C. Bordoy UWC Maastricht Market Failure Public goods Public goods Common access resources and the...

C. BordoyC. BordoyUWC MaastrichtUWC Maastricht

Market FailureMarket Failure

•Public goodsPublic goods•Common access resources Common access resources and the threat to and the threat to sustainability sustainability (Tragakes, 2012, pp. (Tragakes, 2012, pp. 119-130)119-130)

Lack of Public goodsLack of Public goods A private good has two A private good has two

characteristics:characteristics:1.1. Rivalrous: its consumption by one Rivalrous: its consumption by one

person reduces its availability for person reduces its availability for someone else (when you buy a t-shirt, someone else (when you buy a t-shirt, another person cannot buy it).another person cannot buy it).

2.2. Excludable: It is possible to exclude Excludable: It is possible to exclude people from using the good. Normally people from using the good. Normally achieved by charging a price.achieved by charging a price.

Most goods are private goods.Most goods are private goods.C. BordoyC. Bordoy

UWC MaastrichtUWC Maastricht

A (pure) public good has the A (pure) public good has the following characteristics:following characteristics:1.1. Non-rivalrous: its consumption by one Non-rivalrous: its consumption by one

person does not reduce consumption person does not reduce consumption by someone else.by someone else.

2.2. Non-excludable: it is not possible to Non-excludable: it is not possible to exclude someone from using the good.exclude someone from using the good.

Examples: lighthouse, police force, Examples: lighthouse, police force, national defence, non-toll roads, fire national defence, non-toll roads, fire protection,…protection,…


Why are public goods a type of market Why are public goods a type of market failure?failure?

Private firms have an incentive to Private firms have an incentive to provide excludable goods because they provide excludable goods because they can charge a price for them and cover can charge a price for them and cover their costs.their costs.

No profit-maximising firm is willing to No profit-maximising firm is willing to produce a good if it cannot charge a produce a good if it cannot charge a price for it. price for it.

As a result, the market fails to produce As a result, the market fails to produce goods that are non-excludable goods that are non-excludable →→ misallocation of resources to the misallocation of resources to the production of public goods.production of public goods.


Free rider problem: when people can Free rider problem: when people can enjoy the use of a good without enjoy the use of a good without paying for it. It arises from non-paying for it. It arises from non-excludability.excludability.


Non-excludability

Impossibility to charge a price

Free rider problem

Private firms do not

produce them

Underallocation of resources

Quasi-public goods (impure public Quasi-public goods (impure public goods):goods):1.1. Non-rivalrousNon-rivalrous

2.2. Excludable Excludable

Public museums that charge an Public museums that charge an entrance fee, toll roads.entrance fee, toll roads.

They could be provided by private They could be provided by private firms but, since they have very large firms but, since they have very large positive externalities, they are positive externalities, they are directly provided by the government.directly provided by the government.


CorrectionCorrection Public goods are underprovided by the Public goods are underprovided by the

market market →→ the government must ensure the government must ensure that the optimal level is produced.that the optimal level is produced.

Direct provision, financed out of tax Direct provision, financed out of tax revenues. Made available to the public revenues. Made available to the public (nearly) free of charge.(nearly) free of charge.

Decisions to be made:Decisions to be made:1.1. Which public goods to provideWhich public goods to provide

2.2. In what quantitiesIn what quantities


Limited gov funds Limited gov funds → opportunity costs→ opportunity costs Need to decide which public goods will Need to decide which public goods will

provide the greatest social benefits.provide the greatest social benefits. Difficult to estimate these expected Difficult to estimate these expected

benefits, as they do not have a market benefits, as they do not have a market price (which reflects the benefits to price (which reflects the benefits to consumers). consumers).

Information about demand gathered Information about demand gathered through surveys of people and used in through surveys of people and used in ‘cost-benefit analysis’.‘cost-benefit analysis’.


The goods should be provided if The goods should be provided if benefits are greater than costs.benefits are greater than costs.

However, cost-benefit analysis is However, cost-benefit analysis is very rough, as people tend to very rough, as people tend to overvalue goods they really want.overvalue goods they really want.



Common access resources and Common access resources and market failuremarket failure

Common access resourcesCommon access resources are are resources that are not owned by anyone, resources that are not owned by anyone, do not have a price and are available for do not have a price and are available for anyone to use without payment.anyone to use without payment.

Examples: clean air, lakes, rivers, fish in Examples: clean air, lakes, rivers, fish in the open sea, forests, ozone layer,...the open sea, forests, ozone layer,...

They are a type of market failure because:They are a type of market failure because: They are rivalrous (characteristic of private They are rivalrous (characteristic of private

goods)goods) They are non-excludable (characteristic of They are non-excludable (characteristic of

public goods)public goods)


Sustainability and common access Sustainability and common access resourcesresources

Sustainability is the ability of Sustainability is the ability of something to be maintained or something to be maintained or preserved over time.preserved over time.

For the environment it refers to For the environment it refers to environmental preservation.environmental preservation.

