Tragedy of the Commons

The Tragedy of the Commons is a 1968 paper by biologist Garrett Hardin. The paper was meant to focus attention on the lack of technical solutions to arrest overpopulation, but its explanation for why commonly-held resources such as groundwater, grazing land, and fisheries are prone to inevitably degrade has influenced the development of environmental and economic policies for resource management.

A number of users take advantage of a shared resource. As the quality of the resource deteriorates or as it becomes scarcer, the users intensify their use. Eventually, the resource is depleted. The tragedy of the commons is a situation where there is the overconsumption of a particular product/service because rational individual decisions lead to an outcome that is damaging to the overall social welfare. The tragedy of the commons theory assumes that when making decisions, people take the course of action that maximises their own utility. However, if many people seek to do this, the net effect may be to deplete a resource making everyone worse off in the long run. The tragedy of the commons was first mentioned by the Victorian economist William Forster Lloyd in 1833. He used a hypothetical area of common grazing land, in which villagers all took their cows to this common grazing land, but this led to overgrazing and a loss of the resource. In theory, individuals could limit their use so that they do not deplete the common resource. However, there is a free-rider problem where people rely on others to cut back their production. If everyone free-rides and maximises their use, then we get a situation of over-consumption.

Example of Tragedy of the Commons

For example, we may have a plot of land which could tolerate 20 animals grazing per year. This level is sustainable from year to year. However, if the land is open, there may be 40 villagers each bringing their own cow to graze the land. This leads the village green to be overgrazed, meaning the village lose this common land. If there was regulation or a common agreement to limit grazing to 20 cows, then the net welfare would be much greater for the village as it would last from year to year.

Over-fishing and Tragedy of the Commons

Individual fishermen have an incentive to catch as many fish as possible. However, if many fishermen have this same motive, then it can lead to fish stocks being depleted as fish are caught at a faster rate than they are replenished. Unchecked, this can lead to a collapse in fish stocks due to over-fishing. If one individual fisherman holds back on his catch to try and preserve overall fish stocks, it may prove futile because many other fishermen continue to catch as much as possible. The net result is that fisherman does not have any incentive to hold back, so they might as well try and catch as much as possible.

Diagrammatic Explanation:

A number of individuals or groups make use of a common resource. In the beginning, the resource seems to be abundant or unlimited. Users separately take advantage of the resource as if they were the sole owners or beneficiaries. They do not take into account use by other users. No one is aware of, gives any thought to or considers the relevance of limits to the resource. After a while, less of the resource is available, or the resource is less accessible, or its quality diminishes. Users intensify their efforts to get enough of the resource, to get it when they need it, and to get the quality they need. If there is no intervention, no advocate for the common resource, and no adequate warning of the limits, the resource disappears completely, becomes entirely inaccessible, or is degraded to the point of uselessness. 

Figure 1

There are three trend lines in the graph. First, the total activity or total use of the resource by all users rises, sometimes exponentially. In the full lifecycle of the resource, the total use line may finally drop to zero. Second, the quantity or quality of the resource is level for a while, then drops off, sometimes exponentially, and may go to zero. Third, the gain from, benefit from or satisfaction with use of the resource either rises or is stable at a high level for a while, then begins to drop off and may finally plunge to zero.

Policies to Overcome Tragedy of the Commons

1. Voluntary agreements with informal arrangements and local monitoring. A strong sense of civic responsibility can make these arrangements more successful.

2. Government regulation. Government regulation can limit fish catches or the size of fishnets to allow young fish to escape.

3. Clearly defined property rights. If common land is given over to private ownership, the private owner has a stronger incentive to manage the resource for optimum outcome.

Solving Simultaneous Equations by Matrix Inversion - 3 Equations and 3 variables | Addl. Problem 1

    

