©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 1 Chapter 25 “Externalities and Common...

1 ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e

Chapter 25Chapter 25“Externalities and Common “Externalities and Common

Property Resources”Property Resources”

Chapter 25Chapter 25“Externalities and Common “Externalities and Common

Property Resources”Property Resources”

ECONOMICS: ECONOMICS: EXPLORE & APPLYEXPLORE & APPLYby Ayers and Collingeby Ayers and Collinge

ECONOMICS: ECONOMICS: EXPLORE & APPLYEXPLORE & APPLYby Ayers and Collingeby Ayers and Collinge


Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

1.1. Identify examples of externalities and Identify examples of externalities and common property.common property.

2.2. Analyze the effects of externalities on Analyze the effects of externalities on efficiency.efficiency.

3.3. Explain why common property resources are Explain why common property resources are likely to be overused.likely to be overused.

4.4. Discuss the policy instruments that Discuss the policy instruments that government can use to promote a better government can use to promote a better environment and the policies to achieve it.environment and the policies to achieve it.

1.1. Identify examples of externalities and Identify examples of externalities and common property.common property.

2.2. Analyze the effects of externalities on Analyze the effects of externalities on efficiency.efficiency.

3.3. Explain why common property resources are Explain why common property resources are likely to be overused.likely to be overused.

4.4. Discuss the policy instruments that Discuss the policy instruments that government can use to promote a better government can use to promote a better environment and the policies to achieve it.environment and the policies to achieve it.


Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

5.5. Identify efficient amounts of pollution.Identify efficient amounts of pollution.

6.6. Discuss the issue of trans-border Discuss the issue of trans-border pollution and the difficulties in finding pollution and the difficulties in finding solutions.solutions.

5.5. Identify efficient amounts of pollution.Identify efficient amounts of pollution.

6.6. Discuss the issue of trans-border Discuss the issue of trans-border pollution and the difficulties in finding pollution and the difficulties in finding solutions.solutions.


25.125.1EXTERNALITIES AND COMMON EXTERNALITIES AND COMMON PROPERTY RESOURCESPROPERTY RESOURCES

25.125.1EXTERNALITIES AND COMMON EXTERNALITIES AND COMMON PROPERTY RESOURCESPROPERTY RESOURCES• Externalities,Externalities, arise when the production or arise when the production or

consumption of private goods leads to cost or consumption of private goods leads to cost or benefits to third parties, meaning people or benefits to third parties, meaning people or businesses who are not party to the transaction.businesses who are not party to the transaction.

• Market failure also occurs when the ownership Market failure also occurs when the ownership of property is shared, meaning that it is of property is shared, meaning that it is common property.common property.

• Shared ownership occurs most frequently in Shared ownership occurs most frequently in connection with natural resources, such as air connection with natural resources, such as air and water. and water.

• Externalities,Externalities, arise when the production or arise when the production or consumption of private goods leads to cost or consumption of private goods leads to cost or benefits to third parties, meaning people or benefits to third parties, meaning people or businesses who are not party to the transaction.businesses who are not party to the transaction.

• Market failure also occurs when the ownership Market failure also occurs when the ownership of property is shared, meaning that it is of property is shared, meaning that it is common property.common property.

• Shared ownership occurs most frequently in Shared ownership occurs most frequently in connection with natural resources, such as air connection with natural resources, such as air and water. and water.


Externalities – Externalities – When Should there Be Action?When Should there Be Action?


o Pollution is an example of a negative Pollution is an example of a negative externality.externality.

o Negative externalitiesNegative externalities impose external cost. impose external cost.o Positive externalitiesPositive externalities confer external benefits. confer external benefits.o Externalities occur when the Externalities occur when the private cost or private cost or

benefitsbenefits of an action, differ from the social cost of an action, differ from the social cost or benefits.or benefits.

o Social cost or benefitsSocial cost or benefits are defined to equal all are defined to equal all cost or benefits within the economy, including cost or benefits within the economy, including both private and external cost and benefits.both private and external cost and benefits.

o Pollution is an example of a negative Pollution is an example of a negative externality.externality.

o Negative externalitiesNegative externalities impose external cost. impose external cost.o Positive externalitiesPositive externalities confer external benefits. confer external benefits.o Externalities occur when the Externalities occur when the private cost or private cost or

benefitsbenefits of an action, differ from the social cost of an action, differ from the social cost or benefits.or benefits.

o Social cost or benefitsSocial cost or benefits are defined to equal all are defined to equal all cost or benefits within the economy, including cost or benefits within the economy, including both private and external cost and benefits.both private and external cost and benefits.




