Property Rights, Externalities & Environmental problems
According to normative criterion, an environmental problem exists when
resource allocation is inefficient
Let’s examine property rights We all, including govt, undervalue environmental
assets. capitalist economy: PRs refer to entitlements –
use of resource depends on PRs governing them
centrally planned economy: people’s needs more important is objective – efficiency
Why the interests of individual are different than that of a group? Under what circumstances does this happen?
Efficient PR structures
3 main characteristics:I. Exclusivity: C+B to ownerII. Transferability: voluntary exchange of
rightsIII. Enforceability: secure from encroachment
PRs exchanged in market economy – seller: right to stop consumer from using in
absence of payment – consumer: chooses how much to buy at what price for net benefit
Consumer’s net benefit
Area under AR (dd) curve - cost (expenditure)
PS
CS
D/AR
S
Q0
P
Price is adjusted by demand & supply, where both maximise their benefits.
Efficient allocation by static efficiency.
Net benefit= PS+CSVC
It is important to find how net benefits are distributed between the consumer & the producer.
Efficiency is achieved because of the price system & not because of C/ P’s self interests
Adam Smith: selfish people efficiency Freedom of choice to both Consumers &
Producers
Scarcity Rent
Area under price line is TR Area under MC curve is TVC PS related to profits. It’s = profits + rent new firms enter with rise in price rent Without price rise - zero rent Most NRs give rise to rent PS in the long run is scarcity rent
Externalities
A decision maker doesn’t bear cost of consequences of his decision
Externality exists when welfare of a firm / an individual depends not only on his activities but also on activities under control of some other agency e. g. waste in river water imposed external cost on resort.
Pvt sector doesn’t think of externalities ∴ doesn’t consider cost (control pollutants) for it – produces more quantity at lower price
Private MC of steel plant is MCp & for society it is MCs.
Price
production
P*
Social marginal cost
Private marginal cost
Q* Qm
O
Pm
With no control onEmission production = OQm – not efficient OQ* is efficient as NB are maximised – if costs external no search for ↓ pollution – releasing waste outside is inefficiently cheap
Types of externalities
External effects can be +ve or -ve
External diseconomy/economy: pollution/garden
Pecuniary externalities: when external effect is transmitted through altered prices viz rent ↑ with new entry ∴ all land up paying more rent = -ve effect on all those paying rent.
Pollution is not pecuniary externality as the effect is not seen through prices.
Improperly designed PRs system
Entitlements to resource use:
a. Private
b. State ownership
c. Common property ownership
d. Open access regimes: common pool,
non -exclusivity & divisibility.
Exploited by anyone
Capture of resource by one group ↓ availability for others
Open-access resources
First-come first-serve basis Tragedy of the commons American Bison were plentiful – hunting with
no control – aggressiveness of one didn’t affect time & effort by other hunters
In absence of scarcity, efficiency was not threatened by open access.
As DD for bison scarcity ∴ more time & effort
Bison harvesting MB slopes
downwards as amount of hunting efforts rises, number of bison falls. Thus smaller population supports smaller harvests per unit of effort expended.
Excessive exploitation of herd – cannot appropriate scarcity rent ∴ ignore it.
Destroying incentive to conserve
Harvest effort
Total benefits / cost €
Total cost
Total benefits
QO
Public Goods
Non-exclusivity – non-excludability – landscapes. Air, water & biological diversity
Consumption indivisible
Biological diversity: Genetic variability among individuals in single species Number of species within community of organisms
Genetic diversity has proved to be important in development of new crops e.g. disease resistant barley – interdependence of species within ecological communities, a particular species may have more value beyond its intrinsic value
Imperfect Market Structure
Environment problems – when one of the participants in an exchange of PRs is able to exercise an inordinate amount of power over the outcome – Monopoly – violates definition of efficiency in goods market
Monopoly always supplies less and charges more than in competition.
