Applied

Microeconomics
 Applied Microeconomics

Economics of the
Environment
 ECONOMICS OF THE ENVIRONMENT

■ The environmental problem

✜ use of the environment as:
✦ an amenity
✦a source of primary products
✦a dump for waste
 The economy and the environment

Factor services

Goods and services

Resources Waste Amenity value

(Clipart for the environment: e.g. countryside scene)

 ECONOMICS OF THE ENVIRONMENT

■ The environmental problem

✜ use of the environment as:
✦ an amenity
✦a source of primary products
✦a dump for waste

✜ conflicts between these uses

 ECONOMICS OF THE ENVIRONMENT

■ The environmental problem

✜ use of the environment as:
✦ an amenity
✦a source of primary products
✦a dump for waste

✜ conflicts between these uses

✜ population pressures and limited
resources
 Accelerating environmental damage

Total
damage
Environmental damage

O
W1 Waste
 ECONOMICS OF THE ENVIRONMENT

■ The environmental problem

✜ use of the environment as:
✦ an amenity
✦a source of primary products
✦a dump for waste
✜ conflicts between these uses
✜ population pressures and limited
resources
✜ case for optimism
 ECONOMICS OF THE ENVIRONMENT

■ An optimum use of the environment

✜ different approaches to sustainability
✦ free-market approach
✦ social efficiency approach
✦ conservationist approach
✦ Gaia approach

✜ making optimum decisions

 Optimum level of an activity that involves pollution

MC pollution
Costs and benefits (£)

P4

P3
P2

O Q1 Q2 Q3 Q4
MB− MC
Output of good
 ECONOMICS OF THE ENVIRONMENT

■ An optimum use of the environment

✜ different approaches to sustainability
✦ free-market approach
✦ social efficiency approach
✦ conservationist approach
✦ Gaia approach

✜ making optimum decisions

■ Market failures
 ECONOMICS OF THE ENVIRONMENT

■ An optimum use of the environment

✜ different approaches to sustainability
✦ free-market approach
✦ social efficiency approach
✦ conservationist approach
✦ Gaia approach

✜ making optimum decisions

■ Market failures
✜ environment as a public good
 ECONOMICS OF THE ENVIRONMENT

■ An optimum use of the environment

✜ different approaches to sustainability
✦ free-market approach
✦ social efficiency approach
✦ conservationist approach
✦ Gaia approach

✜ making optimum decisions

■ Market failures
✜ environment as a public good
✜ externalities
 Optimum level of an activity that involves pollution

MC pollution
Costs and benefits (£)

P4

P3

O Q1 Q3 Q4
MB− MC
Output of good
 ECONOMICS OF THE ENVIRONMENT

■ An optimum use of the environment

✜ different approaches to sustainability
✦ free-market approach
✦ social efficiency approach
✦ conservationist approach
✦ Gaia approach
✜ making optimum decisions
■ Market failures
✜ environment as a public good
✜ externalities
✜ ignorance
 ECONOMICS OF THE ENVIRONMENT

■ An optimum use of the environment

✜ different approaches to sustainability
✦ free-market approach
✦ social efficiency approach
✦ conservationist approach
✦ Gaia approach
✜ making optimum decisions
■ Market failures
✜ environment as a public good
✜ externalities
✜ ignorance
✜ inter-generational problems
 ECONOMICS OF THE ENVIRONMENT

■ Market-based policies
✜ extending private property rights

✜ charging for use of the environment

 An emissions charge
MSC
Costs and benefits (£)

P2

MB = MSB
P1 = 0
L2 L1
Level of emission
 ECONOMICS OF THE ENVIRONMENT

■ Market-based policies
✜ extending private property rights
✜ charging for use of the environment
✜ environmental ('green') taxes
 A socially efficient green tax

MC pollution
Costs and benefits (£)

Socially efficient
green tax
P1

O Q1 Q2
MB− MC
Output of good
Green tax revenues as a % of GDP
Green tax revenues as a % of GDP
 ECONOMICS OF THE ENVIRONMENT

■ Non-market-based policies
✜ command-and-control systems
✦ technology-based standards
✦ ambient-based standards
✦ social-impact standards

✜ voluntary agreements
✜ education
 ECONOMICS OF THE ENVIRONMENT

■ Tradable permits
✜ how they work
✜ assessment of the system

■ Can we rely on governments?

