EEP 101/Econ 125 lecture 7 Property rights David Zilberman

Outline Property rights and the Coase Theorem Property rights and the Coase Theorem The economics of clean up and restoration The economics of clean up and restoration Limited information Limited information Political economy models Political economy models Capture Capture Rent seeking Rent seeking

Property right and the environment Property right define entitlement that can not eb taken away Property right define entitlement that can not eb taken away Polluter may have rights to pollute- Polluter may have rights to pollute- precedent establishes right in many cases precedent establishes right in many cases A chemical plant got the right to pollute when a plant is established A chemical plant got the right to pollute when a plant is established Victims( pollutees) may have rights for protection from pollutions Victims( pollutees) may have rights for protection from pollutions Downstream users have rights to clean water Downstream users have rights to clean water

The Coase theorem Assumptions Assumptions property rights are clear and enfrocable property rights are clear and enfrocable Full information Full information Zero transaction costs Zero transaction costs Then Then No need for intervention in cases of externalities No need for intervention in cases of externalities Pareto optimality Pareto optimality Regardless of initial distribution of rights Regardless of initial distribution of rights

Negotiations and the Coase outcomes Clear property rights lead to Pareto efficient outcomes Clear property rights lead to Pareto efficient outcomes The exact distribution of surplus gain depend on negotiation The exact distribution of surplus gain depend on negotiation We assumed the parties are splitting the benefits We assumed the parties are splitting the benefits In case of polluter rights the pollutee pay the polluters not to pollute In case of polluter rights the pollutee pay the polluters not to pollute In case of pollutee rights the polluter pays the pollution to pollute In case of pollutee rights the polluter pays the pollution to pollute

Initial outcome B Pollutee pays CEBD,gains CEF Final outcome C Polluter gains BCE Social gains FCB Polluter marginal benefits Marginal pollutee benefits Pollution $$ Gain to polluters B A C D F E D CASE OF POLLUTER RIGHTS

Initial outcome A Polluter pays GCDA,gains DCG Final outcome C Polluter gains GCA Social gain DCA Polluter marginal benefits Marginal pollutee benefits Pollution $$ Gain to polluters B A C D F E D CASE OF POLLUTEE RIGHTS G

Implications and limitations of Coase theorem A functioning legal system is key for environmental policy A functioning legal system is key for environmental policy Externalities-caused by Externalities-caused by Missing markets Missing markets Undefined property rights Undefined property rights Market failure Market failure The Coase theorem works when The Coase theorem works when Small number of actor-low transaction costs Small number of actor-low transaction costs It does not work when there are many parties and negotiation and collaboration are costly It does not work when there are many parties and negotiation and collaboration are costly

Liability rules Allow violation of property rights but imposes penalties Allow violation of property rights but imposes penalties Polluter has to pay damages for accidental water contamination.Has to pay a penalty for intentional Polluter has to pay damages for accidental water contamination.Has to pay a penalty for intentional Pollution tax is a liability payment Pollution tax is a liability payment Negligence Rules: Penalize individuals for not exercising sufficient care in action. Due care standards-set basis for liability A farmer may not be liable for run off damages if she performed due care. Part of policy is establishing these standards

Full Restoration May Be Suboptimal PricePrice Quantity MB of Restoration MC of Restoration Q* Q* = Full Restoration = Optimal Restoration

Waste management Liability may be retroactive- New owners are liable for pollution of old ones. Liability may be retroactive- New owners are liable for pollution of old ones. It leads to care in purchases of new properties and prevent people from polluting and selling It leads to care in purchases of new properties and prevent people from polluting and selling In cases of ex Soviet Union may prevent development-many sites are worth to buyer less than clean up cost- In cases of ex Soviet Union may prevent development-many sites are worth to buyer less than clean up cost- Government may pay if public gain from clean up and development is greater than private gain Government may pay if public gain from clean up and development is greater than private gain

