1. Externalities and Market Failure Lets just rely on the free market to solve environmental problems…right?

2. Setup & Motivation What makes an environmental issue an environmental problem? – When one partys actions affect another party without compensation. Think of the physical stuff that makes up the environment as goods and bads – Goods: clean air, fuzzy critters, safe water – Bads: NOx, CO2, oil slicks, harm to species A large part of economics is to classify and design/inform regulation of goods and bads. – Characteristics of goods/bads drives policy design

3. 3 Characteristics of goods -- I Excludability: A good/bad is excludable if it is feasible and practical to selectively allow consumption of the good – Examples (excludable?) Harvest of a particular fish Hamburger Air pollution in LA

4. 4 Characteristics of goods -- II Rivalry: A good/bad is rival if one persons consumption reduces amount available to others (holding supply fixed) – Examples (rival?) A particular fish Hamburger Space on an uncongested freeway A nonrival good can be simultaneously consumed by many people Nonrival goods can become congested

5. 5 Characteristics of goods -- III Externalities: An externality exists when one person or firm controls something I consume or that affects my consumption (or well-being) – Smoke – Snowmobiling in Yellowstone – Biodiversity loss

6. 6 Importance of rivalry and excludability Excludability – necessary for price system to be used…why? Rivalry – necessary for efficiency of price system….why?

7. 7 Importance of rivalry and excludability Excludability – necessary for price system to be used…why? – If cannot exclude, nobody will pay Rivalry – necessary for efficiency of price system….why? – If non-rival, people will free-ride

8. 8 A taxonomy

9. 9 Examples

10. 10 Examples Markets work fine

11. 11 Examples Markets work but poorly

12. 12 Examples Markets dont work

13. 13 More examples Rival? Excludable? – Prairie before invention of barbed wire – Litter before anti-littering laws – Municipal garbage – Fisheries subject to ITQs An important finding: – Excludability can be changed with technology – Rivalry a fundamental characteristic

14. 14 Why important? Important for diagnosing problems – If we can rely on markets, it is much easier – If we know the market cannot work, we should expect things to need fixing Important for fixing problems – If we can use technology to make an open access resource excludable, we know we can fix