Sustainable Development and Its Indicators

     Introduction:
Sustainable development is the organizing principle for meeting human development goals while at the same time sustaining the ability of natural systems to provide the natural resources and ecosystem services upon which the economy and society depend. The desired result is a state of society where living conditions and resource use continue to meet human needs without undermining the integrity and stability of the natural system. Sustainable development can be classified as development that meets the needs of the present without compromising the ability of future generations.
Sustainable Development (SD) implies economic growth together with the protection of environmental quality, each reinforcing the other. Sustainable Development, thus, is maintaining a balance between the human need to improve lifestyles and feeling of well-being on one hand, and preserving natural resources and ecosystems, on which we and future generations depend. SD may also be defined as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs” (Brundtland Report, 1987).
Indicators of Sustainable Development
A sustainable development indicator can generally be understood as a quantitative tool that analyses changes, while measuring and communicating progress towards the sustainable use and management of economic, social, institutional and environmental resources.
The following are certain characteristics that all the SD indicators have in common: • Alert a problem before it gets too bad • Helps recognize what needs to be done to fix the problem • Build clarity and accountability • Reflect a sense of purpose • Illustrate relationships • Show trends Such multidimensional SD indicators that possess all these characteristics and show the links among a community’s economy, environment, and society are described below: Gross National Happiness (GNH) Human Development Index (HDI) Ecological Footprint (EF) The Happy Planet Index (HPI)
1. Ecological footprint Measure: Ecological Footprint Measure (EFM) compares human consumption of natural resources with Earth’s ecological capacity to regenerate them. This indicator is an estimate of the amount of space on the earth that an individual uses in order to survive using existing technology. This space includes the biologically productive land and water area that produces the resources consumed by that individual such as food, water, energy, clothing, and building materials. It also includes the amount of land and water required to assimilate the wastes generated by that person. In other words, the ecological footprint measures a person's demand on the bio-capacity of the Earth.
The Footprint then can be compared to how much land and sea area is available. Biologically productive land and sea includes cropland, forest and fishing grounds, and do not include deserts, glaciers and the open ocean. Ecological Footprint is a measure of human impact on Earth's ecosystem and reveals the dependence of the human economy on natural capital. Ecological footprint analysis is widely used around the Earth in support of sustainability assessments. It enables people to measure and manage the use of resources throughout the economy and explore the sustainability of individual lifestyles, goods and services, organizations, industry sectors, neighborhoods, cities, regions and nations.
2. Index of Sustainable Economic Welfare (ISEW): The Index of Sustainable Economic Welfare (ISEW) is an economic indicator intended to replace the Gross Domestic Product, which is the main macroeconomic indicator of System of National Accounts (SNA). Rather than simply adding together all expenditures like the gross domestic product, consumer expenditure is balanced by such factors as income distribution and cost associated with pollution and other unsustainable costs. It is similar to the Genuine Progress Indicator (GPI).
The Index of Sustainable Economic Welfare (ISEW) is roughly defined by the following formula.
ISEW = personal consumption
+ public non-defensive expenditures
- private defensive expenditures
+ capital formation
+ services from domestic labour
- costs of environmental degradation
- depreciation of natural capital
3. Gross National Happiness (GNH): Gross National Happiness (GNH) is an attempt to define quality of life in a more holistic and psychological terms than Gross National Product. The four pillars of GNH are the promotion of equitable and sustainable socio-economic development, preservation and promotion of cultural values, conservation of the natural environment, and establishment of good governance. Gross National Happiness (GNH) conventional development models stress economic growth as the ultimate objective. GNH is based on the assertion that true development of human society takes place when material and spiritual development occur side by side to complement and reinforce each other. The term was coined by Bhutan’s King Jigme Singye Wangchuck in 1972. It serves as a unifying vision for the Five Year planning process and all the derived planning documents that guide the economic and development plans of Bhutan.
4. Human Development Index (HDI): The HDI measures the average achievements in a country in three basic dimensions of human development: 1. A long and healthy life, as measured by life expectancy at birth. 2. Knowledge, as measured by the adult literacy rate and the combined primary, secondary, and tertiary gross enrolment ratio. 3. A decent standard of living, as measured by the log of gross domestic product (GDP) per capita at purchasing power parity (PPP) in USD. The index was developed in 1990 by Indian Nobel prize winner Amartya Sen, Pakistani economist Mahbub ul Haq.
5. The Happy Planet Index (HPI): The Happy Planet Index (HPI) is an index of human well-being and environmental impact. The index challenges other well-established indices such as Gross Domestic Product (GDP) and the Human Development Index (HDI). The Happy Planet Index is an innovative measure that shows the ecological efficiency with which human well-being is delivered. HPI value is a function of its average life satisfaction, Life expectancy at birth, and ecological footprint per capita.
6. Genuine progress indicator (GPI): Genuine progress indicator (GPI)is a metric that has been suggested to replace, or supplement, gross domestic product (GDP). The GPI is designed to take fuller account of the well-being of a nation, only a part of which pertains to the size of the nation's economy, by incorporating environmental and social factors which are not measured by GDP. The GPI separates the concept of societal progress from economic growth. GPI is an attempt to measure whether the environmental impact and social costs of economic production and consumption in a country are negative or positive factors in overall health and well-being. By accounting for the costs borne by the society as a whole to repair or control pollution and poverty, GPI balances GDP spending against external costs.