Social Cost = Private Cost + External CostSocial Cost = Private Cost + External Cost

Social Benefits = Private benefits + External benefitsSocial Benefits = Private benefits + External benefits

Marginal social cost = Marginal social cost = Marginal private cost + Marginal external costMarginal private cost + Marginal external cost

Marginal social benefit = Marginal social benefit = Marginal private benefit + Marginal external benefitMarginal private benefit + Marginal external benefit


It is externalities that occur at the margin – It is externalities that occur at the margin – marginal external cost and marginal external marginal external cost and marginal external benefitsbenefits - that are of most interest in economics, - that are of most interest in economics, because these externalities at the margin cause because these externalities at the margin cause market outcomes to differ from what is efficient.market outcomes to differ from what is efficient.

When marginal external benefits are present, the When marginal external benefits are present, the free market produces too little. Output falls short free market produces too little. Output falls short of the efficient quantity.of the efficient quantity.

When marginal external cost are present, the free When marginal external cost are present, the free market produces too much. Output exceeds the market produces too much. Output exceeds the efficient quantity.efficient quantity.

It is externalities that occur at the margin – It is externalities that occur at the margin – marginal external cost and marginal external marginal external cost and marginal external benefitsbenefits - that are of most interest in economics, - that are of most interest in economics, because these externalities at the margin cause because these externalities at the margin cause market outcomes to differ from what is efficient.market outcomes to differ from what is efficient.

When marginal external benefits are present, the When marginal external benefits are present, the free market produces too little. Output falls short free market produces too little. Output falls short of the efficient quantity.of the efficient quantity.

When marginal external cost are present, the free When marginal external cost are present, the free market produces too much. Output exceeds the market produces too much. Output exceeds the efficient quantity.efficient quantity.




Externalities – All Around UsExternalities – All Around UsExternalities – All Around UsExternalities – All Around Us

SAMPLE ACTIVITIES WITH EXTERNAL COSTS

• Allowing your cell phone to ring in class• Being distracted by your cell phone

while driving• Driving a vehicle that emits exhaust

gas• Using river water to remove industrial

waste• Burning coal to generate electricity

SAMPLE ACTIVITIES WITH EXTERNAL COSTS

• Allowing your cell phone to ring in class• Being distracted by your cell phone

while driving• Driving a vehicle that emits exhaust

gas• Using river water to remove industrial

waste• Burning coal to generate electricity


Externalities – All Around UsExternalities – All Around UsExternalities – All Around UsExternalities – All Around Us

SAMPLE ACTIVITIES WITH EXTERNAL BENEFITS

• Answering questions in class Looking your best

• Having your car washed • Getting immunized against disease • Inspiring others with your ideas

and actions

SAMPLE ACTIVITIES WITH EXTERNAL BENEFITS

• Answering questions in class Looking your best

• Having your car washed • Getting immunized against disease • Inspiring others with your ideas

and actions


External Benefits – External Benefits – Too Little ProducedToo Little ProducedExternal Benefits – External Benefits – Too Little ProducedToo Little Produced

$

QuantityEfficientquantity

Marginal social benefit

Marginal external benefit

Market quantity

Demand = marginal private benefit

Market price

Supply = marginal private cost

••

The intersection of market demand and supply determine market quantity.

The existence of any marginal external benefits at this quantity would mean that the market produces less than would be efficient.


External Benefits – External Benefits – Too Little ProducedToo Little ProducedExternal Benefits – External Benefits – Too Little ProducedToo Little Produced

$

QuantityMarket quantity

Demand = marginal private benefit

Market price

Supply = marginal private cost

Efficientquantity

Marginal social benefitMarginal external cost

When external costs are present, supply lies below marginal social cost and the free market produces more than would be efficient.


The Link Between Environmental The Link Between Environmental Quality and External CostQuality and External Cost

The Link Between Environmental The Link Between Environmental Quality and External CostQuality and External Cost

Quantity of environmental quality

Marginal social benefit

$

Effect of pollution

Environmental qualityA public good

Emissions of pollutants

Marginal external cost

$

Effect of pollution

External costs of emitting pollutants


When Markets are MissingWhen Markets are MissingWhen Markets are MissingWhen Markets are Missing

o If environmental services provided by If environmental services provided by common-property water and air were priced, common-property water and air were priced, as they would be if sold in a market, firms as they would be if sold in a market, firms would economize and pollute less.would economize and pollute less.

o Occasionally, firms compete on the basis of how Occasionally, firms compete on the basis of how environmentally friendly their products are.environmentally friendly their products are.

o Typically, competition forces firms to be Typically, competition forces firms to be environmentally neglectful unless there are environmentally neglectful unless there are public policy incentives to be otherwise.public policy incentives to be otherwise.

o If environmental services provided by If environmental services provided by common-property water and air were priced, common-property water and air were priced, as they would be if sold in a market, firms as they would be if sold in a market, firms would economize and pollute less.would economize and pollute less.

o Occasionally, firms compete on the basis of how Occasionally, firms compete on the basis of how environmentally friendly their products are.environmentally friendly their products are.

o Typically, competition forces firms to be Typically, competition forces firms to be environmentally neglectful unless there are environmentally neglectful unless there are public policy incentives to be otherwise.public policy incentives to be otherwise.