✜ game theory and international agreements
 Outcomes for countries from strategies
of pollution reduction

Other countries’ strategy

All cut Some cut None cut
pollution pollution pollution

A B Small loss C
Cut pollution Large loss
Moderate for USA for USA
net gain for all Gain for Slight gain for
USA’s countries not other countries
strategy cutting pollution

Don’t cut D E F
High gain Fairly high No gain
pollution for USA gain for USA for any
Small gain for Loss for other country
other countries countries
 Applied Microeconomics

Traffic Congestion and

Transport Policies
 TRAFFIC CONGESTION AND
TRANSPORT POLICIES

■ The allocation of road space

✜ demand for road space
✦a derived demand
✦ determinants of demand
Cars per thousand population Increase in car ownership

UK

Energy and Transport in Figures (EC, 2002); Federal Highway Administration: http://www.fhwa.dot.gov/ohim/qfvehicles.htm
 Increase in car ownership

USA
Cars per thousand population

UK

Energy and Transport in Figures (EC, 2002); Federal Highway Administration: http://www.fhwa.dot.gov/ohim/qfvehicles.htm
 Increase in car ownership

USA
Cars per thousand population

Sweden Belgium

UK

Energy and Transport in Figures (EC, 2002); Federal Highway Administration: http://www.fhwa.dot.gov/ohim/qfvehicles.htm
 Increase in car ownership

USA
Germany
Cars per thousand population

W Germany

Sweden Belgium

UK

Energy and Transport in Figures (EC, 2002); Federal Highway Administration: http://www.fhwa.dot.gov/ohim/qfvehicles.htm
 Increase in car ownership

USA
Germany
Cars per thousand population

W Germany

Sweden Belgium

UK Spain

Energy and Transport in Figures (EC, 2002); Federal Highway Administration: http://www.fhwa.dot.gov/ohim/qfvehicles.htm
 TRAFFIC CONGESTION AND
TRANSPORT POLICIES

■ The allocation of road space

✜ demand for road space
✦a derived demand
✦ determinants of demand
✦ the price and income elasticities of demand
 Motoring costs as % of
UK household expenditure: 2000/1
household expenditure
Motoring costs as % of

Quintile groups of household income

Passenger transport in Great Britain
(percentage of passenger kilometres by road)
Passenger transport in Great Britain
(percentage of passenger kilometres by road)
Passenger transport in Great Britain
(percentage of passenger kilometres by road)
Passenger transport in Great Britain
(percentage of passenger kilometres by road)
Passenger transport in Great Britain
(percentage of passenger kilometres by road)
 TRAFFIC CONGESTION AND
TRANSPORT POLICIES

■ The allocation of road space

✜ demand for road space
✦a derived demand
✦ determinants of demand
✦ the price and income elasticities of demand

✜ supply of road space

 TRAFFIC CONGESTION AND
TRANSPORT POLICIES

■ The allocation of road space

✜ demand for road space
✦a derived demand
✦ determinants of demand
✦ the price and income elasticities of demand

✜ supply of road space

✦ short run
 TRAFFIC CONGESTION AND
TRANSPORT POLICIES

■ The allocation of road space

✜ demand for road space
✦a derived demand
✦ determinants of demand
✦ the price and income elasticities of demand

✜ supply of road space

✦ short run
✦ long run
 TRAFFIC CONGESTION AND
TRANSPORT POLICIES

■ Social optimum level of road usage

✜ marginal social benefit
✜ marginal social cost
✦ congestion costs: time
Time taken to travel between two points along a given road
Time taken to travel between two points along a given road
Time taken to travel between two points along a given road
Time taken to travel between two points along a given road
 TRAFFIC CONGESTION AND
TRANSPORT POLICIES

■ Social optimum level of road usage

✜ marginal social benefit
✜ marginal social cost
✦ congestion costs: time
✦ congestion costs: monetary
 TRAFFIC CONGESTION AND
TRANSPORT POLICIES