Population, Poverty and Environment linkage

The complex relationship between population, poverty and the environment has received substantial attention over recent decades, especially in the context of the simultaneous occurrence of population growth and environmental degeneration. When discussing the linkage between population growth and impact on Environment, the connections that bind human and natural systems are innumerable, but arguably one of the most discussed through human history has been the ever-increasing size of the human population and its relation with the natural resources upon which it depends. Population growth is identified as one of the key indirect drivers of the degradation of these ecosystem services in many countries. Also, high fertility contributes to population growth which increases demands for food and resources from an essentially static resource base; the declining per capita resource base reinforces poverty through soil fertility loss, declining yields, and poor environmental sanitation. Population growth has a direct and indirect impact on poverty and this further leads to ecosystem depletion.

The world population has been increased last few decades which has had an impact on poverty and environmental changes. It is projected to grow from 6.1 billion in 2000 to 8.9 billion in 2050, increasing therefore by 47 per cent. With this increasing growth, especially the high fertility and related demographic variables have been identified as contributing factors to poverty in many different underdeveloped countries. In many developing and transitional economies, fertility increases absolute poverty both by retarding economic growth and by skewing distribution against the poor. Malthus maintained his view that higher fertility would raise the supply of unskilled labour and the demand for food, pushing real wage rates down, and thus increasing poverty through distribution.  

Although the rate of population growth is projected to slow down in the early decades of the 21st century, there will still be significant increases in absolute numbers, especially in less developed and poorest countries. Infant mortality in poor households tends to be higher than national averages, meaning that poor families may perceive the need to have more births in order to achieve desired family size. Moreover, due to the lack of knowledge and awareness, women in poor families do not practice preventive methods for unwanted pregnancies. This has been a result of young women from poor households being more likely to marry early and have less education, both of which are associated with higher fertility in most contexts. The high fertility and migration due to lack of economic strength have increased the population in certain countries.

Poverty and the environment are also closely interrelated. Many reports claim that environmental degradation is a major cause of poverty. This is because the poor population is more likely to be dependent on their natural resource and environment as they are lacking the means to fulfil their needs. Whilst people living in poverty are seldom the principal creators of environmental damage, they often bear the brunt of environmental damage and are often caught in a downward spiral, whereby the poor are forced to deplete resources to survive, and this degradation of the environment further impoverishes people. When this self-reinforcing downward spiral becomes extreme, people are forced to move in increasing numbers to marginal and ecologically fragile lands or to cities.

The above summarizes interlinkages between population, poverty and the environment can be shown and explained in detail in figure 1. In the diagram, the interlinkages between the three components of the analysis are summarised and depicted clearly.

From the above discussion, it can be understood that the links between poverty and population and that of the poverty and environment is two way while that of the population and the environment is one way from population to environment. It is clear to understand the direction of the interlinkages. 

Development and Environment Trade-off

Introduction:

The link between the economy and the environment are manifold. The environment provides resources to the economy and acts as a sink for emissions and waste. Natural resources are essential inputs for production in many sectors, while production and consumption also lead to pollution and other pressures on the environment. Poor environmental quality in turn affects economic growth and development and well-being by lowering the quantity and quality of resources or due to health impact, etc. In this context, environmental policies can curb the negative impacts from the economy on the environment and vice versa.

A trade-off is when we choose one option in favour of another and the opportunity cost is what is sacrificed in order to get something. The economy and the environment are inextricably linked. Since resources are scarce, choices have to be made about how to use them. The decision about how to allocate resources relating to the environment has an impact on all sectors of the economy, primarily because of the complex relationship between utilizing natural resources and economic output. Many times, the cost of utilizing these resources and services include direct costs as well as opportunity and external costs, which are not traded in markets or assessed directly in monetary terms.  

One of the tools we can use to analyze the tradeoff between economic output and environmental protection is a production possibility frontier, or (PPF). The PPF shows the opportunity cost of choosing either more environmental protection or more economic development or output. Countries with low per capita gross domestic product or GDP tend to place a greater emphasis on economic output, which in turn helps to produce nutrition, shelter, health, education, and desirable consumer goods. Countries with higher income levels, where a greater share of people have access to the basic necessities of life, maybe willing to place a relatively greater emphasis on environmental protection.

Figure 1

All choices represented by points on the PPF are productively efficient, i.e., they just represent different balances of environmental protection and economic development. A choice that is inside the PPF, for example, point M, however, is productively inefficient. If a country is choosing point P, it would be selecting a high level of economic output but very little environmental protection. On the other hand, if a country chooses point T, it would be selecting a high level of environmental protection but little economic output.

Depending on their income levels and political preferences, different countries are likely to make different choices about how to balance economic output and environmental protection. All countries benefit from making a choice that is productively efficient, that is, a choice somewhere on the production possibility frontier rather than inside it. Unfortunately, it is not possible for a country to maximize both its environmental protection and its economic output.  At every point and every level of development, countries need to make choices between often conflicting goals. Many developed countries having high income are able to spend some portion of their national income towards the protection of the environment. . Developed countries have achieved substantial economic growth and development and can afford to focus on environmental goals because basic living necessities have been achieved. However, it is difficult for developing and underdeveloped countries that are struggling to achieve stable and high growth of national income through industrialisation involving increased use of natural resources resulting in pollution of the environment.  Developing countries desire to achieve high economic growth and ensure energy for all at a competitive price to achieve and sustain economic development and poverty reduction.