When Markets are MissingWhen Markets are MissingWhen Markets are MissingWhen Markets are Missing

o While reliance on public policy is commonplace, it While reliance on public policy is commonplace, it is not the only means to resolve externalities.is not the only means to resolve externalities.

o The The Coase theoremCoase theorem holds that parties to an holds that parties to an externality would voluntarily negotiate an efficient externality would voluntarily negotiate an efficient outcome without government involvement.outcome without government involvement.o Government need merely define and clearly Government need merely define and clearly

enforce property rights.enforce property rights.o Strategic behavior interferes with the practical Strategic behavior interferes with the practical

application of the Coase theorem.application of the Coase theorem.o The Coase theorem only applies in the absence The Coase theorem only applies in the absence

of transaction cost.of transaction cost.

o While reliance on public policy is commonplace, it While reliance on public policy is commonplace, it is not the only means to resolve externalities.is not the only means to resolve externalities.

o The The Coase theoremCoase theorem holds that parties to an holds that parties to an externality would voluntarily negotiate an efficient externality would voluntarily negotiate an efficient outcome without government involvement.outcome without government involvement.o Government need merely define and clearly Government need merely define and clearly

enforce property rights.enforce property rights.o Strategic behavior interferes with the practical Strategic behavior interferes with the practical

application of the Coase theorem.application of the Coase theorem.o The Coase theorem only applies in the absence The Coase theorem only applies in the absence

of transaction cost.of transaction cost.


Comparison of Growth Areas and Comparison of Growth Areas and Emission TrendsEmission Trends

Comparison of Growth Areas and Comparison of Growth Areas and Emission TrendsEmission Trends

1970 1980 1990 2000

U.S. gross domestic product increased 158%

Vehicle miles traveled increased 143%

Energy consumption increased 45%

U.S. population increased 36%

Aggregate emissions decreased 29% (six principal pollutants)


Common Property ResourcesCommon Property ResourcesCommon Property ResourcesCommon Property Resources

Common property resourcesCommon property resources are owned jointly, are owned jointly, including groundwater, public lands, wild including groundwater, public lands, wild animals, and fish in the oceans lakes, and animals, and fish in the oceans lakes, and rivers.rivers.

Common property resources lead to too much Common property resources lead to too much production in the present, with insufficient production in the present, with insufficient regard for the future.regard for the future.

When many people own the same resource, no When many people own the same resource, no one has any personal incentive to conserve it.one has any personal incentive to conserve it.

Owners ignore the opportunity cost in terms of Owners ignore the opportunity cost in terms of future value forgone from using something up future value forgone from using something up today.today.

Common property resourcesCommon property resources are owned jointly, are owned jointly, including groundwater, public lands, wild including groundwater, public lands, wild animals, and fish in the oceans lakes, and animals, and fish in the oceans lakes, and rivers.rivers.

Common property resources lead to too much Common property resources lead to too much production in the present, with insufficient production in the present, with insufficient regard for the future.regard for the future.

When many people own the same resource, no When many people own the same resource, no one has any personal incentive to conserve it.one has any personal incentive to conserve it.

Owners ignore the opportunity cost in terms of Owners ignore the opportunity cost in terms of future value forgone from using something up future value forgone from using something up today.today.


Common Property ResourcesCommon Property ResourcesCommon Property ResourcesCommon Property Resources

Common property owners also do not care if they Common property owners also do not care if they get in the way of one another’s efforts.get in the way of one another’s efforts.

Government can solve common property resource Government can solve common property resource problems by selling the common property to a problems by selling the common property to a single owner.single owner.

Such transfers would be impractical or politically Such transfers would be impractical or politically unacceptable. unacceptable.

The alternative is for the government to act as the The alternative is for the government to act as the owner’s agent and apportion the use of common owner’s agent and apportion the use of common property so that overuse is avoided.property so that overuse is avoided.

This is the rationale for user fees, and other This is the rationale for user fees, and other restrictions on common property.restrictions on common property.

Common property owners also do not care if they Common property owners also do not care if they get in the way of one another’s efforts.get in the way of one another’s efforts.

Government can solve common property resource Government can solve common property resource problems by selling the common property to a problems by selling the common property to a single owner.single owner.

Such transfers would be impractical or politically Such transfers would be impractical or politically unacceptable. unacceptable.

The alternative is for the government to act as the The alternative is for the government to act as the owner’s agent and apportion the use of common owner’s agent and apportion the use of common property so that overuse is avoided.property so that overuse is avoided.

This is the rationale for user fees, and other This is the rationale for user fees, and other restrictions on common property.restrictions on common property.


