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Market Failure

Environmental Economics
Chapter 10:

 Free Market (Efficient allocation of

resources among alternatives ends)
 But only for limited goods
 Monopoly is a type of market failure
 Market failure because of two
Market reasons
failure
 Inherent characteristics of certain
resources
 Clearly defined property rights (PRs) in
the absence of institutions

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Excludability and Non-excludability

• Excludable resource regime
– One person can prevent another from using the
resource
– Necessary for markets to exist
• Non-excludable
– No enforceable property rights due to
technology or social institutions
– Can’t charge for use
– Markets not possible
• Some resources non-excludable by
nature. None are inherently excludable.
• Excludability is a product of institutions.
• Example: Ocean fishery

• Rival Goods
– My use leaves less for you to use
– All ecosystem goods are rival
• Non-rival (or non-depletable)
– My use does not leave less for you to
Rivalness use
– Marginal cost for additional user = 0
– What is optimal price under MC=MB
rule?
– Rationing function of price leads to
under-consumption
– All non-rival resources are services

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Rivalness
• Non-rival but congestible
– Rival at high levels of use
• Anti rival
– My use makes you better off
Rivalness – What's an example?
(Cont…) • Markets in non-rival resources lead
to under consumption.

• Rival or non-rival is an inborn

characteristic of the good, not a
result of institutions

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So What?
Excludable Non-Excludable
Market Good: cars, Open Access Regime:
houses, land, oil, Oceanic fisheries, timber
Rival timber, waste etc. from unprotected
absorption capacity? forests, waste absorption
capacity

Tragedy of the non- Pure Public Good:

Non-rival, commons: Information, most ecosystem
patented information, services, e.g. climate stability,
Anti-rival e.g. energy efficiency, coastline protection, life
pollution control tech. support functions, etc.

Non-rival Toll Good, club good: Free Rider Problem

congestible Roads, parks, beaches,
etc.

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Monopolies (or other market

structures)
Impossible – inefficient allocation
to reach – type of market failure generated by a
the structural problem: the absence of
competition.
efficient
outcome? Characteristics of certain types of
resources (non-rival, open-access,
pure public)
“Missing” markets
No institutions clearly defining
property rights

 Hardin: « The tragedy of the commons »

 Grazing commons in England
– 100 HH
– Grazing areas can support 100 cows indefinitely
 If 1HH adds 1 more
Open access – Grass need to be shared among more cows
regimes – Grass yield declines, and each cow will be just a bit
thinner.
– One person  benefits of having two cows but
will share the costs of all the cattle being thinner with
everyone else;
– If everyone thinks in the same manner, households
will keep adding cattle to the commons productive
capacity has declined
– Each person acting in rational self-interest degrades
the commons, and everyone is worse off than if he or
she had stuck with one cow per person.

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US Bison

Bison population
• Plentiful and available for all  Unrestricted
hunting access for hides and meat
• In the absence of scarcity it was easily available

Efficiency
• Hunting did not affect the time and effort of other
hunters
• Efficiency was not threatened by open access

Eventually
• Demand and scarcity increased  No. of hunters
increased
• Additional unit of hunting activity increased the
amount of time and effort required to produce
given yield of bison

•
The “Tragedy of the commons”
•
Non-excludable but rival
•
Lead to Tragedy of the commons.
•
Common property vs. open access

Open Access Tragedy of Open access regime/

•
Open access problem
• Communities make their own rules
to govern resources.
• Perverse feedback mechanism

• Ocean fishery
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Ending the tragedy of the commons

Public Goods

• Free-riding
• No price signal as feed-back mechanism
– Scarcity  price increase  innovation

- Lack of Incentives to produce them

- Lack of incentives to create technologies

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• Why do we have patents?

Non-rival & • When did patents come
Excludable:
tragedy of about?
the non- – 1790s in US
commons – 1947 international, rarely used
(PATENTS) before 1980s

Do patents promote ecologically

sustainable scale?

• Create inadequate incentives for

inventions that provide or preserve
public goods
• Raise costs for research that
promotes the public good
• Example: new technology for
highly efficient solar energy

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Market goods:
The theory of
Externalities
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• Definition
– “an activity by one agent
causes a loss (gain) of welfare
to another agent”
Externalities – “The loss (gain) of welfare is
uncompensated”
• Completely Internal to the
Economic Process. Why?
• How are these related to public
goods?
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Externalities

 Efficient PRs structure  exclusiveness (a main

characteristics)
 Violation of PRs cause market failure, if the agent does not
bear all cost/consequences of his/her action.
 Example: “Indus River and industrial affluent”
 River bank upstream manufacturer or other industry etc.
and downstream residential/ recreational or
agriculture/fishing.
 Industry does not bear all cost e.g. health cost/ reduced
business cost of downstream people.
 Efficient allocation may not be possible.

Kotri Industry

Price Social marginal cost

$/unit

Private marginal cost

(Exclusive pollution control
and damage)

P*
Pm

Quantity (Q)
Q* Qm

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 If no emission control
 Producer seek to maximize his/her
private producer surplus
 Producer produces quantity Qm

Kotri
Industry…  But its not efficient choice
 Since we consider societal benefit
that maximized at Q*

What Can we Do?

• Regulations
– Best management practices
– Best available technologies
– Caps on production
• Property rights
– Let market figure it out

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What Can we Do?

• Tax
– Set price, let this determine
Q at which demand = price
• Tradable quota
– Set Q, let this determine
price

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• Who owns the environment?

Property • polluter ‘rights’

Rights

• sufferer rights

• What about future

generations?
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• Economic growth must imply loss

of ecological function
– Ecosystem services are ecological
functions with value to humans
Internal
Nature of • Externalities from ecosystem
‘Externalities’ structure lost

• Externalities from waste outputs

• If ‘externalities’ are unavoidable,

they are not external
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What’s better, tax or

quota?

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• For a market to work, everyone must be

able to participate

Missing • Future generations can’t participate in

markets today’s markets

• People without money cannot

participate, e.g. many indigenous
peoples

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• Irreversible changes…e.g
Thar Coal.
Missing – Topsoil loss
markets – Non-renewable resource use
and emissions
– Ecosystem loss and extinction
– Redesigning community
infrastructure to depend on
non-renewables

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The End!

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