Conclusion:

Making decisions about how best to conserve natural resources and environmental quality is not a simple task, particularly since many environmental problems are not easy to mitigate and the solutions may be expensive and could pose other risks. Because the environment provides both direct value and the raw material intended for economic activity, the environment and the economy are interdependent. For that reason, the way the economy is managed can have an impact on the environment that, in turn, may affect both welfare and the performance of the economy.

 

Types of Goods | Public Good and Private Good

Public goods have two defining characteristics. They are non-rival and non-excludable. A public good is one for which consumption is non-rival and from which it is impossible to exclude a consumer. A good is non-rival if consumption of one unit by one person does not decrease available units for consumption by another person. The second feature of a public good is that it is non-excludable. A good is non-excludable if it is impossible, or extremely costly, to prevent someone from benefitting from a good who has not paid for it.

Air quality is an important environmental example of a public good. Under most circumstances, one person’s breathing of fresh air does not reduce air quality for others to enjoy, and people cannot be prevented from breathing the air. Public goods are defined in contrast to private goods, which are, by definition, both rival and excludable. A public good is a good or service that can be consumed simultaneously by everyone and from which no one can be excluded. Pure public goods pose a free-rider problem.

Private goods have two characteristics - rival and excludable. A private good is one for which consumption is rival and from which consumers can be excluded. A good is rival if consumption of one unit by one person does decrease available units for consumption by another person. A private good is also excludable. A good is excludable if it is possible to prevent a person from enjoying the benefits of a good if they have not paid. A sandwich is a private good because one person’s consumption clearly diminishes its value for someone else, and sandwiches are typically excludable to all individuals not willing to pay.

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Types of Goods:

Types of Economics

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Methods to Abate Pollution

Introduction:

Economic activity has a direct bearing on natural and environmental resources. Excessive and indiscriminate use of natural resources and energy leads to pollution and environmental degradation. Activities involving processes like extraction, manufacture, transport, consumption, and disposal add some stress to the environment and affect its assimilative capacity. When such activities are carried out inefficiently, the impact is much higher. This has brought about a need for environmental planning and management to prevent other exploitation and for optimum use of natural resources available to us.

The government is the supreme manager of the environment and it is the duty of the government to manage the security and sovereignty of air, water and land. Today the magnitude of the pollution problem due to the rapid growth of population, urbanization, industrialization and motorization especially since the 1960s proved to be serious. This requires public action to tackle the problem. The reason for this is the failure of the market system to allocate environmental resources efficiently due to externalities. Environmental quality is a public good and economic efficiency in environmental resource allocation necessities and intervention of the government. Generally, four methods have been proposed for the control of activities that damage the environment.

1. Moral Suasion:

Moral Suasion refers to voluntary programmes such as non-mandatory investment in pollution control equipment’s by firms to meet their social responsibilities. The successes of these programmes depend on the participation of the citizens. It is said that only around 5% of the population is willing to participate in such programmes. Hence, where the problem of pollution is high and substantial improvement in environmental quality is posing a problem, direct control and price incentives are more efficient. Also, the majority of the low and middle-income group countries fails to generate enough funds for the maintenance of voluntary cleanup programmes. A voluntary programme like afforestation, avoiding the use of plastic bags and carry bags, arranging environmental awareness campaigns and classes, following energy conservation programmes garbage/ trash disposal, launching of environmental movements etc, are highly helpful to bring down the degree of pollution.

2. Direct Methods:

Another method of pollution abatement is direct control. Direct control is not an economic tool of environmental protection, instead, it is a policy initiated by the government. Direct government is of two types:

a) Fixation of pollution emission standards: This implies the imposition of logical ceilings on the amount any polluter is permitted to emit or discharge. If the emissions or effluents are beyond the prescribed limit, such firms will be prosecuted as per the existing laws. In India, Minimum National Standards (MINAS) for wastewater discharges and emission standards have been fixed by the Central Board for prevention and control of water pollution and air pollution.  One drawback of this method is that it permits a certain level of pollution.

b) Specification of method and technologies to be followed: This instructs the firms to use a particulars pollution control device. For example, all the chemical-based industries are directed to install an electrostatic precipitator to capture some of the emissions of the polluting firms. But in several instances, due to weak environmental laws and regulations, the polluting firms try to follow old and conventional technologies of production. Direct control is particularly significant in the case of pollution involving highly hazardous pollutants.

