Market failures and (potential) fixes

objectives

• Understand the causes and types of market failures and

  environmental externalities

  • Identify how items such as taxes, subsidies and regulations

  influence environmental pollution patterns

  • Understand the key principles of effective market-based instrument

Guiding items

-Revisiting supply and demand

• Categorize costs of economic activities

• Types of market failures

• Intervention through taxes and quotas

• Aftermatch: workshop How to assess total costs of production

1. Revisiting Supply and Demand

• The traditional Demand-Supply curve:

  - Producer willingness to sell (S)

  - Consumer willingness to pay (D)

  - Equilibrium between private parties

Categorize costs of economic activities

• What costs are captured in the supply-demand model for the following goods and services:

  • Principal cost (from seller)

  • Cost to access market/product/service (from buyer)

• What’s missing?

  • Costs to parties not involved in exchange (i.e. external to the buyer and seller)

    - Social and environmental costs of consumptio

Types of market failures

What is a “market failure”?

• Market failure: a situation in which the market-driven allocation of goods and services is not

efficient (not optimal for human welfare)

• There exists another conceivable outcome where an individual may be made better-off without

making someone else worse-off

• Market failures can be the results of ...

• ... the nature or design of a market (interaction of actors needed)

• ... the nature of a good

Externality?

• Externality:

  Markets respond to private costs

  Product price does not reflect total, societal costs of production

  Societal costs exceed market costs → production exceeds social optimum

Obvious solution: price the externality!!!

A negative externality implies social cost are above private cost

• Hence: Apply a tax to raise the private marginal cost

• “Internalize the externality” (polluter pays)

• If the tax rate is set at the level equal to the marginal damage, the tax is called a Pigouvian tax

• Vice versa for positive externalities

What is climate change?

Exam practice question:

There can be positive externalities

• vaccines help other people not to get the diseases

• more green spaces are better

• = affects other ppl in a good way 

Guiding items

Revisiting supply and demand

• Categorize costs of economic activities

• Types of market failures

• Intervention through taxes and quotas

• Aftermatch: workshop How to assess total costs of productions

Intervention through taxes and quotas

Environmental taxes and quota

Defining a tax

A compulsory contribution to state revenue, levied by the government

on workers' income and business profits, or added to the cost of some

goods, services, and transactions. (Oxford English Dictionary)

Defining a quota

Pollution standards in the form of maximum amounts of emmission of

a particular pollutant in the air or the water. They also cover maximum

harvest quotas or minimum forest and natural area covers. (OUP)

Purpose of taxes (and quotas)

• • Raising of revenues & control price

  • Compensate for damages

  • Frequently used to steer behaviour

Examples

- Beard tax (introduced in Russia 1698) to ‘modernize’ the appearance of the society

- Stamp Act 1712 (UK): Tax on newspaper: initially designed to tax the rich. Increasing the circulation of newspaper /made it less accessible for the poor

- Climbing permits in Nepale for high mountains (15,000$ for Mt Everest spring spring season)

- Functionarities in Gongan county, China, Hubei had been orderd to smoke at least 23,000 packs of

(locally produced) cigarettes a yea

Effects of environmental taxes

optimal is A

Environmental taxes

• - A meat tax could be levied on producers, consumers, or both.

  - Taxation level = the social cost of health and environmental impacts

  linked to meat consumption and production

  - The demand change of consumers depends on the price elasticity of

  meat…

  - Carbon tax: Ideally identify the virtual carbon content of goods, then

  apply the tax equivalent to all damages

Price elasticity of demand (ped

• inelastic—> change in price= not rlly a change

• elastic—> change in price= a big change

  • cant substituted easily 

Pros and cons of environmental taxes

• Pros of environmental taxes

  1. *Generates revenue which can be earmarked for green investment

  2. Works on the polluter pays principle

  3. Easier to implement than a quota to implement on consumption

  4. Gives a clear signal, sets economic incentives to adjust

  *Hypothecation: dedicated tax revenue to a particular expenditure does not always occur

