Lecture 6

Property Rights, Externalities, and Natural Resource Problems

Byeong-Hak Choe
bchoe@geneseo.edu

SUNY Geneseo

September 9, 2024

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

Externalities as a Source of Market Failure

Public Goods

  • Public goods are goods enjoyed in common (e.g. the warning service provided by a lighthouse)

  • One key characteristic of public goods is that they are non-excludable

    • A good is excludable if the provider of the good can prevent people who have not paid for it from using or consuming it.

  • The other key characteristic of public goods is that they are non-rivalrous

    • A good is rivalrous if its consumption by one individual reduces its availability for consumption by others.

Externalities as a Source of Market Failure

Public Goods

  • The top two graphs show individual demand for preserving biodiversity among two people, \(A\) and \(B\).

  • The market demand curve is represented by the vertical summation of the two individual demand curves.

    • If everyone can simultaneously consume the same level of biological diversity, market demand is the vertical sum, not the horizontal sum, of individual demand curves.

  • The allocation that maximizes economic surplus is \(Q^{*}\), the allocation where the demand curve crosses the MC curve.

Externalities as a Source of Market Failure

Public Goods

  • The two consumers have very different marginal willingness to pay from the efficient allocation of this good (\(OA\) versus \(OB\)).

    • An efficient pricing system would require charging a different price to each consumer.

  • In the absence of excludability, all consumers have an incentive to understate the strength of their preferences to try to shift more of the cost burden to the other consumers.

  • Therefore, inefficiency results because each person can become a free rider on the other’s contribution.

Externalities as a Source of Market Failure

Public Goods

  • Because biodiversity is non-rival in consumption and non-excludable, consumers receive the value of any biodiversity purchased by other people.

  • These properties of the public good diminishes incentives to contribute, so the public good will be under-supplied.

  • The privately supplied amount may not be zero, because some diversity is likely to be privately supplied.

    • Relying solely on the private provision of public goods result in the preservation of a smaller-than-efficient amount of biological diversity.

Imperfect Market Structure

Asymmetric Information

  • A situation where one or more parties have more information than the others.

  • Asymmetric information creates problems for the market when it results in a decision-maker knowing too little to make an efficient choice.

Imperfect Market Structure

Asymmetric Information

  • Example: Consumer preference for organic food
  • Problem: Difficulty in distinguishing genuine organic produce
  • Causes:
    • Easy for producers to falsely claim organic status
    • Consumers lack accurate information
  • Consequences:
    • Consumers unwilling to pay premium for “organic” produce
    • Reduced profits for genuine organic farmers
    • Inefficiently low output of organic produce

Imperfect Market Structure

Government Failure

  • Government failure, like market failure, can lead to inefficient outcomes in environmental resource allocation

  • Root cause: improper incentives in political processes

  • Rent seeking: special interest groups use lobbying to secure favorable legislation

  • Rent seeking often increases benefits for the group but lowers overall societal surplus

  • Reasons why losers don’t protect their interests:

    • Voter ignorance (rational due to high information costs and low impact of single vote)
    • Difficulty in organizing diffuse groups with small individual impacts
    • Free-rider problem in opposing special interests

Imperfect Market Structure

Government Failure

  • Forms of rent seeking:
    • Seeking tariffs or price floors
    • Pursuing regulations that disproportionately affect competitors
    • Obtaining subsidies to transfer costs to taxpayers
  • Other sources of inefficient policy:
    • Government acting without full information
      • E.g., US EPA required the addition of a chemical substance to gasoline to promote cleaner combustion. However, this resulted in unintended water pollution.

Imperfect Market Structure

Government Failure

  • Key takeaway:
    • Blind faith in one institution or another is no substitute for rational choices that take the specific context into consideration
  • Environmental problems arise from divergence between individual and collective objectives
  • Solution:
    • Re-align individual incentives with collective objectives