3. Economic Methods or Pricing Techniques:

These techniques help to internalise the external cost of pollution through a variety of steps like taxes, subsidies, pollution permits and refundable deposits.

a) Pollution Tax (charges):

A pollution charge is a payment or fee charged to the polluter, which varies with the quantity of pollutants being emitted. It provides financial incentives that will induce the polluter to reduce the damage to maintain an acceptable level of environmental quality. Pollution charges are implemented through various methods like:

1) Efficient or emission charges

2) Product charges

3) Use charges

4) Administrative charges.

A charge is a fee levied on the user of environmental resources. The impact of these charges is the rise in the price of commodities which in turn will reduce the level of pollution. In the early 20th century, the English Economist Arthur C. Pigou argued for the imposition of taxes on the generators of pollution. Hence pollution tax is also known as Pigouvian Tax.

b) Subsidies:

Subsidies can be viewed as financial assistance to bring down the level of pollution by enhancing pollution abatement activities. A subsidy is just the opposite of pollution charges; subsidy is an intensive for pollution abatement, whereas pollution a charge is aimed to bring down the level of pollution. Subsidies may be in the form of:

a) Partial payment of the cost of installation of pollution control equipment.

b) Offer a fixed reward for every reduction in emission from some basic level.

Pollution abatement equipment is executed through the use of grant aid, zero or low-interest loans or tax benefits etc. If a subsidy is offered for a pollution abatement good, then its price in the market would come down to be equal to the marginal external benefits associated with the pollution abating good. This type of subsidy is known as Pigouvian Subsidy since it is analogous to that of a Pigouvian tax.

c) Pollution Permits:

The public authorities determine the maximum amount of specific type of pollution per unit of time with safe limits and its price is determined by the forces of supply and demand. A pollution permit trading system is implemented through the use of ‘credits’ or ‘allowances’. Pollution credits mean tradable permits issued to polluters for emitting below an established standard. For example, if a tradable permit in the form of permission to pollute (air pollution, water pollution etc) is allowed to a firm, and if the firm actually produces pollution below the assigned level, that firm becomes eligible to receive ‘credits’ or ‘allowances’. The main philosophy of tradable pollution permits is to allocate rights to the polluters and make their pollution a tradable commodity. This will result in a market for the right to pollute and consequently a market for this ‘right to pollute’. If a polluter crosses the limits or standards fixed by the competent authorities like pollution control boards, he will be penalized.

d) Refundable deposits:

Robert Solow and Edwin Mills have suggested this method to control pollution in the case where it is not possible to monitor, observe and detect environmental damage. In this method, the parties concerned are detected to deposit a sum for the ‘potential’ occurrence of environmental damage. If such an occurrence does not happen, the entire amount will be refunded to the concerned parties. For example, oil tankers are always requested to deposit a sum with the government, since any leakage in the transit, accounts for pollution offshore and onshore. If any damage occurs, the deposit amount will be used for the cleaning up process. This technique has been found to be very useful in handling hazardous goods and in the encouragement of recycling or re-use.

e) Allocation of Property Rights:

According to Nobel Laureate Ronald Coase, an effort is internalised environmental externalize requires an effective scheme for assigning property rights. Property rights are essential to the sound functioning of the market system. Allocation of property rights is a method that protects the environmental resources by putting them into the hands of private individuals who consequently have a financial stake in their preservation.

4. Government Investment Programme:

These include industrialization of waste plants, slum-clearance, management of wildlife refuges, reforestation and afforestation etc. Besides these, the research programmes and programmes to create environmental awareness also are part of government investment programmes to create environmental resources also are part of government investment programmes. The public good character of the environmental resources necessities government’s investment and participation to maintain and preserve environmental quality.

5. Other Methods:

Other methods of abating pollution include ecological marketing, eco-labelling, voluntary standards. Ecological marketing or Green marketing is the marketing of products that are presumed to be environmentally safe. Thus Green marketing incorporates a broad range of activities, including product modification, changes to the production process, packaging changes, as well as modifying advertising. Nowadays, firms are using eco-labelling to indicate to their customers that their products have certain environmentally friendly benefits. Another step towards sustainable development is the use of voluntary standards to integrate environmental responsibility into corporate management.

Conclusion:

These are the various policy instruments to control pollution and preserve environmental quality. New methods are also being developed along with new technologies to control pollution. None of these policies would be exclusively applicable. For efficient management of the environment, various combinations of the different tools are required.

Solution to Externality | The Coase Theorem

The Coase theorem describes the economic efficiency of an economic allocation or outcome in the presence of externalities. This "theorem" is commonly attributed to Nobel Memorial Prize in Economic Sciences 1991 winner Ronald Coase. The Coase Theorem states that, “if property rights and liabilities for an activity are fully assigned, then an efficient outcome will result, even in the presence of externalities. Moreover, the level at which the activity is carried out will not depend on the particular assignment of rights and liabilities.”

