Property rights, externalities, and environmental problems Chapter 4

property rights bundle of entitlements defining owner’s rights, privileges, limitations for using the resource how do environmental problems arise from different property rights structures note: capitalism / pursuit of profits is not the source of all environmental problems

efficient property right structures exclusivity all benefits and costs accrue to owner transferability voluntary exchange enforceability secure from involuntary seizure

consumer’s choice

producer’s choice

market equilibrium in a system of well-defined property rights, consumers and producers act in own self interest, resulting in an efficient outcome (invisible hand)

externalities as market failure exclusivity is chief characteristic in efficient property rights structure: often violated agent sometimes does not bear all of the consequences of action 2 firms located by a river steel (waste) resort hotel (recreation) externality: welfare of agent depends not only on own activities but activities under other’s control

the market for steel

if no outside regulation, can expect 5 results output of steel too great too much pollution produced price of steel too low no incentives to search for ways to yield less pollution per unit steel recycling and reuse of polluting substances discouraged since release into river is so inefficiently cheap

types of externalities external diseconomy (affected is damaged) external economy (affected is benefited) pecuniary externality external effect transmitted through higher prices new firm moves into area and drives up rental price of land: negative effect on those paying rent in the area but no market failure because higher rents are reflecting scarcity of land

incentives and property rights what else besides private property? state property (govt owned) common property (joint ownership) res nullius / open-access (no ownership) all create different incentives for resource use

state ownership former communist countries parks and forests efficiency depends on incentives of bureaucrats

common property managed commonly rather than privately grazing rights / fishing rights entitlements may be formal or informal (tradition / custom) unsuccessful management more common than successful Elinor Ostrom, Governing the Commons 1990

res nullius / open-access fishing / grazing rights / whales vs. chickens tragedy of the commons common-pool resources nonexclusivity (exploited by anyone) divisibility / rival (your use diminishes my use)

bison harvesting TB = constant price x growth AB, MB = downward sloping because with more effort, smaller population size Efficiency is MB = MC (Q1) But no individual hunter has incentive to restrain themselves, compare their AB to MC/AC (do not say if I try harder this will make it harder for everybody else so marginal benefit will go down). Just compare their benefit and cost of hunting. (Q2) => too much effort!

two characteristics of open-access resource will be overexploited profit (scarcity rent) will be dissipated unlimited access destroys incentive to conserve

public goods as market failure nonexcludable (even if do not pay cannot be excluded from enjoying it) indivisible / nonrival (my enjoyment does not lessen your enjoyment) national defense / air / information / diversity free-rider problem

person a’s contribution to diversity

person b’s contribution to diversity

market demand for diversity: sum it vertically!

efficient provision of public goods

free-rider problem inefficiency results because each person able to free-ride on another’s contribution due to indivisibility and nonexcludability, consumers reap the benefits of any diversity purchased by others diminishes incentives to contribute if contributions are not large enough to finance public good, it will be undersupplied this is why we see gov’t control of many PG’s (compel you to pay through taxation)

information revelation problems efficient allocation requires charging different prices for each consumer but how does government / producer know how much individuals willing to pay? consumers do not reveal strength of their preference for the good hard to know what to charge

imperfect market structures monopolies / oligopolies big player in environmental problems oil-exporting countries and cartels cartel: restrict production / increase prices allows group to act as monopolist

monopoly and inefficiency Efficient: OB, charge price OG, net benefits HIC Equilibrium: OA, charge price OF Producers lose JDC (pure loss) but gain FEJG Consumers lose FECJG (FEJG transfer to producer, but EJC pure loss) Total society loss: EDC (dead weight loss)

government failure rent-seeking: use of resources in lobbying and other activities directed at securing protective legislation fossil fuel subsidies increases net benefits to special interest group, but may lower benefits to society voter ignorance: economically rational to remain ignorant high cost of information low probability of single decisive vote

how to correct these failures (property rights / market / govt)? bargaining (private negotiation or courts) regulation (price/ tax or quantity/ limits)

private resolution through negotiation resort could bribe steel company resort could offer to pay amount equal to damages it would otherwise incur for every level of output the steel company would reduce what level of output would steel company choose?

again, the market for steel

resort bribes the steel maker resort offers CD if produce at Q* if refuse, steel producer surplus is ABD if accept, steel producer surplus is AB, but also get value of bribe (CD), so total is ABCD better off by C if accept bribe

the courts: property and liability rules who should start negotiation? what if steel company refuses bribe? court system can respond to environmental conflicts by imposing property / liability rules specify who gets what and rules does it matter who gets what?

Coase Theorem Ronald Coase (1960) argued: as long as negotiation costs are negligible and parties can negotiate freely, court can allocate entitlement to either party and an efficient allocation will result

steel vs. resort if steel company has right, in resort’s interest to bribe if resort has property right, steel company should bribe resort for right to pollute either way, Q* would be chosen

rancher & farmer Cattle occasionally leave pasture for farmer’s property, damaging his crops If rancher ↑ herd by 1 unit, receives profits of $3, but farmer suffers loss $10 Will rancher pursue private benefit and add the cow?

rancher & farmer cont. No! The rancher and the farmer will negotiate, because an agreement will make them both better off Farmer WTP rancher < 10 to forgo adding cow Rancher WTA > 3 to forgo adding cow Clearly, room for agreement

practical flaws with Coase thm incentives for polluting if steel company has property right, when other firms see them receiving bribes might be encouraged to increase pollution to earn bribes negotiation difficult if many parties involved high transaction costs (court time, lawyers fees,…)

Pigouvian taxes Use taxes to correct divergence between MPC and MSC Set Pigouvian tax = divergence (measured at Q*) – this raises firm’s private costs, forcing MPC=MSC “Internalizing the externality”

the market for steel