Lecture 3

Property Rights, Externalities, and Natural Resource Problems

Byeong-Hak Choe
bchoe@geneseo.edu

SUNY Geneseo

August 28, 2024

The Economic Approach: Property Rights, Externalities, and Natural Resource Problems

Introduction

  • This chapter introduces the general conceptual framework used in economics to approach environmental problems.
    • Static Efficiency
    • Economic Surplus, Consumer Surplus, Producer Surplus
    • Property Rights
    • Scarcity Rents
    • Externalities
    • Public Goods

The Economic Approach

  • Positive Economics: Describing what is, what was and what will be.

  • Normative Economics: Attempting to answer what ought to be.

  • While these two types of analysis are conceptually distinct, they often inform each other.

The Economic Approach

Economic Impacts of Reducing Hazardous Pollutant Emissions from Iron and Steel Foundries

  • The U.S. Environmental Protection Agency (EPA) developed a “control technology standard” to reduce hazardous air pollutant emissions from iron and steel foundries.

  • How large would the impacts of the standard on production cost at affected facilities?

The Economic Approach

Economic Impacts of Reducing Hazardous Pollutant Emissions from Iron and Steel Foundries

  • The rule would increase production costs by $21.73 million annually for existing sources.

  • The analysis projected small price increases: 0.1% for iron castings and 0.05% for steel castings.

  • Iron foundries using cupola furnaces and consumers of iron foundry products would experience the primary impact.

  • The analysis showed the impacts were below the $100 million threshold, avoiding the need for an extensive review by the Office of Management and Budget.

  • The findings helped reduce opposition by demonstrating the minimal expected economic impacts.

Economic Efficiency

Static Efficiency

\[ \text{(Economic Surplus)} \,=\, \text{(Consumer Surplus)} \,+\, \text{(Producer Surplus)} \]

  • An allocation of resources satisfies the static efficiency criterion if the economic surplus derived from those resources is maximized by that allocation.

Economic Efficiency

Consumer Surplus (CS)

  • CS is the value that consumers receive from an allocation minus what it costs them.

  • CS is measured as the area under the demand curve minus the consumer’s cost.

    • Why?

Economic Efficiency

Producer Surplus (PS)

  • PS is the difference between the amount that a seller receives minus what the seller would be willing to accept for the good

  • PS is the area under the price line that lies above the supply curve.

    • Why?

Economic Efficiency

Review on MC/MB curves

  • In a perfectly competitive market, a marginal benefit (\(MB\)) curve is essentially synonymous with a demand curve.
    • Each point on the demand curve represents the maximum price a consumer is willing to pay for a specific quantity of the good.
    • This willingness to pay is directly related to the \(MB\) of the next unit of the good.
    • Consumers are willing to buy an additional unit of a good only if the \(MB\) of that unit is greater than or equal to its price.
    • The \(MB\) curve shows how many units consumers are willing to purchase at each price, which is the demand curve.
  • In a perfectly competitive market, a firm’s marginal cost (\(MC\)) curve can be thought of as its supply curve:
    • \(MC\) is a cost of producing one more unit of a good.
    • Firms aim to maximize profit by producing where \(MC\) equals marginal revenue (\(MR\)).
    • The market price (\(P\)) that a firm can charge for its product is determined by the market and is equal to its \(MR\).
    • Therefore, the firms produce the quantity where \(MC\) equals \(P\).
      • The \(MC\) curve directly determines how much the firms will supply at any given price.

Property Rights

Property Rights and Efficient Market Allocations

  • Property rights refers to a bundle of entitlements defining the owner’s rights, privileges, and limitations for use of the resource.
    • Can be vested in individuals, firms, or the state.
    • Understanding property rights allows us to better understand how natural resource problems arise from government and market allocations.

Property Rights

Efficient Property Right Structures

  • Exclusivity: All the benefits and costs should only accrue to the owner.

  • Transferability: Property rights should be transferred to others.

  • Enforceability: Property rights should be secure from seizure or encroachment.

Property Rights

Efficient Property Right Structures

  • In a system with well-defined property rights and competitive markets in which to sell those rights, the actions of self-interested individuals will result in an efficient equilibrium.

Property Rights

Water Rights in Agriculture

  • Consider a region where water is a scarce natural resource, and there are well-defined property rights for water usage, particularly among farmers in agricultural production.
  • In this region, a competitive market exists where these water rights can be bought and sold.

Property Rights

Water Rights in Agriculture

  • Farmers hold water rights and aim to maximize their surplus by using water efficiently to grow crops that yield the highest profit.
  • If a particular farmer finds that selling a portion of their water rights in the market would yield a higher return than using that water for low-value crops, they may choose to sell.
  • Other farmers or industries in the region, needing water for higher-value crops or more profitable uses, are willing to buy water rights.
  • They seek to maximize their surplus by obtaining water that enables them to produce more efficiently or profitably.
  • The price of water rights reflects the supply and demand for water.
  • As self-interested farmers sell or buy water rights based on their own profit-maximizing decisions, water is allocated to its most valuable use.

Property Rights

PS, Scarcity Rent, and Long-Run Competitive Equilibrium

  • In the short-run, \[ \overbrace{PS}^{\text{Producer}\\\,\text{ Surplus}} \,=\, \overbrace{\Pi}^{\text{Profits}} + \overbrace{FC}^{\text{Fixed}\\\,\text{Cost}} \]

  • This is because: \[ \begin{align} \overbrace{\Pi}^{\text{Profits}} &\,=\, \overbrace{TR}^{\text{Total Revenue}} \,–\, \overbrace{VC}^{\text{Variable}\\\;\;\text{Cost}} \,–\, \overbrace{FC}^{\text{Fixed}\\\,\text{Cost}}\\ \quad\\ \underbrace{PS}_{\text{Producer}\\\,\text{ Surplus}} &\,=\, \underbrace{TR}_{\text{Total Revenue}} \,–\, \underbrace{VC}_{\text{Variable}\\\;\;\text{Cost}} \end{align} \]

  • Thus, \(PS \,=\, \Pi + FC\) in the short-run.

Property Rights

PS, Scarcity Rent, and Long-Run Competitive Equilibrium

  • In the long run, \[ \overbrace{PS}^{\text{Producer}\\\,\text{ Surplus}} \,=\, \overbrace{\Pi}^{\text{Profit}} \,+\, \text{(Rent)} \]

  • \(\text{Rent}\): return to scarce inputs owned by the producer.

  • Under perfect competition,

    • Long-run profits equal zero;
    • Any \(PS\) in natural resource industries in the long-run equals rent.

  • This \(PS\) in long-run equilibrium is called scarcity rent.

    • Cannot be eliminated by competition due to scarcity of natural resources.

Property Rights

Scarcity Rents in New England Fisheries

  • Data suggest that fishing off the New England coast would need be reduced by about 70% to eliminate overfishing and achieve an efficient harvest.

  • This would generate a scarcity rent of about $130 million.

  • If this were collected by the government, it would be sufficient to compensate those boats put out of business due to fishing restrictions.