Market Failure

1. Market Failure Public goods Common access resources and the threat to sustainability (Tragakes, 2012, pp. 119-130) C. Bordoy UWC Maastricht

2. Lack of Public goods • A private good has two characteristics: • Rivalrous: its consumption by one person reduces its availability for someone else (when you buy a t-shirt, another person cannot buy it). • Excludable: It is possible to exclude people from using the good. Normally achieved by charging a price. Most goods are private goods. C. Bordoy UWC Maastricht

3. A (pure) public good has the following characteristics: • Non-rivalrous: its consumption by one person does not reduce consumption by someone else. • Non-excludable: it is not possible to exclude someone from using the good. Examples: lighthouse, police force, national defence, non-toll roads, fire protection,… C. Bordoy UWC Maastricht

4. Why are public goods a type of market failure? • Private firms have an incentive to provide excludable goods because they can charge a price for them and cover their costs. • No profit-maximising firm is willing to produce a good if it cannot charge a price for it. • As a result, the market fails to produce goods that are non-excludable → misallocation of resources to the production of public goods. C. Bordoy UWC Maastricht

5. Free rider problem: when people can enjoy the use of a good without paying for it. It arises from non-excludability. Impossibility to charge a price Free rider problem Non-excludability Private firms do not produce them Underallocation of resources C. Bordoy UWC Maastricht

6. Quasi-public goods (impure public goods): • Non-rivalrous • Excludable Public museums that charge an entrance fee, toll roads. They could be provided by private firms but, since they have very large positive externalities, they are directly provided by the government. C. Bordoy UWC Maastricht

7. Correction • Public goods are underprovided by the market → the government must ensure that the optimal level is produced. • Direct provision, financed out of tax revenues. Made available to the public (nearly) free of charge. • Decisions to be made: • Which public goods to provide • In what quantities C. Bordoy UWC Maastricht

8. Limited gov funds → opportunity costs • Need to decide which public goods will provide the greatest social benefits. • Difficult to estimate these expected benefits, as they do not have a market price (which reflects the benefits to consumers). • Information about demand gathered through surveys of people and used in ‘cost-benefit analysis’. C. Bordoy UWC Maastricht

9. The goods should be provided if benefits are greater than costs. • However, cost-benefit analysis is very rough, as people tend to overvalue goods they really want. C. Bordoy UWC Maastricht

10. Common access resources and market failure • Common access resources are resources that are not owned by anyone, do not have a price and are available for anyone to use without payment. • Examples: clean air, lakes, rivers, fish in the open sea, forests, ozone layer,... • They are a type of market failure because: • They are rivalrous (characteristic of private goods) • They are non-excludable (characteristic of public goods) C. Bordoy UWC Maastricht

11. Sustainability and common access resources • Sustainability is the ability of something to be maintained or preserved over time. • For the environment it refers to environmental preservation. • For the economy it refers to the preservation of humankind’s ability to provide goods and services to satisfy needs and wants in the future. C. Bordoy UWC Maastricht

12. Conflicts between environmental and economic goals: • Economic goals involve • efforts to increase the quantities of output produced and consumed, but • focusing in economic goals while disregarding the environment may result in its destruction. • Environmental goals involve • the preservation of the environment, but • focusing on environmental goals while disregarding the economy may result in humankind’s inability to satisfy needs and wants. C. Bordoy UWC Maastricht

13. Balance between both goals: Sustainabledevelopment, ie, development that meets the needs of the present without compromising the ability of future generations to meet their own needs. • Society should pursue economic growth that does not deplete or degrade natural resources. C. Bordoy UWC Maastricht

14. Pollution of affluence and pollution of poverty • Two types of environmental damage: • Pollution of affluence. It arises from industrial production and high-income consumption patterns that involve the heavy use of fossil fuels, using up open access resources and leading to climate change. • Pollution of poverty. It arises from production and consumption activities that are due to poverty. Due to economic activities by very poor people in an effort to survive. C. Bordoy UWC Maastricht

15. Overuse of common access resources and their depletion are the external costs of industrial production and high-income consumption activities, both based on use of fossil fuels. • Difference between MPC and MSC curves represents the external costs in terms of overuse of common access resources: • Social cost arising from the cement factory’s overuse of clean water, sea life and ozone layer, • The cost to society of causing global warming C. Bordoy UWC Maastricht

