Transcript Property rights to the Polluter

Part 3 Market failure, public policy
and the environment
Necessary conditions for markets to produce
efficient allocations
1.
Markets exist for all goods and services produced and consumed
2.
All markets are perfectly competitive.
3.
All transactors have perfect information
4.
Private property rights are fully assigned in all resources and commodities.
5.
No externalities exist.
6.
All goods and services are private goods. That is, there are no public goods.
7.
All utility and production functions are 'well behaved'.
8.
All agents are maximisers.
4.9 Public Goods
•
Two characteristics of goods and services are relevant to the public/private question.
•
These are rivalry and excludability. What we call rivalry is sometimes referred to in the literature as
divisibility.
–
–
Rivalry refers to whether one agent's consumption is at the expense of another's consumption.
Excludability refers to whether agents can be prevented from consuming. The question of excludability is a
matter of law and convention, as well as physical characteristics.
•
Pure private goods exhibit both rivalry and excludability. These are 'ordinary' goods and services,
such as ice cream. For a given amount of ice cream available, any increase in consumption by A
must be at the expense of consumption by others, is rival. Any individual can be excluded from ice
cream consumption.
•
Pure public goods exhibit neither rivalry nor excludability. An example is the services of the national
defence force.
•
Open access natural resources exhibit rivalry but not excludability. An example would be ocean
fisheries outside the territorial waters of any nation.
•
Congestible resources exhibit excludability but not, up to the point at which congestion sets in,
rivalry. An example is the services to visitors provided by a wilderness area.
Table 4.4 Characteristics of private
and public goods
Public goods and economic efficiency
• For a two person with two private goods economy, the top level,
product mix, condition for allocative efficiency is
MRUSA = MRUSB = MRT
(4.14)
• For a two person economy where X is a public good and Y is a
private good, the corresponding top level condition is:
MRUSA + MRUSB = MRT
(4.15)
• The first of these will be satisfied in a pure competitive market
economy under ideal condition. Hence equation 4.15 will not be
satisfied in a market economy. A pure market economy cannot
supply a public good at the level required for allocative efficiency.
Public goods and ideal market
economies
• For a public good, each individual must, by virtue of nonrivalry, consume the same amount of the good.
• Efficiency does not require that they all value it equally at the
margin.
• It does require that the sum of their marginal valuations is
equal to the marginal cost of the good.
• Markets cannot provide public goods in the amounts that go
with allocative efficiency.
• In fact, markets cannot supply public goods at all. This follows
from their non-excludability characteristic.
• The supply of public goods is (part of) the business of
government. The existence of public goods is one of the
reasons why there is a role for government in economic
activity.
Figure 4.12 The efficient level of supply for a public good.
£
MRUSA + MRUSB = MWTPA + MWTPB
MC = MRT
MRUSB
= MWTPB
MRUSA
= MWTPA

X
X*
Table 4.5: The preference revelation problem
4.10 Externalities
•
An externality occurs when the production or consumption decisions of one agent have an impact
on the utility or profit of another agent in an unintended way, and when no compensation/payment
is made by the generator of the impact to the affected party.
•
Consumption and production behaviour often do affect, in uncompensated/unpaid for ways, the
utility gained by other consumers and the output produced, and profit realised, by other
producers.
•
The two key things to keep in mind:
–
–
we are interested in effects from one agent to another which are unintended,
and where there is no compensation, in respect of a harmful effect, or payment, in respect of a beneficial
effect.
•
Some authors omit from the definition of an externality the condition that the effect is not paid or
compensated for, on the grounds that if there were payment or compensation then there would be
no lack of intention involved, so that the lack of compensation/payment part of the definition is
redundant.
•
The definition given here calls attention to the fact that lack of compensation/payment is a key
feature of externality as a policy problem. Policy solutions to externality problems always involve
introducing some kind of compensation/payment so as to remove the unintentionality, though the
compensation/payment does not necessarily go to/come from the affected agent.
Table 4.6 Externality classification
Externalities and economic efficiency
• Externalities are a source of market failure.
• Given that all of the other institutional conditions for a pure market
system to realise an efficient allocation hold, if there is
– a beneficial externality the market will produce too little of it in relation to the
requirements of allocative efficiency
– a harmful externality the market will produce more of it than efficiency
requires.
• The text looks at three cases of environmental pollution-based harmful
externalities:
– a consumer to consumer case
– a producer to producer case
– a case where the unintended effect is from a producer to consumers
Solutions: Coase vs Pigou
• Pigou  internalising through taxation
– Public economic approach
• Coase  definition of property rights
– Law and economics approach
– Influences liability schemes
– Emission trading mixes the two
Pigouvian taxes
(Arthur Cecil Pigou, 1920)
Tax imposition equal to the MEC of the externality (in the efficient market
equlibrium)
p
MEC = social – priv
costs
Social cost
B
Priv cost
EI
pB
t
DD
qB
q
1. No externality in the market
2. Output reduction
3. Environmental taxes are the only fiscal tool that INCREASES NET social
welfare
p
pE
EI
revenu
e
t
A
DD
qE
Revenue out of the tax
q
•
Net social welfare?
