A) Property Rights and Efficient Markets
Competitive market equilibria are efficient. To the list of assumptions or conditions needed to ensure a competitive market we need to add a structure of property rights you probably accepted as given.
1) Exclusivity: Give examples of resources whose benefits and costs do not accrue solely to the owner.
2) Transferability: Why is this condition essential to market equilibrium?
3) Enforceability: Why is this condition essential to market equilibrium?
B) Scarcity Rent and Producer Surplus
1) What characteristic distinguishes increasing, decreasing and constant returns to scale from one another? Which would you expect to observe in the long run?
2) Why do supply curves for most natural resource-based industries slope up in the long-run?
3) Alison grows corn in the rich, fertile soil of Iowa; Robert grows corn on his family’s rocky Vermont farm; both sell their corn at the nationally determined price. Robert barely breaks even. Even after paying herself a salary, Alison has cash left over at the end of the year. Explain the economic role of this surplus. What distinguishes it from profit?
We encounter scarcity rents throughout a free economy whenever the quality of resources vary in nature. Think Michael Jordan and Luciano Pavarotti as well as well as the oil fields of Saudi Arabia. Efficient outcomes often include an unequal distribution of scarcity rents.
C) Externalities
Externalities arise whenever the exclusivity assumption is violated: The use of a product or a transaction between buyer and seller imposes costs or benefits on other agents.
| 1) In the steel mill-resort hotel example (draw Figure 4.4 in your notes), | |
| a) what costs do the buyers and sellers of steel not bear? | |
| b) why is the market output of steel too large? | |
| c) is the socially desirable level of pollution zero? | |
| d) is the socially desirable level of pollution below the market level? | |
| e) what incentives exist to recycle or reuse the polluting substance? to find less polluting ways of producing steel? | |
| f) indicate on your graph the lost surplus (the harm to society) from the pollution externality. | |
2) (C1) is an example of a negative externality or external diseconomy. Give an example of a positive externality (external economy); draw a graph comparing the market equilibrium with the social optimum (think carefully about whether the externality drives a wedge between private demand and social marginal benefit or between private supply and social marginal costs); indicate on the graph the lost surplus resulting from the market solution.
3) Not all externalities lead to inefficiency. Pecuniary externalities arise when the external effect is transmitted through higher or lower prices. Explain the pecuniary externality that arises when a new firm moves into town bidding up the rental price of land.
D) Effects of Other Ownership Structures
1) Common-property regimes apply, for example, to possessions within a household, some traditional tribal communities, and grazing and fishing rights possessed by the individuals or communities that surround the resource.
Mary (who attends Rosemont) and Beth (who goes to Villanova) rent rooms in a house off campus. Their landlady told them they were free to harvest all the apples from the tree in the backyard. If they cooperate in harvesting the apples (waiting until they are fully ripe and sharing the harvest equally) they will each get $50 worth of apples. Each worries that the other may sneak out at night and harvest the apples early. Early harvesting yields a number of unripened fruit reducing the total value to $75; but this all goes to the harvester, leaving nothing for the person who waited. If both of them sneak out at night to do early harvesting, then each ends up with $25.
| a) If Mary and Beth act purely out of self-interest (and will never see each other again) each will end up with $25 (a socially inefficient solution), because harvesting early is the best strategy each can play given the decision of the other. Explain why this is so. | |
| b) How would your answer change if Mary and Beth were sisters or planned to live in the house for the foreseeable future? | |
| When family, community, religious, or ideological ties are strong, common-property arrangements can be efficient. History suggests that such arrangements rarely survive population pressures, technological change, or changes in family or community beliefs. | |
| c) Can you give examples of common-property arrangements that appear to be working well? or that don’t seem to be working? | |
2) Open-access resources are available on a first-come, first-served basis because no one owns them except by possession. Think through the bison example (Figure 4.5). Note that this does not describe the market for bison, but rather the market for bison hunting. Quantity of hunting effort might be days or hours of hunting. The example assumes away the actual marginal cost of hunting (food and other supplies the hunter uses as well as the opportunity cost of her time) since it will be constant per unit of time spent hunting.
| a) Why does the marginal benefit from hunting effort fall? | |
| b) From the standpoint of hunters who have not yet entered the prairie, increased hunting by one group raises the hunting effort needed to achieve a particular harvest. It imposes a marginal users cost on the new hunters. Why is this social marginal cost the mirror image of the marginal benefit curve? | |
| c) In the market equilibrium, hunters do not face the marginal users costs. Net social benefit (total surplus) is the difference between marginal benefit and marginal cost. Use Figure 4.5 to illustrate why the market equilibrium is inefficient (it produces zero total surplus) relative to the socially efficient outcome MB = MC. | |
| The "tragedy of the commons" is that open-access resources are over-exploited. | |
| d) Suppose Ted Turner gains title (ownership) of the bison grazing land. How much will he charge hunters per unit of hunting effort if his goal is to maximize the social benefits of hunting bison? | |
| e) How much will he charge hunters if decides to exploit his monopoly control over the bison herd? (review your Econ 105 notes on monopoly) | |
| f) How would your answer to (d) change if AMTRAK customers enjoy watching bison on cross-country train journeys? | |
3) Public goods (or bads) arise when the exclusivity property rights assumption is violated because the resource is indivisible (one person’s consumption does not diminish the amount available for others) and, once made available to paying customers, the resource cannot be denied to those who fail to pay for it (nonexcludability).
| a) Determine whether each of the following is a public good: bio-diversity, the Bryn Mawr movie theater, a pornographic drive-in movie theater. | |
| b) In Figure 4.6, B comes along first. Why doesn’t A put qa into the bio diversity collection box? Suppose A had come along first, how much do you think he would put in? | |
| c) Summarize the basic logic: Why will a market economy under-produce public goods? | |
| d) National Public Radio is arguably a public good. The amount it raises in contributions exceeds the maximum the richest and most avid listener would be willing to contribute. Why? | |
4) In the absence of uncertainty the competitive market will yield a discount rate (the rate of exchange between consumption today and consumption in the future) that is equal to the riskless return on investment – the wealth created by transforming resources into capital. Discount rates used by businesses and individuals in practice vary to incorporate a risk premium to compensate the investor for the risk that the project will not succeed.
When social and private discount rates diverge (even after adjusting for the risk premium) market allocations over time are inefficient.
| a) Using the methodology you developed to answer (C4) from the Dynamic Efficiency class, determine what will happen to current consumption of a resource if the market discount rate falls below the social discount rate. Will too much or too little be consumed today? | |
| b) Once source of divergence is fear of government expropriation of resources. What will happen to a firm’s discount rate and current consumption of a resource if it fears the assets providing access to that resource will by taken over by the government? | |
| c) Explain deforestation by poor families around cities in some low income countries as an example of diverging discount rates? | |
E) The Root of the Problem
1) Economics sees environmental problems as examples of social inefficiencies. Inefficiencies, in turn, result from wedges that appear between private and social benefits or between private and social costs. Eliminate the wedges and you eliminate the inefficiencies – and the environmental problems.
2) Others view the problem as more fundamental. Paraphrase Lynn White’s argument.