25.225.2POLICY TOOLSPOLICY TOOLS25.225.2POLICY TOOLSPOLICY TOOLSSome policy approaches to conservation are more Some policy approaches to conservation are more

promising than others.promising than others.Through Through moral suasion,moral suasion, government exhorts us to government exhorts us to

do the right thing by appealing to our social do the right thing by appealing to our social conscience.conscience.

Moral suasion is rarely adequate to the task and Moral suasion is rarely adequate to the task and often has undesirable side effects.often has undesirable side effects.Moral suasion has no way of achieving any particular Moral suasion has no way of achieving any particular

target, efficient or otherwise.target, efficient or otherwise.It also imposes all cost of cutbacks on the “moral”It also imposes all cost of cutbacks on the “moral”Finally, it can lead to a self-righteous intrusion on Finally, it can lead to a self-righteous intrusion on

personal property.personal property.

Some policy approaches to conservation are more Some policy approaches to conservation are more promising than others.promising than others.

Through Through moral suasion,moral suasion, government exhorts us to government exhorts us to do the right thing by appealing to our social do the right thing by appealing to our social conscience.conscience.

Moral suasion is rarely adequate to the task and Moral suasion is rarely adequate to the task and often has undesirable side effects.often has undesirable side effects.Moral suasion has no way of achieving any particular Moral suasion has no way of achieving any particular

target, efficient or otherwise.target, efficient or otherwise.It also imposes all cost of cutbacks on the “moral”It also imposes all cost of cutbacks on the “moral”Finally, it can lead to a self-righteous intrusion on Finally, it can lead to a self-righteous intrusion on

personal property.personal property.


Standards and Technology Standards and Technology MandatesMandates

Standards and Technology Standards and Technology MandatesMandates

Technology mandatesTechnology mandates occur when government occur when government instructs producers as to the exact technology to instructs producers as to the exact technology to install as a remedy for some public problem. install as a remedy for some public problem.

Some mandates are indirect and specify the Some mandates are indirect and specify the standards that must be met and suggest standards that must be met and suggest technologies that will meet these standards.technologies that will meet these standards.

Technology mandates are often much more Technology mandates are often much more expensive and annoying than other policy expensive and annoying than other policy options.options.

Government planners cannot be expected to Government planners cannot be expected to foresee all of the options for pollution control.foresee all of the options for pollution control.

Technology mandatesTechnology mandates occur when government occur when government instructs producers as to the exact technology to instructs producers as to the exact technology to install as a remedy for some public problem. install as a remedy for some public problem.

Some mandates are indirect and specify the Some mandates are indirect and specify the standards that must be met and suggest standards that must be met and suggest technologies that will meet these standards.technologies that will meet these standards.

Technology mandates are often much more Technology mandates are often much more expensive and annoying than other policy expensive and annoying than other policy options.options.

Government planners cannot be expected to Government planners cannot be expected to foresee all of the options for pollution control.foresee all of the options for pollution control.


Pollution Taxes –Pollution Taxes – Environmental User Fees Environmental User Fees


o As an alternative to technology mandates, As an alternative to technology mandates, pollution taxes can reduce pollution without pollution taxes can reduce pollution without creating the problems associated with creating the problems associated with technology mandates.technology mandates.

o Economist advocate pollution taxes, which is Economist advocate pollution taxes, which is referred to as internalizing the cost of an referred to as internalizing the cost of an externality directly into prices.externality directly into prices.

o If an activity generates damages, the value of If an activity generates damages, the value of those damages would be estimated, and a tax those damages would be estimated, and a tax would be imposed equal to the amount of the would be imposed equal to the amount of the marginal external cost to pay the full marginal marginal external cost to pay the full marginal social cost of their activities.social cost of their activities.

o As an alternative to technology mandates, As an alternative to technology mandates, pollution taxes can reduce pollution without pollution taxes can reduce pollution without creating the problems associated with creating the problems associated with technology mandates.technology mandates.

o Economist advocate pollution taxes, which is Economist advocate pollution taxes, which is referred to as internalizing the cost of an referred to as internalizing the cost of an externality directly into prices.externality directly into prices.

o If an activity generates damages, the value of If an activity generates damages, the value of those damages would be estimated, and a tax those damages would be estimated, and a tax would be imposed equal to the amount of the would be imposed equal to the amount of the marginal external cost to pay the full marginal marginal external cost to pay the full marginal social cost of their activities.social cost of their activities.


The pollution tax causes the perpetrators of the The pollution tax causes the perpetrators of the external cost to pay the full marginal social cost external cost to pay the full marginal social cost of their activity.of their activity.

This means that externalities become part of This means that externalities become part of the decisions of those who cause them, and the decisions of those who cause them, and efficient choices will be made in the efficient choices will be made in the marketplace.marketplace.

A corrective tax on shifts the supply curve up A corrective tax on shifts the supply curve up by the amount of the tax.by the amount of the tax. The price would rise, and the quantity would fall as The price would rise, and the quantity would fall as

the market equilibrium would change. the market equilibrium would change.

