Download Market Failures

AGEC 604
Natural Resource
Economics
Lumber Mill
Photo NOAA
Slag Pile
Market Failures
Part I
Market Failures – Introduction
¾
Market Failure
• Occurs when the market system does not achieve
economic efficiency
• Does not imply a barrier to market clearing
• Market clearing forces do not achieve maximum social
net benefits
¾
Causes
• Property rights not well-defined
• Divergence of social and private discount rates
• Government failure
• Market power
Market Failures - 2
¾
Market Failures
• Not all market failures should be corrected
•
Key
– Correct only if the cost of the correction is less than
the benefits of the correction
1
Externalities
¾
¾
Definition
• An externality is present when the welfare of some
economic agent depends directly on his/hers actions
and the actions under the control of some other
economic agent as well
• Exclusivity is violated
Types
• External diseconomy
– Harmful affect
• External economy
– Beneficial affect
• Pecuniary
– Affect arises as higher prices in the market
External Diseconomy
¾
External Diseconomy
• Private marginal costs
are less than society’s
marginal costs
MC social
pe
¾
Results
• Price too low
• Too much of the
resource consumed
• Too much of the
externality being
produced
MC private
p*
qe
q*
D
Q
External Economy
¾
¾
External Economy
• Private marginal costs
are greater than
society’s marginal costs
Results
• Price too high
• Too little of the
resource consumed
• Too little of the
externality being
produced
MC private
p*
MC social
pe
D
q*
qe
Q
2
Externality Exercise
¾
Exercise for the Student
• Provide a graphical analysis when the willingnessto-pay or demand curves differ between private and
society
– What happens to
– Price
– Quantity
– Externality produced
Open Access vs. Common Property
¾
¾
¾
Open Access - everyone has the right to the property
Common Property - rights are defined so there is
excludability to a point
Continuum
Regime
Type
Private
Property
Owner
Owner’s Rights
Individual Control Access
Socially
acceptable uses
Common Collective Exclusion of
Property
non-owners
Owner’s Duties
Avoid socially
unacceptable
uses
Maintenance
Open
Access
None
None
Capture
Open Access
¾
Open Access
• Resources that are not exclusively controlled by a
single economic agent
• Violates
– Exclusivity
– Enforceability
¾
Examples
• Air
• Water
• Animal populations
3
Navajo Example
¾
Navajo Indian Grazing Example
• Source: Johnson and Liebcap, Economic Inquiry
18(1980):69-86.
• Problem - overgrazing on the Navajo Reservation
– Decrease in animal performance
• Background
– Largest tribes
– Loose federation
– Pastoral economy
• Johnson and Liebcap’s argument
– Property rights given to tribe instead of individuals
– Making a common property resource
Navajo - 2
¾
Navajo Indian Grazing Example - Continued
• Result just the opposite as intended
•
Why?
– Uncertainty over land boundaries
– Grazing restrictions not enforced
– Large number of herders with small herds
– Boundaries never marked or written down
Open Access / Common Property Conclusions
¾
Inability to Exclusively Control a Resource
• Use it before someone else uses it - use it or lose it
• Use more than the efficient point
¾
Common Property Allows Some Externalities to Exist
• As long as externalities are relatively unimportant,
common property is fine
– Expensive to manage private property
• As the externality becomes more burdensome, a switch
to private property rights may be advantageous
4
The Road Continues
AGEC 604
Natural Resource
Economics
Lumber Mill
Photo NOAA
Slag Pile
Market Failures
Part II
Public Good – Introduction
¾
Public Good
• A good whose consumption is indivisible
• Indivisible consumption
– One person’s consumption of a good does not
diminish the amount available to others
– Key – non-rival in consumption
• Examples
– Warning systems
– Lighthouses, tornado
– Landscapes
– Genetic diversity
– Defense
– Parks
5
Aggregate Demands
¾
Aggregate Demand
• Demand representing all consumers
• Used to find societies efficient point
¾
Differences in Aggregate Demand
• Market and public goods
• Caused by non-rival consumption
Market Good
¾
Aggregate Demand
•
•
Horizontal summation
Efficiency is achieved
Price
MC
p*
b
qb qa qm
D
a
Quantity
Public Good
¾
Aggregate Demand
•
Vertical summation
•
•
Efficiency is not
achieved
– Free rider
– Absence of
excludability
Price
D
MC
p*
b a
qb qa qm
Quantity
6
Spectrum
Degree of non-rivalry
¾
Spectrum of Non-Rivalry and Non-Excludability
• Degrees of non-rivalry and non-excludability make
the problem more complex
100% Specator sports
National
Defense
Climate
Town Beaches
Parks
0% Blue jeans
Fish in a lake
100%
0%
Degree of non-excludability
Social vs. Private Discount Rate
¾
Dynamic Efficiency
• Maximization of the present value of net benefits
¾
Efficiency
• Based on societies discount rate
¾
Decisions
• Based on private discount rates
¾
Rates the Same
• Leads to inefficiencies
Government Failure
¾
Example
• Special interest groups getting legislation passed
– Political pressure
– Example - Boundary Waters Canoe Area
•
Increasing net benefits to one group does not
necessarily increase net benefits to society
•
BWCA
– Increased net benefits to canoeist
– Decreased net benefits to boaters
– Society’s net benefits the sum of these two
7
Market Power
¾
Monopoly - Single
Seller
• Recall, efficiency
given by societies
marginal cost and
demand curves
•
•
Monopoly - market
power marginal
revenue is 1/2 of
aggregate demand
Price
p*
MR
MC
pe
D
q* qe
Quantity
Inefficient allocation
8