For the economy it refers to the For the economy it refers to the preservation of humankind’s ability preservation of humankind’s ability to provide goods and services to to provide goods and services to satisfy needs and wants in the future.satisfy needs and wants in the future.


Conflicts between environmental and Conflicts between environmental and economic goals:economic goals: Economic goals involve Economic goals involve

efforts to increase the quantities of output efforts to increase the quantities of output produced and consumed, produced and consumed, butbut

focusing in economic goals while disregarding focusing in economic goals while disregarding the environment may result in its destruction.the environment may result in its destruction.

Environmental goals involve Environmental goals involve the preservation of the environment, the preservation of the environment, butbut focusing on environmental goals while focusing on environmental goals while

disregarding the economy may result in disregarding the economy may result in humankind’s inability to satisfy needs and humankind’s inability to satisfy needs and wants.wants.


Balance between both goals: Balance between both goals: SustainableSustainable developmentdevelopment, ie, , ie, development that meets the needs development that meets the needs of the present without compromising of the present without compromising the ability of future generations to the ability of future generations to meet their own needs. meet their own needs.

Society should pursue economic Society should pursue economic growth that does not deplete or growth that does not deplete or degrade natural resources.degrade natural resources.


Pollution of affluence and pollution Pollution of affluence and pollution of povertyof poverty

Two types of environmental damage:Two types of environmental damage:1.1. Pollution of affluencePollution of affluence. It arises from . It arises from

industrial production and high-income industrial production and high-income consumption patterns that involve the consumption patterns that involve the heavy use of fossil fuels, using up open heavy use of fossil fuels, using up open access resources and leading to climate access resources and leading to climate change.change.

2.2. Pollution of povertyPollution of poverty. It arises from . It arises from production and consumption activities production and consumption activities that are due to poverty. Due to economic that are due to poverty. Due to economic activities by very poor people in an effort activities by very poor people in an effort to survive.to survive.


Overuse of common access resources and Overuse of common access resources and their depletion are the external costs of their depletion are the external costs of industrial production and high-income industrial production and high-income consumption activities, both based on use consumption activities, both based on use of fossil fuels.of fossil fuels.

Difference between MPC and MSC curves Difference between MPC and MSC curves represents the external costs in terms of represents the external costs in terms of overuse of common access resources:overuse of common access resources: Social cost arising from the cement factory’s Social cost arising from the cement factory’s

overuse of clean water, sea life and ozone overuse of clean water, sea life and ozone layer,layer,

The cost to society of causing global warming The cost to society of causing global warming


MPC: private costs of a MPC: private costs of a cement factory. External cement factory. External costs can be interpreted costs can be interpreted as the social cost of as the social cost of overuse of clean water, overuse of clean water, sea life and ozone layer sea life and ozone layer or as the cost to society or as the cost to society of causing global of causing global warming. warming.

Burning of fossil fuels Burning of fossil fuels causes overuse of causes overuse of common access common access resources, an external resources, an external cost.cost.

MSC

S=MPC

D=MPB=MSB

External cost

Q

P

Illustrating overuse of common access resources

Qopt Qm

Popt

Pm


If the cement factory payed for the If the cement factory payed for the overuse of these resources, the overuse of these resources, the producer would not stop producer would not stop usingusing common access resources but he common access resources but he would stop would stop overusingoverusing them, leading them, leading to a to a sustainablesustainable use. use.

Overuse of common access Overuse of common access resources can also result from resources can also result from negative consumption externalities negative consumption externalities (example: heating oil).(example: heating oil).


Poverty as a threat to Poverty as a threat to sustainabilitysustainability

Poverty is the most important cause of Poverty is the most important cause of environmental destruction, according to the environmental destruction, according to the BrundtlandBrundtland report. Two examples: report. Two examples: Lacking modern agricultural inputs, poor people Lacking modern agricultural inputs, poor people

deplete soil’s natural minerals, making them less deplete soil’s natural minerals, making them less productive.productive.

The pressure to open up new land for agriculture, The pressure to open up new land for agriculture, causing deforestation.causing deforestation.

These production and consumption These production and consumption activities of very poor people can also be activities of very poor people can also be interpreted as negative externalities interpreted as negative externalities involving overuse of common access involving overuse of common access resources.resources.


Government responses to threats Government responses to threats to sustainabilityto sustainability

1.1. LegislationLegislation. Examples:. Examples: restrictions on emissions from carsrestrictions on emissions from cars restrictions on emissions from factoriesrestrictions on emissions from factories requirements to install devices that requirements to install devices that

reduce air pollutionreduce air pollution issuing licences or permits for fishing issuing licences or permits for fishing

and huntingand hunting restrictions in the form of quotas for restrictions in the form of quotas for

fishingfishing establishment of protected areas for the establishment of protected areas for the

protection of biodiversity and protection of biodiversity and endangered ecosystemsendangered ecosystems


Advantages:Advantages:1.1. SimplicitySimplicity2.2. In most cases, they can be very In most cases, they can be very

effective.effective.3.3. In the case of emissions industrial In the case of emissions industrial

production, they avoid the technical production, they avoid the technical difficulties of market-based solutions.difficulties of market-based solutions.