The pollution tax causes the perpetrators of the The pollution tax causes the perpetrators of the external cost to pay the full marginal social cost external cost to pay the full marginal social cost of their activity.of their activity.

This means that externalities become part of This means that externalities become part of the decisions of those who cause them, and the decisions of those who cause them, and efficient choices will be made in the efficient choices will be made in the marketplace.marketplace.

A corrective tax on shifts the supply curve up A corrective tax on shifts the supply curve up by the amount of the tax.by the amount of the tax. The price would rise, and the quantity would fall as The price would rise, and the quantity would fall as

the market equilibrium would change. the market equilibrium would change.






•

•

Cigarettes

Demand

Supply

Supply + Tax

$

Efficient quantity

Change in quantity

Change in price = 80 cents Tax =

marginalexternal cost = $1

The efficient tax can internalize an external cost. Efficiency requires that the tax rate be set equal to marginal external cost at the efficient quantity of output.


With the cigarette tax, most of the tax is passed With the cigarette tax, most of the tax is passed on to consumers, because demand is inelastic on to consumers, because demand is inelastic with respect to supply.with respect to supply.The rest is absorbed by producers in what is now a The rest is absorbed by producers in what is now a

smaller industry.smaller industry.

Using fees to remedy externalities often Using fees to remedy externalities often encounters difficulties.encounters difficulties.External damages may depend on time and place.It External damages may depend on time and place.It

is not possible to account for this difference in is not possible to account for this difference in imposing cigarette taxes.imposing cigarette taxes.

With the cigarette tax, most of the tax is passed With the cigarette tax, most of the tax is passed on to consumers, because demand is inelastic on to consumers, because demand is inelastic with respect to supply.with respect to supply.The rest is absorbed by producers in what is now a The rest is absorbed by producers in what is now a

smaller industry.smaller industry.

Using fees to remedy externalities often Using fees to remedy externalities often encounters difficulties.encounters difficulties.External damages may depend on time and place.It External damages may depend on time and place.It

is not possible to account for this difference in is not possible to account for this difference in imposing cigarette taxes.imposing cigarette taxes.




Measurement of pollution is another hurdle in the Measurement of pollution is another hurdle in the way applying pollution taxes.way applying pollution taxes.

Of greater concern, however is political support for Of greater concern, however is political support for taxing pollution and providing effective penalties to taxing pollution and providing effective penalties to ensure compliance.ensure compliance.

In contrast to most taxes, those designed to remedy In contrast to most taxes, those designed to remedy externalities are not designed to generate revenue, externalities are not designed to generate revenue, rather they are designed to promote economic rather they are designed to promote economic efficiency. efficiency.

Pollution taxes lack powerful constituencies among Pollution taxes lack powerful constituencies among both environmentalist, consumers, and producers.both environmentalist, consumers, and producers.

Measurement of pollution is another hurdle in the Measurement of pollution is another hurdle in the way applying pollution taxes.way applying pollution taxes.

Of greater concern, however is political support for Of greater concern, however is political support for taxing pollution and providing effective penalties to taxing pollution and providing effective penalties to ensure compliance.ensure compliance.

In contrast to most taxes, those designed to remedy In contrast to most taxes, those designed to remedy externalities are not designed to generate revenue, externalities are not designed to generate revenue, rather they are designed to promote economic rather they are designed to promote economic efficiency. efficiency.

Pollution taxes lack powerful constituencies among Pollution taxes lack powerful constituencies among both environmentalist, consumers, and producers.both environmentalist, consumers, and producers.




To overcome barriers to pollution taxes, policy To overcome barriers to pollution taxes, policy makers sometimes resort to paying for makers sometimes resort to paying for pollution abatement instead. pollution abatement instead. Pollution abatement is accomplished through Pollution abatement is accomplished through subsidies, which are payments from the subsidies, which are payments from the government to producers that are intended to government to producers that are intended to promote certain activities.promote certain activities.Unfortunately, subsidies have two undesirable Unfortunately, subsidies have two undesirable side effects.side effects.

Subsidies drain government resources.Subsidies drain government resources.Subsidies reward polluters, and can lead to too Subsidies reward polluters, and can lead to too many polluting firms.many polluting firms.

To overcome barriers to pollution taxes, policy To overcome barriers to pollution taxes, policy makers sometimes resort to paying for makers sometimes resort to paying for pollution abatement instead. pollution abatement instead. Pollution abatement is accomplished through Pollution abatement is accomplished through subsidies, which are payments from the subsidies, which are payments from the government to producers that are intended to government to producers that are intended to promote certain activities.promote certain activities.Unfortunately, subsidies have two undesirable Unfortunately, subsidies have two undesirable side effects.side effects.

Subsidies drain government resources.Subsidies drain government resources.Subsidies reward polluters, and can lead to too Subsidies reward polluters, and can lead to too many polluting firms.many polluting firms.




