Lecture 4

Property Rights, Externalities, and Natural Resource Problems

Byeong-Hak Choe
bchoe@geneseo.edu

SUNY Geneseo

September 4, 2024

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

Externalities as a Source of Market Failure

Steel Mill and Hotel Resort by a River

  • If these two facilities have different owners, an efficient use of the water is not likely to result.
    • Why?

Externalities as a Source of Market Failure

Steel Mill and Hotel Resort by a River

  • Because the steel plant does not bear the cost of reduced business at the resort resulting from waste being dumped into the river, it does not consider that cost.

  • Externalities exist whenever the welfare of some agent, typically firm or household, depends not only on his or her activities, but also on activities under the control of some other agent.

Externalities as a Source of Market Failure

Steel Mill and Hotel Resort by a River

  • Steel production produces pollution as well as steel.

  • \(MC_{p}\): the private marginal cost of producing the steel.

  • \(MC_{s}\): the social marginal cost

    • Because society considers both the cost of pollution and the cost of producing the steel, \(MC_{s}\) includes both.

Externalities as a Source of Market Failure

Steel Mill and Hotel Resort by a River

  • How much would the steel mill produce in the competitive market?

  • How much level of steel production is desirable to the society?

  • If \(Q^{*} \neq Q_{m}\), what would be the loss in net benefits to the society?

Externalities as a Source of Market Failure

Steel Mill and Hotel Resort by a River

  • The output of the commodity is too large.
  • Too much pollution is produced.
  • The prices of products responsible for pollution are too low.
  • As long as the costs are external, no incentives to search for ways to yield less pollution per unit of output are introduced by the market.
  • Recycling and reuse of the polluting substances are discouraged due to the cheap external cost.

Externalities as a Source of Market Failure

Classwork

Let’s do classwork for Externalities.

Externalities as a Source of Market Failure

Types of Externalities

  • External cost (external diseconomy; negative externalities)
    • Imposes costs on a third party.
  • External benefit (external economy; positive externalities)
    • Imposes benefits on a third party.