization proponents hedged. "The Obion County fire seems a clear example of government failure,

not market failure," wrote Thomas Firey for the Cato Institute. "It's not difficult to imagine what a private

fire service would do in an event like the Obion fire: It likely would extinguish the blaze and then send the

homeowner a bill."

On the National Review Online, writer David Foster suggested this right business decision may not have

been the moral one . Others said the fire was not a good example of privatization anyway: When the subsidized

city department entered the market, it unfairly blocked out competitors.

But even in an entirely free market, the question would remain: When your neighbor's home is burning, do

you have a responsibility to help, or do you let it burn f or a lack of a fee? Or perhaps, if you're not paid up,

we just assume you're not really a neighbor. That's what one poster at The Agonist seems to suggest, blaming

Cranic k for not having just paid the fee and adding, "Jeebus people, step up and be part of the community

already."