Marketable PermitsMarketable PermitsMarketable PermitsMarketable Permits

Marketable permitsMarketable permits offer the same economic offer the same economic advantages as taxes, but in a way that has advantages as taxes, but in a way that has much more political appeal.much more political appeal.Marketable permits represent property rights Marketable permits represent property rights to a certain amount of pollutant emissions.to a certain amount of pollutant emissions.The government sets the overall quantity, and The government sets the overall quantity, and then divides up that quantity into a limited then divides up that quantity into a limited number of permits for the various polluters.number of permits for the various polluters.Marketable permits are valuable property Marketable permits are valuable property rights.rights.These rights can be bought and sold, which These rights can be bought and sold, which appeals to both producers and economist.appeals to both producers and economist.

Marketable permitsMarketable permits offer the same economic offer the same economic advantages as taxes, but in a way that has advantages as taxes, but in a way that has much more political appeal.much more political appeal.Marketable permits represent property rights Marketable permits represent property rights to a certain amount of pollutant emissions.to a certain amount of pollutant emissions.The government sets the overall quantity, and The government sets the overall quantity, and then divides up that quantity into a limited then divides up that quantity into a limited number of permits for the various polluters.number of permits for the various polluters.Marketable permits are valuable property Marketable permits are valuable property rights.rights.These rights can be bought and sold, which These rights can be bought and sold, which appeals to both producers and economist.appeals to both producers and economist.


Marketable permits also provide a promising Marketable permits also provide a promising alternative in the allocation of common alternative in the allocation of common property.property.A central authority determines how much of the A central authority determines how much of the

resource can be used now, and still leave enough for resource can be used now, and still leave enough for the future.the future.

The main issue with marketable permits is The main issue with marketable permits is distributional.distributional.How are the permits to be initially distributed?How are the permits to be initially distributed?

These political questions have been the largest These political questions have been the largest obstacles to more widespread use of permits.obstacles to more widespread use of permits.

Marketable permits also provide a promising Marketable permits also provide a promising alternative in the allocation of common alternative in the allocation of common property.property.A central authority determines how much of the A central authority determines how much of the

resource can be used now, and still leave enough for resource can be used now, and still leave enough for the future.the future.

The main issue with marketable permits is The main issue with marketable permits is distributional.distributional.How are the permits to be initially distributed?How are the permits to be initially distributed?

These political questions have been the largest These political questions have been the largest obstacles to more widespread use of permits.obstacles to more widespread use of permits.

Marketable PermitsMarketable PermitsMarketable PermitsMarketable Permits


Applying Policy Directly to PollutionApplying Policy Directly to PollutionApplying Policy Directly to PollutionApplying Policy Directly to Pollution

Most pollution comes from production rather than Most pollution comes from production rather than consumption.consumption.It is usually best to apply a tax or permit approach It is usually best to apply a tax or permit approach

directly to pollution rather than to outputs.directly to pollution rather than to outputs.Sometimes this is difficult or impossible to do.Sometimes this is difficult or impossible to do.

When pollution control policy is applied to output, When pollution control policy is applied to output, pollution is reduced only to the extent that output pollution is reduced only to the extent that output falls.falls.

In contrast, when control policy is taxed directly, In contrast, when control policy is taxed directly, polluters also have the incentive to reduce the polluters also have the incentive to reduce the amount of pollution per unit of that output.amount of pollution per unit of that output.

Most pollution comes from production rather than Most pollution comes from production rather than consumption.consumption.It is usually best to apply a tax or permit approach It is usually best to apply a tax or permit approach

directly to pollution rather than to outputs.directly to pollution rather than to outputs.Sometimes this is difficult or impossible to do.Sometimes this is difficult or impossible to do.

When pollution control policy is applied to output, When pollution control policy is applied to output, pollution is reduced only to the extent that output pollution is reduced only to the extent that output falls.falls.

In contrast, when control policy is taxed directly, In contrast, when control policy is taxed directly, polluters also have the incentive to reduce the polluters also have the incentive to reduce the amount of pollution per unit of that output.amount of pollution per unit of that output.


o It is only feasible to tax pollution directly in cases of It is only feasible to tax pollution directly in cases of stationary source polluters, such as factories.stationary source polluters, such as factories.

o Such taxes require that the government be able to Such taxes require that the government be able to monitor the quantity of pollution that is emitted.monitor the quantity of pollution that is emitted.

o Firms do not pollute for its own sake, rather they Firms do not pollute for its own sake, rather they use the environment to remove waste products, with use the environment to remove waste products, with pollution being the result.pollution being the result.

o Firms are willing to pay the pollution tax because Firms are willing to pay the pollution tax because using the environment to remove waste is a valuable using the environment to remove waste is a valuable service to them, just like the services of labor.service to them, just like the services of labor.

