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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