Coase Theorem (Part I): When there are well-defined property rights and costless bargaining, then negotiations between the party creating the externality and the party affected by the externality can bring about the socially optimal market quantity.

Coase Theorem (Part II): The efficient solution to an externality does not depend on which party is assigned the property rights, as long as someone is assigned those rights.

Let us take the example of a steel factory releasing waste into the river stream and a community staying near by the river stream. If firms ignore the community and continuously release waste effluents in to the river stram, then there is too much pollution. We can illustrate the Coase theorem by showing the marginal benefits and marginal costs of an economic activity that generates an externality.

Suppose, for example, a factory emits effluent into a river, polluting the water supply of a downstream community. Let us assume that the factory is currently emitting 100 units of effluent. If forced to reduce effluent to zero, the company operating the factory would have to abandon a valuable production line. Thus we can say that the company gains marginal benefits from emitting pollution, and the community incurs marginal costs through damage to the water supply.

The figure shows both marginal costs of the community and marginal benefits of the factory. The emission of 100 units of pollution clearly imposes high marginal costs on the community and brings the company lower marginal benefits. This is “too much” pollution. But suppose emissions were limited to 60 units. Marginal benefits to the company would then equal marginal costs to the community. A further limitation to, say, 20 units, would result in high additional loss to the company due to low output levels meanwile a low marginal cost imposed on the community bring only low additional benefit. The efficient or “optimal” solution, therefore, is at 60 units of pollution. At this level the extra benefit to the company from production just balances the extra cost imposed on the community through pollution.

Assigning Property Rights to the Community:

Suppose the community has the right to say how much pollution can be emitted. The company can offer them up to $200 per unit for pollution permits to allow 60 units of pollution. The company can afford to pay this much; their marginal benefits from producing 60 units exceed $200 up to the 60 units. It will also be to the community’s advantage to accept this offer, granting permits for 60 units of pollution at $200 each. The first 60 units of pollution impose less than $200 per unit of costs on the community. We can measure the total cost of pollution at this level as the area C on the graph, or $6,000. But the amount the company pays to the community will be B + C or 60 x $200 = $12,000. The community can then pay $6,000 to treat the water and still come out $6,000 ahead. The company gains A + B + C = $21,000 in benefits, pays $12,000, and has a net profit of $9,000 (area A).

Assigning Property Rights to the Company:

We can also assign the right to pollute to the company. Would they then emit the full 100 units of pollution? If they did so their gain would be areas A + B + C + D = $25,000. They can do better by negotiating with the community. The community will pay them up to $200 per unit, or areas D + E = $8,000, to cut back their pollution to only 60 units. This saves the community D + E + F = $10,667 in environmental damage or water treatment costs. They still suffer environmental costs equal to C, or $6,000. The company’s net gain will now be A + B + C + D + E = $29,000, better for them than the maximum pollution option. This approach may seem unfair to the community, but it leads to the same equilibrium solution i.e., 60 units of pollution emitted as when the community held the right to control pollution levels.

Conclusion:

The above demonstration of the Coase theorem shows that the participants reach the efficient solution regardless of who holds the property right governing pollution. Provided that right is clearly defined, the party who values it most highly will acquire it, with the result that the external costs of pollution and the economic benefits of production are balanced through the marketplace.

Measures to Correct Market Failure

The following are some of the measures suggested by different economists to correct market failure:

1. Internalisation of Externalities: To achieve optimal allocation of resources in the face of externalities, Pigou suggested social control measures and the use oftaxes and subsidies. The state can interfere in all cases of external diseconomies of production to remove the divergence betweenprivate and social costs and benefits. For instance, it can ask the factory owner to move out of the residential area by providingappropriate facilities to the smoke emitting factory. In the case of negative externalities it should discourage their consumption and production bylevying taxes.

2. Provision of Public Goods: Since public goods are non-excludable and non-rivalled, they are not sold in a free market like private goods. Hence, they cannot be provided by private firms. In this situation, they can be provided by some public authority. As the benefits of public goods are indivisible, the state should make people share the costs of public goods so that everyone is made better off.

3.  Assigning Property Rights: Common property rights lead to externalities. Property rights relate to “who owns property, to what uses it can be put, the rights people have over it and how it may be transferred.” One solution is to extend property rights so completely that everyone has the right to prevent people from imposing any costs on them. Another solution has been suggested by Prof. Ronald Coase, according to him, market failure due to property due to property rights can be eliminated through private bargaining among the affected parties.