Limitations:Limitations:1.1. In the case of pollution, they do not In the case of pollution, they do not

offer incentives to reduce emissions.offer incentives to reduce emissions.2.2. Cannot distinguish between high and Cannot distinguish between high and

low cost polluters.low cost polluters.3.3. Costs of monitoring to detect violations.Costs of monitoring to detect violations.


The following two measures deal with The following two measures deal with the problem of carbon dioxide the problem of carbon dioxide emissions.emissions.

2.2. Carbon taxesCarbon taxes. They aim at taxing the . They aim at taxing the use of fossil fuels in accordance with use of fossil fuels in accordance with the amount of carbon each ones emit. the amount of carbon each ones emit. Hence, users face the incentive to Hence, users face the incentive to swtich to fuels that emit less (or no) swtich to fuels that emit less (or no) carbon.carbon.

Denmark, Finland, France, Ireland, NL, Denmark, Finland, France, Ireland, NL, Poland, Sweden, some states in Poland, Sweden, some states in Canada and the US.Canada and the US.


3.3. Cap and trade schemesCap and trade schemes. Permits . Permits to release carbon dioxide are to release carbon dioxide are distributed to producers, and they distributed to producers, and they can be bought and sold in the can be bought and sold in the market. (EU ETS)market. (EU ETS)


Evaluating carbon taxes and cap Evaluating carbon taxes and cap and trade schemesand trade schemes

Carbon taxes fix the price of the Carbon taxes fix the price of the pollutant in the form of a tax, and pollutant in the form of a tax, and allow the quantity to vary.allow the quantity to vary.

Cap and trade schemes fix the Cap and trade schemes fix the quantity of the permissible pollutant quantity of the permissible pollutant and allow its price to vary according and allow its price to vary according to supply and demand.to supply and demand.


Carbon taxes are preferred because:Carbon taxes are preferred because:1.1. They make energy prices more They make energy prices more

predictable, benefitting firms, which predictable, benefitting firms, which need to plan their costs ahead of need to plan their costs ahead of time.time.

2.2. Easier to design and implement, Easier to design and implement, unlike cap and trade schemes, which unlike cap and trade schemes, which require to set the cap at the right require to set the cap at the right level and distributing the permits.level and distributing the permits.

3.3. Can be applied to all users of fossil Can be applied to all users of fossil fuels. C&T schemes target one fuels. C&T schemes target one particular industry or small group of particular industry or small group of industries.industries.


4.4. Do not allow for manipulation by Do not allow for manipulation by governments and interest groups.governments and interest groups.

5.5. Do not require as much monitoring and Do not require as much monitoring and enforcement.enforcement.

6.6. C&T schemes face strong political C&T schemes face strong political pressures to set the cap too high.pressures to set the cap too high.

7.7. Carbon taxes are less likely to be used to Carbon taxes are less likely to be used to restrict competition between firms. Some restrict competition between firms. Some firms could buy up more tradable permits firms could buy up more tradable permits than needed and drive up their price in than needed and drive up their price in order to prevent new firms from entering order to prevent new firms from entering the market.the market.


Arguments in favour of C&T schemes:Arguments in favour of C&T schemes:1.1. Carbon taxes may be too low. Gov may be Carbon taxes may be too low. Gov may be

unwilling to set carbon taxes high enough for unwilling to set carbon taxes high enough for these to provide the necessary incentives.these to provide the necessary incentives.

2.2. Carbon taxes cannot target a particular level Carbon taxes cannot target a particular level of carbon reduction, leading to uncertain of carbon reduction, leading to uncertain carbon-reducing outcomes.carbon-reducing outcomes.

3.3. Carbon taxes are regressive, as lower income Carbon taxes are regressive, as lower income consumers wuld be affected proportionately consumers wuld be affected proportionately more than higher-income consumers.more than higher-income consumers.

4.4. Carbon taxes must be adjusted for inflation, Carbon taxes must be adjusted for inflation, whereas adjustment is automatic with C&T whereas adjustment is automatic with C&T schemes.schemes.


4.4. Funding for clean technologiesFunding for clean technologies. .

Clean technologies aim towards a more Clean technologies aim towards a more responsible and productive use of responsible and productive use of natural resources , reducing negative natural resources , reducing negative environmental impacts. Ex: wind environmental impacts. Ex: wind power, solar energy, biofuels, power, solar energy, biofuels, recycling...recycling...

It is important that both private firms and It is important that both private firms and governments be involved in activities governments be involved in activities leading to innovation and leading to innovation and development of clean technologies. development of clean technologies. However, funding is insufficient. However, funding is insufficient.

Funding for clean technologies has Funding for clean technologies has opportunity costs. However, opportunity costs. However, governments should make a greater governments should make a greater effort to allocate resources to this effort to allocate resources to this area and to promote private sector area and to promote private sector funding and participation.funding and participation.


C. Bordoy UWC Maastricht Market Failure Public goods Public goods Common access resources and the...

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