Point vs. non point source pollution When pollution can be assigned to pollution we have polluters we have source point When pollution can be assigned to pollution we have polluters we have source point Example-when each smoke stack is monitored Example-when each smoke stack is monitored When individual pollution can not be assigned we have non point source When individual pollution can not be assigned we have non point source Pollution at point source can be taxed Pollution at point source can be taxed In case of non point pollution of individuals can not be observed- other action related to pollution can be regulated or taxed In case of non point pollution of individuals can not be observed- other action related to pollution can be regulated or taxed

Contamination by firms-point vs non point Suppose that there are N firms, each firm is index by n who assume values from 1 to N Suppose that there are N firms, each firm is index by n who assume values from 1 to N Pollution of the nth farmer is Z n.It is produced by the input of this farmer X n.This input is generating output Y n. Pollution of the nth farmer is Z n.It is produced by the input of this farmer X n.This input is generating output Y n. The production function of the nth producer is Y n =F n (X n ). The pollution function of the nth producer is Z n =Gn(X n ) The production function of the nth producer is Y n =F n (X n ). The pollution function of the nth producer is Z n =Gn(X n ) Suppose output price is P, input price is W and pollution damage per unit is V. Suppose output price is P, input price is W and pollution damage per unit is V.

Case of point source If the policy maker can observe Zn, he will charge the nth firm VZ. It will lead to optimal outcome. If the policy maker can observe Zn, he will charge the nth firm VZ. It will lead to optimal outcome. The optimal choice of the firm will be The optimal choice of the firm will be The optimality is The optimality is At optimal outcome At optimal outcome value of marginal benefit of production is equal to value of marginal benefit of production is equal to input price plus input price plus marginal pollution damage cost marginal pollution damage cost

Example If If Optimality condition Optimality condition Implying Implying If If A tax of $2 will lead to optimality if Z n is observable. A tax of $2 will lead to optimality if Z n is observable. If Zn is not observables but X n is a tax on input 2V c n Xn.It will also be optimal.In our case the input tax is $12. If Zn is not observables but X n is a tax on input 2V c n Xn.It will also be optimal.In our case the input tax is $12.

Heterogeneity Suppose all firms have the same production function, but vary pollution function. Suppose all firms have the same production function, but vary pollution function. 50% have c n= 1and the other 50% have c n= 0 50% have c n= 1and the other 50% have c n= 0 If the policy maker observes Zn If the policy maker observes Zn Firms with c n= 1 pay tax of $2 per unit of pollution and produce 3 units making Firms with c n= 1 pay tax of $2 per unit of pollution and produce 3 units making The clean firms have X n =.5(20-2)=9 and make The clean firms have X n =.5(20-2)=9 and make Average income is $54 per firm Average income is $54 per firm

Non point source If only X n is not observable the policy maker will optimize average behavior If only X n is not observable the policy maker will optimize average behavior So the tax will be based $2 per unit of output resulting in output of Xn=.5(20-2)/(1+1)=6 So the tax will be based $2 per unit of output resulting in output of Xn=.5(20-2)/(1+1)=6 The profit per firm will be The profit per firm will be The social welfare will be $72 for clean firms and 0 for dirty ones. Since the cost fo their pollution is 2*36. The social welfare will be $72 for clean firms and 0 for dirty ones. Since the cost fo their pollution is 2*36. Average welfare is $ 36 per firm Average welfare is $ 36 per firm Information will generate welfare gain of $9 per firm. Information will generate welfare gain of $9 per firm.

The Gain From Information MB MEC H MEC L Avg. MEC High Tax Avg. Tax Low Tax A C E B D The area ABC is loss of pollution generated by dirty firms. The area CDE is loss of insufficient pollution by cleaner firms.

Investment in Monitoring Monitoring of pollution allows discrimination among polluters and non-polluters and increases welfare. Monitoring of pollution allows discrimination among polluters and non-polluters and increases welfare. If monitoring cost is greater than the gain from information, do not invest. If monitoring cost is greater than the gain from information, do not invest. Government can induce monitoring by assuming that everyone is a heavy polluter and is being taxed accordingly. Refunds will be issued to firms that prove to be clean. Government can induce monitoring by assuming that everyone is a heavy polluter and is being taxed accordingly. Refunds will be issued to firms that prove to be clean. This leads to an industry of monitoring and environmental auditors. This leads to an industry of monitoring and environmental auditors.