4. Complete Knowledge and symmetric Information: Market failure can be eliminated when rules are framed by regulating authorities by requiring producers to describe correctly about their products and prices. This will provide people with correct and relevant information about products. Market failure can also be corrected if produces produce high quality standard products and offer guarantees and warranties to buyers.

5. Control of Monopoly Power: Monopoly power can be controlled by the government by anti-monopoly laws and restrictivetrade practices legislation. These aim at removing unfair competition, preventing unfair pricediscrimination and fixing prices equal to competitive prices.The government can also bring down monopoly price to competitive level by price regulationand taxation.

6. Active Government Participation: The government can play an active role in correcting market failure. It can enact legislation and laws to banned smoking in public places. Goods which have maximum social welfare such as merit and public goods are to be provided by the government. The government can issue tradable permits that allow firms to produce a certain amount of something, commonly pollution. 

Market Failure for Environmental Goods

A market is an exchange institution that serves society by organizing economic activity. Market use prices to communicate the wants and limits of a diffuse and diverse society so as to bring about coordinated economic decisions in the most efficient manner. Market work well when prices reflect all values. ‘Market Failure’ occurs when some costs and/or benefits are not fully reflected in market price. For environmental assets, market can fail if prices do not communicate society’s desire and constrains accurately. Price often understate the full range of services provided by an asset, or do not exist to send a signal to the market place about the value of asset.

Market failure occurs when private decisions based on these prices or lack of them; do not generate an efficient allocation of recourses. Efficiency is defined as Pareto optimality – the impossibility of reallocating resources to make one person better off without making anyone else worse off. Habitat destruction through deforestation has increased rapidly over the last few decades. The factors leading to habitat destruction and the loss of biodiversity originate in several sources of market failure. The market system fails to function properly for many kinds of environmental goods because such resources including the services they provide are often not traded in market.

Market failure for environmental goods can occur due to any or all of the following:

1. Incomplete markets: Markets for certain things are incomplete or missing under perfect competition. The absence of markets for such things as public goods and common property resources is a cause of market failure. There is no way to equate their social and private benefits and costs either in the present or in the future because their markets are incomplete or missing.

2. Lack of or weak property rights: A key requirement to avoid a market failure is that markets are complete - enough markets exist to cover each and every possible transaction or contingency so that resources and move to their highest valued use. Markets will be complete when traders can costlessly creates a well-defined property rights system such that a market will exist to cover any exchange necessary. Most of the market failures with environmental assets can be linked to incomplete markets. Markets are incomplete because of the failure or inability of institutions to establish well-defined property rights. For example, many people own land and are able to take action when damage is done to it, but they do not generally own the rivers or the air, though which significant amount of pollution travel. The lack of clear and well-defined property rights for clean air thus makes it difficult for market to exist such that people who live downwind from a coal-fired power plant can halt the harm that the plant does to them or successfully demand a fee, equivalent to the costs they bear, from the operator of the upwind plant.

3. Common Property Resources: Another cause of market failure is a common property resource. Common ownership when coupled with open access, would also lead to wasteful exploitation in which a user ignores the effects of his action on others. Open access to the commonly owned resources is a crucial ingredient of waste and inefficiency. Its most common example is fish in a lake. Anyone can catch and eat it but no one has an exclusive property right over it. It means that a common property resource is non-excludable (anyone can use it) and non-rivalrous (no one has an exclusive right over it). The lake is a common property for all fishermen. When a fisherman catches more fish, he reduces the catch of other fishermen. But he does count this as a cost, yet it is a cost to society. Because the lake is a common property resource where there is no mechanism to restrict entry and to catch fish. The fisherman who catches more fish imposes a negative externality on other fishermen so that the lake is overexploited. This is called the tragedy of the commons which leads to the elimination of social gains due to the overuse of common property. Thus when property rights are common, indefinite or non-existent, social costs will be more than private costs and there will not be Pareto Optimality.

4. Public Goods: Another cause of market failure is the existence of public goods. A public good is one whose consumption or use by one individual does not reduce the amount available for others. An example of a public good is water which is available to one person and is also available to others without any additional cost. Its consumption is always joint and equal. It is non-excludable if it can be consumed by anyone. It is non-rivalrous if no one has an exclusive rights over its consumption. Its benefits can be provided to an additional consumer at zero marginal cost. Thus public goods are both non-excludable and non- rivalrous. Moreover, environmental quality is generally considered as a public good and when it is valued at market price, it leads to market failure.

5. Externalities: Externalities arise because of the non-existence of market, that is, there are no markets in clean air or peace and quiet. An externality arises when a mutually beneficial transaction between two or more than two parties results in a third-party effect where someone not a party to the transaction is either better off or worse off. Externalities can be positive, that is, there can be gains for both the affected parties and the generators of externalities. A quantitative analysis of externalities would require that both parties can be precisely identified and that the externalities can be evaluated in monetary terms. In many situations, such an analysis of externalities is too difficult. This could be due to lack of information, an inability to define the monetary value of the external effects.