o It is only feasible to tax pollution directly in cases of It is only feasible to tax pollution directly in cases of stationary source polluters, such as factories.stationary source polluters, such as factories.

o Such taxes require that the government be able to Such taxes require that the government be able to monitor the quantity of pollution that is emitted.monitor the quantity of pollution that is emitted.

o Firms do not pollute for its own sake, rather they Firms do not pollute for its own sake, rather they use the environment to remove waste products, with use the environment to remove waste products, with pollution being the result.pollution being the result.

o Firms are willing to pay the pollution tax because Firms are willing to pay the pollution tax because using the environment to remove waste is a valuable using the environment to remove waste is a valuable service to them, just like the services of labor.service to them, just like the services of labor.



o Environmental services are not priced, because Environmental services are not priced, because there is no one in the free market to charge firms there is no one in the free market to charge firms for environmental services, as no one owns the for environmental services, as no one owns the environment.environment.

o In the absence of government actions, firms are In the absence of government actions, firms are free to pollute as much as they want.free to pollute as much as they want.

o To substitute for the missing efficient market price, To substitute for the missing efficient market price, the government could charge firms a fee per unit the government could charge firms a fee per unit of emissions. of emissions.

o To remedy an externality with a tax, the tax rate To remedy an externality with a tax, the tax rate must be set equal to marginal external cost at the must be set equal to marginal external cost at the efficient level of pollution.efficient level of pollution.

o Environmental services are not priced, because Environmental services are not priced, because there is no one in the free market to charge firms there is no one in the free market to charge firms for environmental services, as no one owns the for environmental services, as no one owns the environment.environment.

o In the absence of government actions, firms are In the absence of government actions, firms are free to pollute as much as they want.free to pollute as much as they want.

o To substitute for the missing efficient market price, To substitute for the missing efficient market price, the government could charge firms a fee per unit the government could charge firms a fee per unit of emissions. of emissions.

o To remedy an externality with a tax, the tax rate To remedy an externality with a tax, the tax rate must be set equal to marginal external cost at the must be set equal to marginal external cost at the efficient level of pollution.efficient level of pollution.



The Missing Market for PollutionThe Missing Market for PollutionThe Missing Market for PollutionThe Missing Market for Pollution

•

Demand for firms

Marginal external cost$

Efficient quantity

Efficient pollution

tax

Missing market supply

•Market

equilibrium

Pollution abatement

0

Without government action, the market price of emissions is zero.


25.325.3CARING FOR THE GLOBAL CARING FOR THE GLOBAL ENVIRONMENTENVIRONMENT

25.325.3CARING FOR THE GLOBAL CARING FOR THE GLOBAL ENVIRONMENTENVIRONMENT

Policies to control pollution or preserve common Policies to control pollution or preserve common property resources require a government.property resources require a government.

Oftentimes market failures go beyond the Oftentimes market failures go beyond the confines of any single country.confines of any single country.

In these situations, the best solutions often involve In these situations, the best solutions often involve international cooperation.international cooperation.

It is important to recognize that many countries It is important to recognize that many countries governments have been responsible for the governments have been responsible for the world’s pollution. world’s pollution.

Policies to control pollution or preserve common Policies to control pollution or preserve common property resources require a government.property resources require a government.

Oftentimes market failures go beyond the Oftentimes market failures go beyond the confines of any single country.confines of any single country.

In these situations, the best solutions often involve In these situations, the best solutions often involve international cooperation.international cooperation.

It is important to recognize that many countries It is important to recognize that many countries governments have been responsible for the governments have been responsible for the world’s pollution. world’s pollution.


25.4 EXPLORE & APPLY25.4 EXPLORE & APPLYBorderlands of the SouthwestBorderlands of the Southwest

25.4 EXPLORE & APPLY25.4 EXPLORE & APPLYBorderlands of the SouthwestBorderlands of the Southwest

Our vision of America’s southwest is one of Our vision of America’s southwest is one of expansiveness and freedom.expansiveness and freedom.

As more people come into the southwest to live, As more people come into the southwest to live, unlimited personal freedom comes into conflict unlimited personal freedom comes into conflict with preservation of the environment that with preservation of the environment that attracts them there.attracts them there.

The environment of the southwest is ill-suited The environment of the southwest is ill-suited to accommodate unrestricted pollution.to accommodate unrestricted pollution.

Trans-border pollution is also a growing Trans-border pollution is also a growing problem.problem.

Our vision of America’s southwest is one of Our vision of America’s southwest is one of expansiveness and freedom.expansiveness and freedom.

As more people come into the southwest to live, As more people come into the southwest to live, unlimited personal freedom comes into conflict unlimited personal freedom comes into conflict with preservation of the environment that with preservation of the environment that attracts them there.attracts them there.

The environment of the southwest is ill-suited The environment of the southwest is ill-suited to accommodate unrestricted pollution.to accommodate unrestricted pollution.

Trans-border pollution is also a growing Trans-border pollution is also a growing problem.problem.