Static efficiency is achieved when OB is supplied – net benefit is ∆ HIC. But monopoly will sell OA & charge OF.
price
quantity
MC
D/AR
A B
E
MR
D
C
I
F
G
O
Producer’s surplus is maximised is clearly inefficient. Society looses net benefit = ∆ EDC
H
Divergence of Social & Private Discount Rates
Producers while achieving max surplus, maximise present value of net benefits under “right” conditions, viz. absence of externalities
Firms must use the same rate to discount future net benefits, for efficient use of the resources, that is appropriate for the society
Higher rate: extract & sell faster than efficient Lower rate: excessively conservative
Private & Social Rates
Social discount rate= social opportunity cost of capital
Risk premium = additional cost of capital required to compensate owner when actual ≠ expected
Risk-free cost of capital – rate of return when no risk = rate expected
Therefore, due to the risk premium, the cost of capital is higher in risky business than in no-risk industries. Private & Social discount rates are different as the risk premiums in the two are different.
Risk taken by a single person is higher than when it is taken by society as a whole.
∴ private risk > social risk ∴ private discount rate> social discount
rate current production is higher than desirable to maximize net benefits to the society
Energy production & forestry both inefficient
Private & Social discount rates may not always diverge.
If they do, then market decisions are not efficient
Government Failure
Market & political processes are sources of inefficiency.
Improper incentives are the root cause Rent seeking → net benefits to special group
→ but ↓ net benefits to society as a whole Losers don’t protest? – voter ignorance –
economically rational – high cost of keeping informed & low probability that a single voter is decisive – difficult to unite those – opposition to special groups is always under funded
Rent seeking – takes many forms - High price under ‘infant industry argument’ - Special subsidies to consumers Govt. policies that are inefficient : rationing,
low price of oil, free education to a few…. Policies create evn problems: easy loans for
cars → more cars → more pollution Govt. failure - direct challenge: to assumption
that intervention by govt. automatically leads to greater efficiency & sustainability.
Environmental problems due to divergence between individual & collective objectives – can be resolved by realigning individual incentives to make them compatible with collective objectives
Economists reluctant to argue that values of consumers are warped – assume ‘correct set’ of values
Capitalism & democracy on presumption: majority knows what it is doing – ballots for representative or $ votes for goods & services
The pursuit of efficiency
PRs are ill-defined ∴ evn problems To restore efficiency when affected
people are a few Example: a Resort & a Steel Plant: o Both are on the bank of a river.o Both have PRs to use river.o Water flowing from plant towards resort.o Resort gets polluted water, due to
dumping of waste by the plant.o Its’ clientele is affected.
If accepts - returns higher = A+B (surplus)+ C+D (bribe)
Price
production
P
Social marginal cost
Private marginal cost
Q* Qm
A
B
DC
O
If resort offers a bribe of C+D less production from OQm to OQ*. Damage less.But if plant refuses PS = A+B+D.
Society better off by C.
Net benefits from production OQm = A – C. and from OQ* = A
Find:
Whom should PRs belong? To the party who seized it first? How to handle environmental risks? Answers By whom?
By the court system
Resolving the conflict
The courts can resolve environmental conflicts by imposing property or liability rules
PRs specify initial allocation Entitlement : right to add waste & right to attractive
river view Court goes by pre-eminent right –injunction on
violating rights injunction removed by the Consent of the party whose right was violated
Out-of-court settlement – monetary gain In absence of court - who can seize it easily -naturally Goes to steel co. Court should decide whether to overturn this
allocation.
Coase Theorem: Ronald Coase (1960)
Negotiation costs are negligible + affected parties only a few, court - give PRs to anyone
Any way efficient allocation - theorem C-B will change for parties PRs to Co. bribe by resort PRs to resort steel co. must bribe = compensation
for all damages - ∴ produces OQ* as prv benefits maxm. (uses Soc MC as Prv MC due to compensation
PRs to resort – cost borne by steel co. PRs to Co. cost borne by resort Either way efficient production
Shouldn’t forget administrative cost + lawyer’s fees + court’s time…
Govt. can create regulations on pollution control – backed by fines, jail sentence, tax..
Bribes : not the only means If transaction costs high & benefits little –
better to live with inefficiency New ways of life: create problems Role of govt.
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