• Cons of environmental taxes

  1. Effects on demand depend on the price elasticity of demand

  2. Can be regressive, particularly when applied to staple foods/products

  3. Requires iteration to be effective (i.e. guesswork on effects)

Effects of environmental quotas

Discover the world at Leiden University

Applied originally to industry then to mobile source

• Mainly focused on air pollutants (187 overall): e.g. particulate matter, ozone,

nitrogen dioxide

• Impact: passenger vehicles 98% cleaner, fuels 90% cleaner

• Estimation: $1:$9 multiplier benefits

Pros and cons of environmental quotas

• Pros of environmental quotas

  • Immediate effect (good in the case of harmful substances and avoiding tipping

  points)

  • Informed by science based goals

  • Outcome largely expected

  Cons of environmental quotas

  • Quotas do not incentivise further mitigation

  • Disadvantages small and older production facilities

  • Fines must ≥ cost of abatement to avoid pollution

  • Raises little revenue (only from fines)

Exam practice question:

Hybrid solution

• Auctioning of quotas

  - Limit overall pollution and

  - Create a market

  - Indicate that quotas will decline over time

  • Example: EUETS

Economics in practice!

Market externalities and fixes:

• In addition to negative externalities, positive externalities imply goods which produce a spillover benefit to third parties, such as the pollination service of bees.

• Denmark introduced meat tax

• And a tax on cows (methane taks)

• EU deforestation regulation is a zero quota for traded products linked to overseas deforestation

• Corporate Sustainability Reporting Directive

(CSRD), 2023, requires businesses to report social and environmental impacts

what are the economic costs of the oil spill and design a scheme for compensation of impacted stakeholders

• social impacts

• economic impacts

• env impacts

  • species die

  • affects food chain

  • destroys coastal and marine ecosystems

  • biodiversity loss

for each impact aim for 2-3 categories 

• impacted stakeholders

  • fisherman, consumers, oil producers, companies/ people near the coast

• method for monetizing impact

  • cost of fish

  • cost to clean up the env impact 

  • loss of business cost

• pros and cons limitations of method

  • loss of business cost

    • how do we measure it

    • hard to put monetary value of ecosystem services

  • pros for price of fish

    • can the polluter be fully payed or is it also regulated or bailed out by gov

  • fining the company

    • pros: maybe they will make more successful equipment that prevents oil spill

    • con: less economic growth for companies 

  • cost to clean up the env impact

    • con: only be based on precedent hard to estimate - uncertainty in long term damages

    • pros: there is an exact cost  ; companies invest in an emergency fund

observstions

• most costs not formally marketed (demand proxy markets to evaluate)

• some are extremely difficult to quantify

• costs demand boundary setting (spatially, econ, morally , time horizon)

• feedbacks and causality difficult to evaluate

  • gloal reercussions on energy prices

  • long term health outcome and intergenerational impacts reputational damage  

Cost benefit analysis (CBA)

• compares traditional (marketed) costs and benefits of policies

• common in early economic policy appraisal

• excluded public goods and costs (Externalities)

• ex: investing a wind farm involves a large upfront costs (infrastructure , and labor)  but reduces long term energy costs

• not always counted: carbon saving, effect on local house prices , impacts on nature, shifts jobs

weighted/multi criteria analysis

• Economic or non-economic method to compare policy impact(s)

  • Impacts given weights in appraisal to reflect their prioritisation

  • Reveals trade-offs + helps to achieve desired policy outcomes

  CBA = single balance sheet

  MCA = multiple balance sheets

Total Economic

Valuation (TEV)

• Attempt to capture all costs/benefits into

economic terms

• Non-tangible costs are also quantified

Total Economic Valuation (TEV) methods

• Contingent Valuation: estimate an economic value for a non-market good/service,

  using direct or indirect survey techniques

  - Method 1: Willingness to Pay (WTP) survey: How much are you willing to pay for an X

  improvement in a good/service (e.g. pandas or rainforests)

  - Limitation: no one parts with their money and people want to appear generous

  → overestimated value

  - Answer? Indirect questioning: ask what an average person is WTP. People are

  more likely to reveal their actual preference

  - Method 2: Choice Experiments: elicit the value assigned to an attribute of interest (e.g.

  sustainable sourcing or water quality improvement) by surveying consumers on

  bundles of attributes and changing them in order to reveal inferred value of the

  attribute of interest.

  Hedonic pricing: Experimental method for using existing markets to infer price of non-

  market goods/services, e.g. green spaces near housing (using house market prices) or

  recreation