Terms Along the WayTerms Along the WayTerms Along the WayTerms Along the Way

externalitiesexternalities common property common property

resourcesresources external costs or external costs or

benefits benefits private cost or private cost or

benefitsbenefits social costs or social costs or

benefitsbenefits

externalitiesexternalities common property common property

resourcesresources external costs or external costs or

benefits benefits private cost or private cost or

benefitsbenefits social costs or social costs or

benefitsbenefits

marginal external marginal external costs or benefitscosts or benefits

Coase theoremCoase theorem user feesuser fees moral suasionmoral suasion technology mandatestechnology mandates subsidiessubsidies marketable permitsmarketable permits

marginal external marginal external costs or benefitscosts or benefits

Coase theoremCoase theorem user feesuser fees moral suasionmoral suasion technology mandatestechnology mandates subsidiessubsidies marketable permitsmarketable permits


Test YourselfTest YourselfTest YourselfTest Yourself

1.1. The costs associated with a person’s The costs associated with a person’s actions that the person actually bears actions that the person actually bears are called are called

a.a. social cost.social cost.b.b. external cost.external cost.c.c. private cost.private cost.d.d. private cost + external cost.private cost + external cost.

1.1. The costs associated with a person’s The costs associated with a person’s actions that the person actually bears actions that the person actually bears are called are called

a.a. social cost.social cost.b.b. external cost.external cost.c.c. private cost.private cost.d.d. private cost + external cost.private cost + external cost.



2.2. Spillover cost to third parties are also Spillover cost to third parties are also calledcalled

a.a. private cost.private cost.

b.b. marginal cost.marginal cost.

c.c. external cost.external cost.

d.d. internal cost.internal cost.

2.2. Spillover cost to third parties are also Spillover cost to third parties are also calledcalled

a.a. private cost.private cost.

b.b. marginal cost.marginal cost.

c.c. external cost.external cost.

d.d. internal cost.internal cost.



3.3. People who serve as role models to People who serve as role models to inspire othersinspire others

a.a. impose social cost.impose social cost.

b.b. confer private benefits only.confer private benefits only.

c.c. confer external benefits.confer external benefits.

d.d. are not the cause of any externalities.are not the cause of any externalities.

3.3. People who serve as role models to People who serve as role models to inspire othersinspire others

a.a. impose social cost.impose social cost.

b.b. confer private benefits only.confer private benefits only.

c.c. confer external benefits.confer external benefits.

d.d. are not the cause of any externalities.are not the cause of any externalities.



4.4. Does the free market ever produce too Does the free market ever produce too much?much?

a.a. No.No.

b.b. Yes, when there are external benefits.Yes, when there are external benefits.

c.c. Yes, when there are external cost Yes, when there are external cost present.present.

d.d. Yes, when social cost equal private cost.Yes, when social cost equal private cost.

4.4. Does the free market ever produce too Does the free market ever produce too much?much?

a.a. No.No.

b.b. Yes, when there are external benefits.Yes, when there are external benefits.

c.c. Yes, when there are external cost Yes, when there are external cost present.present.

d.d. Yes, when social cost equal private cost.Yes, when social cost equal private cost.



5.5. Common property resources users ignoreCommon property resources users ignore

a.a. taxes, and so use more of the resources than taxes, and so use more of the resources than they otherwise would.they otherwise would.

b.b. taxes, and so use less of the resources than taxes, and so use less of the resources than they other would.they other would.

c.c. the value of conserving the resources for the the value of conserving the resources for the future.future.

d.d. all of the social cost.all of the social cost.

5.5. Common property resources users ignoreCommon property resources users ignore

a.a. taxes, and so use more of the resources than taxes, and so use more of the resources than they otherwise would.they otherwise would.

b.b. taxes, and so use less of the resources than taxes, and so use less of the resources than they other would.they other would.

c.c. the value of conserving the resources for the the value of conserving the resources for the future.future.

d.d. all of the social cost.all of the social cost.



6.6. Moral suasion isMoral suasion isa.a. another name for pollution tax.another name for pollution tax.b.b. the cost of purchasing a marketable the cost of purchasing a marketable

permit.permit.c.c. the process of implementing technology the process of implementing technology

mandates.mandates.d.d. an effort to change harmful behavior an effort to change harmful behavior

through appeals to conscience.through appeals to conscience.

6.6. Moral suasion isMoral suasion isa.a. another name for pollution tax.another name for pollution tax.b.b. the cost of purchasing a marketable the cost of purchasing a marketable

permit.permit.c.c. the process of implementing technology the process of implementing technology

mandates.mandates.d.d. an effort to change harmful behavior an effort to change harmful behavior

through appeals to conscience.through appeals to conscience.


The End!The End!Next Chapter 26Next Chapter 26““Public Choice"Public Choice"

©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 1 Chapter 25 “Externalities and Common...

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