Market Failure Common Access Resources IB Economics

What is a common access resource?  Alternative names – Common pool resources or common property resources  Typically natural resources e.g. fishing grounds, forests, pastures, and manmade systems for managing natural resources such as irrigation systems  The market failure is the overuse or over consumption leading to depletion of the resource  Because there is no price there are no market signals  This is called tragedy of the commons Watch this video that explains the tragedy of the commons watch?v=MLirNeu-A8I

Tragedy of the commons  Another example:  There are fishing grounds near to a village  The villagers have open access to them  Individuals will take as many fish as they can  Each fish give the individual marginal utility (the extra satisfaction that a person gets by consuming one more unit of a good or service)  If the fishing harms the stock of fish the damage is shared by the entire group including future generations  The benefits to the individual (MPB) outweighs the external cost (EC) and gives the individual the incentive to keep using the resource  Market failure takes place due to overconsumption

Sustainability  This concept of tragedy of the commons is closely linked to sustainability  Sustainability exists where the consumption needs of the present generation are met without reducing the ability to meet the needs of future generations  In the case of the fishing example the resources are not being protected for future generations – consumption is not sustainable  The lack of price means that over consumption will eventually lead to the resource running out  If the resource is degraded enough it will not be available for future generations

Solution to Tragedy of the Commons?  Traditional thinking had been that in order for resources to be sustainable it was necessary for them to be managed by governments or private companies  Elinor Ostrom (awarded the Nobel Memorial Prize for Economics in 2009) proposed that the resources could be managed by the people that own them if certain factors were in place:  Resources had clear boundaries  There must be a real threat of depletion and be no available substitutes  Stable community with democratically agreed rules for use  Incentives for appropriate use and punishments for overuse  It may be possible with national resources but international/global resources need international negotiation and solutions which are very difficult to achieve

Further threats to sustainability  High levels of poverty and the pursuit of economic growth result in environmental problems such as over- exploitation of land, soil erosion, land degradation and deforestation  For developing countries this can make poverty and standards of living worse  Take the example of deforestation  Low income people in rural areas may depend on wood as their only source of fuel and therefore use the common source  When the trees are cut down  The households travel further to acquire wood  Those travelling waste time otherwise used to earn income  This may keep households in the vicious poverty cycle  There will be 3 rd party costs due to soil erosion and land degradation perhaps leading to landslides and flooding  We can use a negative externality of consumption drawing to illustrate this Quantity of Trees Price of Trees

Further threats to sustainability  We can look at this example from another perspective  If a company privately owns the forested land in a developing country with lenient government regulation  The goal of the company will be to profit maximize  As a self interest economic agent they only take into consideration their private costs  They do not think of the external costs such as loss of bio diversity, flooding and soil erosion  There will be overproduction and underpricing of the wood products  This can be illustrated using a negative externality of production diagram Quantity of Trees Price of Trees

Use of Fossil Fuels (another source of sustainability)  When fossil fuels are burned greenhouse gases are emitted which heat up the earth’s atmosphere creating climate change  The cost of climate change is a massive external cost  The producers and consumers of fossil fuels are not made accountable for the external costs to future generations  Fossil fuels are therefore both over produced and over consumed and represent a significant market failure

Government responses to threats to sustainability  Cap and trade (watch this video)watch this video  Clean technology  Subsidize production renewable energy  Without a subsidy a wind farm will make Q1 electricity  The subsidy lowers the cost of production shifting the supply curve to S1+subsidy leading to a higher quantity of power Q2  The additional revenue (both blue areas) are an incentive to make more  This will act as a substitute to fossil fuels leading to less fossil fuel consumption/production  The problem is that the subsidy is tax payer money and an opportunity cost  This should only be short term  In addition, these wind farms are not voter friendly

Evaluating Market Failure  When you are evaluating market failure policies use EEES  Is the policy Efficient?  Does the policy reduce the welfare loss or the potential welfare gain (does the triangle reduce in size)?  The extent to which it is efficient will probably depend on how effective the policy is.  Is the policy Effective?  Does the policy actually work?  For example the demand may be so inelastic that a change in price may have very little effect like with smoking or alcohol  There might be black markets as a result of the policy  Firms might move to other countries with less regulation as a result of the policy  Is the policy Equitable?  Is the policy fair to every one?  For example a tax on smokers punishes lower income smokers more than higher income smokers  Is the policy Sustainable?  Does the policy protect resources for future generations?  If it does all or most of these then you can probably make a judgement that it a good policy You will need to use this system when you are writing your market failure IA

Student Research  Do some research on your example of tragedy of the commons  Create a presentation that includes  The problem (including a market failure diagram with analysis and explanation of why this is a tragedy of the commons)  The main solution  Evaluation of the solution (using EEES)  Try to make this as colourful as possible and include videos if you can  Overfishing in Europe – Michel  Unregulated logging – Noor  Global Warming – Yasmin  Water Pollution – Nida  Fly tipping – Sheran  To be finished by the 2 nd half of next lesson