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Property rights, externalities, and environmental problems

Property rights, externalities, and environmental problems. Chapter 4. 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

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Property rights, externalities, and environmental problems

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  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

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