1. Property rights, externalities, and environmental problems
Chapter 4

2. 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

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

4. consumer’s choice

5. producer’s choice

6. 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)

7. 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

8. the market for steel

9. 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

10. 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

11. 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

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

13. 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

14. 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)

15. 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!

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

17. 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

18. person a’s contribution to diversity

19. person b’s contribution to diversity

20. market demand for diversity: sum it vertically!

21. efficient provision of public goods

22. 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)

23. 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

24. 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

25. 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)

26. 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

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

28. 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?

29. again, the market for steel

30. 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

31. 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?

32. 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

33. 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

34. 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?

35. 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

36. 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,…)

37. 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”

38. the market for steel