•
The move from q0 to qE causes costs and benefits
•
Usual costs of a tax or monopoly (deadweight loss) = consumer + produces surplus
•
The higher demand elasticty, the lower the CS share of losses
•
CS (PE-e-EI-d) + PS (ebad)
•
If we recycle the revnue to fund public goods, the net cost is adEI triangle
p
c
pE
EI
revenue
e
t
d
a
b
DD
qE
Revenue out of the tax
q0
q
•
Net social welfare?
•
BUT EI-a-d-c is a gross gain in lower social costs (BENEFIT – Public GOOD)
•
It opens an issue: how to evaluate social
•
benefits? (Lectures on Valuation)
•
Thus, a Pigovian tax generatesa net gain of EI-c-d
p
c
pE
EI
revenue
e
t
d
a
b
DD
qE
Revenue out of the tax
q0
q
Pareto efficiency and taxes
1. The polluter faces incorrect market prices
2. A market does not exist: a market for
pollution/air quality
3. The polluter should internalise the cost
1. We do see below that by merging polluters and
victims benefit / utility functions, profit
maximisation produces the correct optimal
outcome
• For a firm (s=steel, x=pollution, P=price,
C=cost)
– Max Ps*S – Cs (s,x) – tx
– we get
– - ∆Cs (s,x) / ∆x = t
– For a firm, optimality is t=MAC
– Facing t, a firm will adjust x following this rule
• To set the optimal level of x, we should know
the ‘social’ optimal level
– Important information challenge
• If we dont know optimal x, a given t assures in
any case that t=MAC across heterogeneous
firms
– This links to Baumol&Oates ‘Efficiency without
optimality criterion’
Taxes or subsidies?
• A subsidy uses tax revenues
• Proper subsidies should fund positive externalities: R&D and
training
• Subsidies to reduce pollution (give money after a defined
reduction) ate a mix of tax and lump sum subsidy in technical
terms
• They lower average costs, reduce fixed costs, may dynamically
increase firms in the market and then supply
• Against polluter pays principle
• In Monopolies with externalities, we should use two
instruments to cope with two mkt failures: a subsidy and a
pigou tax
• Again, taking a steel factory (s) which max
profits managing s and x, a subsidy is
• psS – Cs (s,x) - s(x-x*)
• -sx + sx*
– Tax + lump sum
– Lowers average costs
Subsidy
Often used in conjunction with technology
MSC (Tech 1)
MSC (Tech 2)
MPC (Tech 2)
MPC (Tech 1)
Subsidy
COASE THEOREM
Bargaining solutions and the limitations on bargaining
solutions to environmental problems
•
In a classic paper, Ronald Coase (1960) explored the connection between property
rights and the likelihood of efficient bargaining solutions to inefficient allocations
of resources.
•
Coase proposed that a necessary condition for bargaining between agents to bring
about efficient resource allocation is the existence of a well defined and
enforceable allocation of property rights.
•
Coase also showed that efficient bargaining may be hindered by the presence of
non-trivial transactions costs.
Figure 4.13 The Coase bargaining solution to an externality.
€
MB
MEC
Steel factory and
the Fishery
a
b
0
c

Both using water
as inputs
d
Steel Production /
Pollution of water
• If the property rights are allocated to the
polluter (or not allocated, so we do have
implied polluter’s allocation)
– The polluter will choose the point where marginal
benefits of pollution are 0
– Ps*S – C(s, x); steel, x=pollution
– So first derivative wrt x
• ∆C/ ∆x=0
Coase theorem bargaining
Property rights to the polluter
€
MEC
Bargaining:
willingness to pay
vs Willingness to
accept
E*
WTP
WTA
MB
O
I
Property rights to the polluter
€
E*
WTP >
WTA
E
O
PE
P*
Pmax
I
Property rights to the Polluter
€
MEC
E**
E
MB
O
P**
PE
Unfeasible, WTP < WTA no bargain
Pmax
I
Property rights to the victim
€
E*
O
Pmin
P*
Pmax
P
€
E*
E
O
Pmin
P*
PE
Pmax
P
Coase theorem
• We need to define property rights
• Efficiency does not depend on whom
polluter/victim owns it (irrelevance theorem)
• It mimicks a ‘monopoly’ or ‘merger’ between polluters and
victims
• Merger = society as a whole manages steel, fishery and
pollution
• Equates marginal benefits and costs of steel to maximise
social welfare
• Max Ps*S +Pf*F – Cs(s,x) – Cf(f,x)
• Wrt to x
– ∆Cs/ ∆x + ∆Cf/ ∆x =0
– Optimal solution  marginal costs (one is a benefit) equalised
irrelevance theorem
• *this implies that preferences are quasi linear
or no income effects are present
– Optimal level of externality is independent upon
income distribution (otherwise the eq. Depends
on whom owns property rights in a Edgeworth
box)
– See Varian H. Intermediate MicroEconomics
• Drawbacks
– Useful with not many agents, if not transaction
costs high
– Polluters may fail or be incapable of paying
• Issues of ‘Funds’ creation (through taxes) when
applying Liability
Bargaining solutions and the limitations on bargaining
solutions to environmental problems
•
In a classic paper, Ronald Coase (1960) explored the connection between property
rights and the likelihood of efficient bargaining solutions to inefficient allocations
of resources.
