Property rights, externalities, and environmental problems

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

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 • public good • 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