■ Social optimum level of road usage

✜ marginal social benefit
✜ marginal social cost
✦ congestion costs: time
✦ congestion costs: monetary
✦ environmental costs
 TRAFFIC CONGESTION AND
TRANSPORT POLICIES

■ Social optimum level of road usage

✜ marginal social benefit
✜ marginal social cost
✦ congestion costs: time
✦ congestion costs: monetary
✦ environmental costs

✜ socially efficient level of road usage

Costs and benefits (£) Actual and optimum road usage

MSB

O
Cars per minute
Costs and benefits (£) Actual and optimum road usage

MC (private)

MSB

O
Cars per minute
Costs and benefits (£) Actual and optimum road usage

MC (private)

e
a

MSB

O Q1
Cars per minute
 Actual and optimum road usage
MSC
Costs and benefits (£)

MC (private)

b
e
a

MSB

O Q1
Cars per minute
 Actual and optimum road usage
MSC
Costs and benefits (£)

MC (private)

d Optimum
b charge
e
a c

MSB

O Q2 Q1
Cars per minute
 TRAFFIC CONGESTION AND
TRANSPORT POLICIES
■ Policy 1: direct provision
✜ the road solution
✜ public transport
■ Policy 2: regulation and legislation
✜ restricting car access
✦ bus and cycle lanes
✦ no entry to side streets
✦ pedestrian-only areas
✜ parking restrictions
 TRAFFIC CONGESTION AND
TRANSPORT POLICIES

■ Policy 3: changing market signals

✜ extending existing taxes
✜ road pricing
✦ variable tolls
✦ supplementary licences
✦ electronic road pricing

✜ subsidising alternative means of transport

 Applied Microeconomics

Competition Policy
 COMPETITION POLICY

■ Competition, monopoly and the public

interest
■ The targets of policy
✜ abuse of monopoly power
Equilibrium of industry under perfect competition and
monopoly: with the same MC curve
£ MC

Monopoly
P1

AR = D

MR
O Q1 Q
Equilibrium of industry under perfect competition and
monopoly: with the same MC curve
£ MC ( = supply under
perfect competition)

Comparison with
P1 Perfect competition

P2

AR = D

MR
O Q1 Q2 Q
Equilibrium of industry under perfect competition and
monopoly: with different MC curves
£

MCmonopoly

P1

AR = D

MR
O Q1 Q
Equilibrium of industry under perfect competition and
monopoly: with different MC curves
£ MC ( = supply)perfect competition

MCmonopoly

P2
ACmonopoly
P1
x
P3
P4

AR = D

MR
O Q2 Q1 Q3 Q4 Q
 COMPETITION POLICY

■ Competition, monopoly and the public

interest
■ The targets of policy
✜ abuse of monopoly power
✜ mergers
 COMPETITION POLICY

■ Competition, monopoly and the public

interest
■ The targets of policy
✜ abuse of monopoly power
✜ mergers
✜ oligopolistic collusion: restrictive practices
 COMPETITION POLICY

■ EU legislation

✜ Article 81: restrictive practices

✜ Article 82: monopolies and mergers

✜ merger control measures

✜ assessing EU policy
 COMPETITION POLICY

■ UK competition policy
✜ the OFT and the Competition Commission
✜ restrictive practices policy
✦ Chapter 1 prohibition
✦ types of anti-competitive behaviour
✦ powers of the OFT
✜ monopoly policy
✦ Chapter 2 prohibition
✦ market-share criterion
✦ market contestability
✦ anti-competitive practices
 COMPETITION POLICY

■ UK competition policy (cont.)