•
Coase proposed that a necessary condition for bargaining between agents to bring
about efficient resource allocation is the existence of a well defined and
enforceable allocation of property rights.
•
Coase also showed that efficient bargaining may be hindered by the presence of
non-trivial transactions costs.
Difficulties of, and limitations of, bargaining as a solution to
externalities problems
•
In Chapter 4, we considered an example in which the noise generated by a
musician disturbed a neighbour.
•
We showed how bargaining between those two parties could generate an
efficient quantity of music playing.
•
Our discussion also demonstrated that efficient bargaining outcomes are
often hard to obtain, and are sometimes impossible.
•
These limitations are particularly likely for many kinds of environmental
problem. Why this should be so?
Difficulties of, and limitations of, bargaining as a solution to
externalities problems
1. The likelihood of bargaining taking place is at best low unless well-defined and
enforceable property rights exist.
–
–
For many environmental resources, well-defined and enforceable property rights do not exist.
An important example is that in which the environmental resource is an open access resource in which
exclusion is impossible except at very high, and possibly prohibitive, cost.
2. Second, bargaining solutions require that the expected gains from bargaining are larger
than the expected costs of carrying out that bargaining.
–
–
–
Thus, bargaining is facilitated by the existence of a relatively small number of affected parties, and by all such
parties being easily identifiable.
Again, many environmental problems fail to satisfy either of those properties. Typically, environmental
degradation affects many people and in many cases, as with vehicle pollution, is attributable to a large number
of sources.
It is often difficult to identify all affected parties, and the transactions costs associated with undertaking a
bargaining exercise can be enormous. Hence where the number of affected individuals is large, the scope for
efficient bargaining behaviour is restricted.
Difficulties of, and limitations of, bargaining as a solution to
externalities problems
3. Difficulty (or impossibility) of intertemporal bargaining, including bargaining between
current and future generations.
–
–
–
Often, environmental externalities cut across generations – our behaviour today imposes externalities on
future persons.
While bargaining between affected individuals at one point in time seems feasible, it is difficult to imagine that
this could happen between representatives of the present generation and those not yet living.
One would not, therefore, expect that bargaining between directly affected individuals and firms would offer
much prospect of bringing about an efficient response to global climate change, involving as it does many
generations.
Role of government
•
•
•
•
•
•
If bargaining does offer the prospect of substantial efficiency gains, then government
should facilitate it wherever that is cost-effective.
It could do so by clearly defining and explicitly allocating property rights where that is
practicable (and ethically acceptable).
Where environmental problems spill over national boundaries, as in the case of
biodiversity decline or greenhouse gas emissions, further complications arise.
Government might seek to develop and sustain an institutional structure that
maximises the scope for bargaining behaviour.
Gains may also derive from government’s taking some responsibility for environmental
monitoring so as to identify pollution producers and recipients, and disclosing
information from this to affected parties.
Access to the judicial system should be easy and cheap, and also equitable as between
different classes of parties. This will facilitate use of the liability principle.
Role of government
•
Elinor Ostrom (1990) has shown that in many societies bargaining solutions to resolve
disputes are often embedded in long standing cultural traditions and social norms, and
collective choice mechanism operating within these frameworks.
•
These social structures can be of great efficacy and can bring about efficient resources
allocations even in the context of common property (as opposed to private property)
regimes.
•
However, increased complexity of social and economic systems, along with greater
geographical and social mobility, tends to weaken those traditions and norms.
•
One has to conclude that the limitations to bargaining that we have described do
appear to be very substantial, and it would be inappropriate to place too much reliance
on such a mechanism as far as environmental pollution problems are concerned.
•
When it comes to dealing with pollution, or other environmental, problems that spill
over national boundaries, the absence of supra-national sovereign institutions means
that there is often little or no alternative to bargaining solutions.