common pool resources and negative externalities

common pool resources

• resources not owned by anyone

• don’t have a price

• free to use without payment or other restrictions

• eg: clean air, lakes, rivers

common pool resources are…

• rivalrous: the consumption by one person reduces the availability for someone else

• non-excludable: it is not possible to exclude people from using the resources since there is no price

tragedy of the commons

• situation in which individuals sharing a common resource act based on self-interest

• ultimately, depleting the resource

unsustainable production

production that uses resources unsustainably

maximum sustainable yield

maximum use that can be made of a resource that is also sustainable, in that the resource can reproduce itself.

market failure

• the failure of market to allocate resources efficiently

• results in allocative inefficiency

private benefit, external benefit and social benefit

• private: the benefit gained directly by the consumer

• external: the benefit gained by a third party

• social: private + external

private cost, external cost and social cost

• private: cost firm pays when producing a good

• external: cost incurred by third parties

• social: private + external

externality

occurs when the actions of consumers or producers give rise to negative or positive side effects on other people who are not part of these actions and whose interests aren’t taken into consideration

• MSB>MPB

• MSC>MPC

allocative efficiency

when MSC=MSB

negative production externalities

• costs created by producers, in the form of pollution as a side-effect of production

• the free market overallocates resources to the production of a good and more produced than what is socially optimal

negative production externalities graph

• when Qm > Qopt

• MSC > MSB at Qm

indirect tax to correct NPE and overuse of CPR

• increases the cost of production and results in a shift of the supply curve to the left, reducing supply

• if tax is same as the external cost, externality will be corrected and will result in allocative efficiency

consequences of an indirect tax

• advantages: internalise the externality (polluter pays principle), generate govt revenue, lower pollution at a lower overall cost to society

• disadvantages: difficult to design, politically difficult to impose taxes high enough to make a difference, administrative costs, regressive

carbon tax to correct NPE and overuse of CPR

• designated to deal with emissions of greenhouse gasses

• tax/unit of carbon emitted, so the more carbon emitted the higher the tax

• since there are substitutes for carbon, firms may be incentivised to switch to less polluting sources to lower their costs

• Qopt increases because the external cost of production will be smaller

consequences of carbon taxes

• advantages: provides an incentive for firms to switch to less polluting resources, makes energy prices more predictable, internalises the externality, directly targets emissions, govt revenue

• disadvantages: regressive, political pressures to be set too low to make a difference, can’t target a particular level of carbon reduction

tradable permits to correct NPE and overuse of CPR

• involve a system of permits to pollute issued to firms by the government

• permits can be traded in a market, so firms that can produce using less of the permits, can sell them for a profit

• supply of permits is perfectly inelastic and is set at a level lower than what would be the level of pollution without the permits

• As the economy grows, the number of permits demanded increases, increasing their price

consequences of tradable permits

• advantages: internalise the externality, governments can manipulate the distribution, gives the market some freedom, if it’s set at the right level pollution will be lower, exact amount is set

• disadvantages: cap may be set too high due to political pressures so will be ineffective, firms may abuse market power, trading costs

government legislation and regulation

the government uses its authority to enact legislation and regulations in the public’s interest. Could involve: emission standards, quotas, licenses, permits

examples:

• banning of harmful substances

• prohibiting construction in protected areas

• restrictions in the form of quotas

• requirement for firms to install smokestack scrubbers to reduce emissions

consequences of legislation and regulation

• advantages: simple to put into effect and reinforce, easier to implement compared to market-based policies, force firms to comply

• disadvantages: don’t always offer incentive to reduce emissions, no ability to distinguish between firms with lower/higher pollution levels, partially effective since they don’t have specific knowledge on the cause, monitoring costs

collective self-governance

• Users take control of the common pool resources and use them in a sustainable manner.

• Communities that can come together to discuss the best use and allocaiton of resources with future generations in mind, but if the communities cannot communicate or if the cost of self-organizaion are too high, there will be failures. 

education and awareness creation

• Provision of information regarding the polluting activities of firms may turn consumers away from their products- negative impact on their sales. Companies are forced to take the consumer’s opinions into consideration

negative consumption externalities

• costs created by consumers in the form of externalities on third parties

• the free market overallocates resources to the provision of the good and more is consumed than what is socially optimal

negative consumption externalities graph

• when Qm > Qopt

• MSC > MSB at Qm

indirect taxes to correct NCE and prevent overuse of CPR

• internalise the externality

• difficult to estimate the external cost

• inelastic demand so increase in price doesn’t reduce consumption by much but increases govt revenue- can be reinvested in education programmes to discourage consumption

government legislation and education to correct NCE and prevent overuse of CPR

• used to prevent/limit activities by consumers

• restrictions on activities such as in public places or age restrictions

• education and awareness is simple but costly to the govt

• may be ineffective

nudges to correct NCE and prevent overuse of CPR

• designing methods to influence consumer behaviour

• unhealthy foods can be placed in less accessible places or graphic pictures can be used to discourage consumption

• desirable behaviour can be stimulated through incentives