16. Illustrating overuse of common access resources • MPC: private costs of a cement factory. External costs can be interpreted as the social cost of overuse of clean water, sea life and ozone layer or as the cost to society of causing global warming. • Burning of fossil fuels causes overuse of common access resources, an external cost. P MSC S=MPC External cost Popt Pm D=MPB=MSB Q Qopt Qm C. Bordoy UWC Maastricht

17. If the cement factory payed for the overuse of these resources, the producer would not stop using common access resources but he would stop overusing them, leading to a sustainable use. • Overuse of common access resources can also result from negative consumption externalities (example: heating oil). C. Bordoy UWC Maastricht

18. Poverty as a threat to sustainability • Poverty is the most important cause of environmental destruction, according to the Brundtland report. Two examples: • Lacking modern agricultural inputs, poor people deplete soil’s natural minerals, making them less productive. • The pressure to open up new land for agriculture, causing deforestation. • These production and consumption activities of very poor people can also be interpreted as negative externalities involving overuse of common access resources. C. Bordoy UWC Maastricht

19. Government responses to threats to sustainability • Legislation. Examples: • restrictions on emissions from cars • restrictions on emissions from factories • requirements to install devices that reduce air pollution • issuing licences or permits for fishing and hunting • restrictions in the form of quotas for fishing • establishment of protected areas for the protection of biodiversity and endangered ecosystems C. Bordoy UWC Maastricht

20. Advantages: • Simplicity • In most cases, they can be very effective. • In the case of emissions industrial production, they avoid the technical difficulties of market-based solutions. • Limitations: • In the case of pollution, they do not offer incentives to reduce emissions. • Cannot distinguish between high and low cost polluters. • Costs of monitoring to detect violations. C. Bordoy UWC Maastricht

21. The following two measures deal with the problem of carbon dioxide emissions. • Carbon taxes. They aim at taxing the use of fossil fuels in accordance with the amount of carbon each ones emit. Hence, users face the incentive to swtich to fuels that emit less (or no) carbon. Denmark, Finland, France, Ireland, NL, Poland, Sweden, some states in Canada and the US. C. Bordoy UWC Maastricht

22. Cap and trade schemes. Permits to release carbon dioxide are distributed to producers, and they can be bought and sold in the market. (EU ETS) C. Bordoy UWC Maastricht

23. Evaluating carbon taxes and cap and trade schemes • Carbon taxes fix the price of the pollutant in the form of a tax, and allow the quantity to vary. • Cap and trade schemes fix the quantity of the permissible pollutant and allow its price to vary according to supply and demand. C. Bordoy UWC Maastricht

24. Carbon taxes are preferred because: • They make energy prices more predictable, benefitting firms, which need to plan their costs ahead of time. • Easier to design and implement, unlike cap and trade schemes, which require to set the cap at the right level and distributing the permits. • Can be applied to all users of fossil fuels. C&T schemes target one particular industry or small group of industries. C. Bordoy UWC Maastricht

25. Do not allow for manipulation by governments and interest groups. • Do not require as much monitoring and enforcement. • C&T schemes face strong political pressures to set the cap too high. • Carbon taxes are less likely to be used to restrict competition between firms. Some firms could buy up more tradable permits than needed and drive up their price in order to prevent new firms from entering the market. C. Bordoy UWC Maastricht

26. Arguments in favour of C&T schemes: • Carbon taxes may be too low. Gov may be unwilling to set carbon taxes high enough for these to provide the necessary incentives. • Carbon taxes cannot target a particular level of carbon reduction, leading to uncertain carbon-reducing outcomes. • Carbon taxes are regressive, as lower income consumers wuld be affected proportionately more than higher-income consumers. • Carbon taxes must be adjusted for inflation, whereas adjustment is automatic with C&T schemes. C. Bordoy UWC Maastricht

27. Funding for clean technologies. Clean technologies aim towards a more responsible and productive use of natural resources , reducing negative environmental impacts. Ex: wind power, solar energy, biofuels, recycling... It is important that both private firms and governments be involved in activities leading to innovation and development of clean technologies. However, funding is insufficient. C. Bordoy UWC Maastricht

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