✜ merger policy
✦ role of OFT and Competition Commission
✦ criteria for judgement
✜ features of the 2002 Enterprise Act
UK competition legislation
 COMPETITION POLICY

■ Assessment of competition policy

✜ focus on behaviour rather than market
structure

✜ prohibition of certain practices

✜ tougher powers to identify secret collusion

Applied Microeconomics

Privatisation
 PRIVATISATION

■ Nationalisation and privatisation

✜ history of nationalisation
✜ forms and history of privatisation
Nationalisation and privatisation in the UK
Nationalisation and privatisation in the UK
Nationalisation and privatisation in the UK
 PRIVATISATION

■ Arguments for privatisation

✜ market forces
✦ greater competition in the goods market
✦ greater competition for finance
✦ accountability to shareholders

✜ reduced government interference

✜ reducing the PSNCR
✜ increased share ownership
 PRIVATISATION
■ Arguments against privatisation
✜ natural monopolies
 Profit-maximising natural monopoly
£

LRAC

Q
 Profit-maximising natural monopoly
£

LRAC
LRMC

Q
 Profit-maximising natural monopoly
£

LRAC
LRMC
D

Q
 Profit-maximising natural monopoly
£

LRAC
LRMC
D

MR Q
 Profit-maximising natural monopoly
£

Pm

LRAC
LRMC
D

Qm Q
MR
 Profit-maximising natural monopoly
£

Pm

LRACm

LRAC
LRMC
D

Qm Q
MR
 Profit-maximising natural monopoly
£

Pm

LRACm

LRAC
Pn
LRMC
D

Qm Qn
MR Q
 PRIVATISATION
■ Arguments against privatisation
✜ natural monopolies
✜ capital costs and entry barriers
 PRIVATISATION
■ Arguments against privatisation
✜ natural monopolies
✜ capital costs and entry barriers
✜ lack of co-ordination of industries
 PRIVATISATION
■ Arguments against privatisation
✜ natural monopolies
✜ capital costs and entry barriers
✜ lack of co-ordination of industries
✜ externalities
 PRIVATISATION
■ Arguments against privatisation
✜ natural monopolies
✜ capital costs and entry barriers
✜ lack of co-ordination of industries
✜ externalities
✜ fairness and social justice
 PRIVATISATION
■ Arguments against privatisation
✜ natural monopolies
✜ capital costs and entry barriers
✜ lack of co-ordination of industries
✜ externalities
✜ fairness and social justice
✜ problems with the PSNCR
 PRIVATISATION
■ Arguments against privatisation
✜ natural monopolies
✜ capital costs and entry barriers
✜ lack of co-ordination of industries
✜ externalities
✜ fairness and social justice
✜ problems with the PSNCR
■ Ownership and the public interest
Applied Microeconomics

Regulation
 REGULATION
■ Identifying short-run optimum price
and output
✜ industry has monopoly power
✦ the first-best situation
✦ second-best pricing rules
✜ industry produces externalities
✜ questions of fairness
■ Identifying long-run optimum price and
output
Short-run and long-run marginal cost pricing
£

MSC

PS

D = AR

O QS Q
Short-run and long-run marginal cost pricing
£

MSC

PS

PL LRMSC

D = AR

O QS QL Q
 REGULATION
■ Regulation in practice: RPI – X formula
■ Advantages of UK regulation
✜ discretionary; flexible
✜ incentives

■ Disadvantages of UK regulation
✜ disincentives of changes to X
✜ excessive power of regulator?
✜ playing ‘games’ with industry
✜ alternatively, regulatory capture
✜ complexity of regulation
 REGULATION
■ Increasing competition in the privatised
industries
✜ limited extent of true natural monopoly
✜ allowing competition where there is no
natural monopoly
✜ allowing access to grids by competitors
✜ forbidding suppliers from being grid owners
✜ capping market share of established firms
✜ competitive franchising to make monopolies
contestable
 Applied Microeconomics

Privatisation in
Transition Economies
 PRIVATISATION IN TRANSITION
ECONOMIES
■ State ownership under communism
✜ the system of central planning
✜ problems of inconsistency
✜ inappropriate success indicators and
rewards
✜ results
■ Transition to a market economy
✜ forms of market liberalisation
✜ degree of transition achieved
 PRIVATISATION IN TRANSITION
ECONOMIES
■ Privatisation
✜ forms of privatisation
✜ insider and outsider privatisation
■ Requirements for successful
privatisation
✜ supportive environment
✜ price liberalisation
✜ restructuring of firms
✜ corporate governance