6. Asymmetric Information: Pareto optimality assumes that producers and consumers have perfect information regarding market behaviour. But according to Joseph Stiglitz, “In the real world, there is asymmetric (incomplete) information due to ignorance and uncertainty on the part of buyers and sellers. Thus they are unable to equate social and private benefits and costs.” Suppose a producer introduces a new antipollution device in the market. But it is very difficult for him to predict the current demand of his product. On the other hand, consumers may be ignorant about quality and utility of this anti-pollution device. In some cases, information about market behaviour in the future may be available but that may be insufficient or incomplete. Thus market asymmetries, fail to allocate efficiently.

Externality | Types & Solution

Externality

An externality is a cost or a benefit imposed upon a third party by the production or consumption of a good. Externalities exist when the activities of one or more agents affect the welfare of other agents and the welfare of other agents was not considered in decisions determining the level of activity. Externalities are types of market failure. An externality is a cost or benefit that is experienced by someone who is not a party to the transaction that produced it. Under an externality, market prices do not reflect true marginal costs and/or benefits associated with the goods or services created by the activity when they are traded in the market. Externalities lead to suboptimal outcomes. Externalities may be positive or negative.

Negative Externality:

Negative externalities arise when an action by an individual or group produces harmful effects on others. Pollution is a negative externality. Let us assume a paper producing firm located near a residential plot and a river. The paper producing industry pollute the environment in the neighborhood by realizing toxic air in to the atmosphere and waste effluent in to a river stream. When a factory discharges its untreated effluents in a river, the river is polluted and consumers of the river water bear costs in the form of health costs or/and water purification costs. In an activity generating negative externality, social cost is higher than private cost i.e., MSC>MPC.

Figure 1

The graph shows the effects of a negative externality. For example, the paper industry is assumed to be selling in a competitive market. The marginal private cost (MPC) is less than the marginal social cost (MSC) by the amount of the external cost (MEC), i.e., the cost of air pollution and water pollution. This is represented by the vertical distance between the two supply curves. It is assumed that there are no external benefits, so that social benefit equals individual benefit.

If the consumers only take into account their own private cost, they will end up at price P and quantity Q, instead of the more optimal and efficient price P^* and quantity Q^*. These latter reflect the idea that the marginal social benefit should equal the marginal social cost, that is that production should be increased only as long as the marginal social benefit exceeds the marginal social cost. The result is that a free market is inefficient since at the quantity Q, the MSC is greater than MPC, so society as a whole would be better off if the goods between Q and Q^* had not been produced. Even if the producer choose to produce at Q, the firm should take in to account both MPC and MEC and charge a higher price at P₁.The problem is that people are buying and consuming too much paper.

When a negative externality occurs the marginal social cost (MSC) will be higher than the marginal private cost (MPC) or price and hence the private optimal level of output will be higher than the social optimal output.

Positive Externality:

Positive externality arises when an action by an individual or a group confers benefits to others. A technological spill over is a positive externality and it occurs when a firm’s invention not only benefits the firm but also enters into the society’s pool of technological knowledge and benefits the society as a whole. In an activity generating positive externality, social benefit is higher than private benefit, i.e., MSB>MPB.

Figure 2

The graph shows the effects of a positive or beneficial externality. For example, the industry supplying smallpox vaccinations is assumed to be selling in a competitive market. The marginal private benefit (MPB) of getting the vaccination is less than the marginal social benefit (MSB) by the amount of the external benefit. This marginal external benefit of getting a smallpox shot is represented by the vertical distance between the two demand curves. Assume there are no external costs, so that social cost equals individual cost.

If consumers only take into account their own private benefits from getting vaccinations, the market will end up at price P and quantity Q, instead of the more efficient price P^* and quantity Q^*. These latter reflect the idea that the marginal social benefit (MSB) should equal the marginal social cost (MSC), i.e., that production should be increased as long as the marginal social benefit (MSB)exceeds the marginal social cost (MSC). The result in an unfettered market is inefficient since at the quantity Q, the social benefit (MSB) is greater than private benefit (MPB), so society as a whole would be better off if more goods had been produced. The problem is that people are buying too few vaccinations.

When a positive externality occurs, the marginal social benefit (MSB) will be higher than the marginal private benefit (MPB) or price and hence the private optimal output will be lower than the social optimal output.

Types of Negative and Positive Externalities:

1. Negative production externality: When a firm’s production reduces the wellbeing of others who are not compensated by the firm.

2. Negative consumption externality: When an individual’s consumption reduces the well-being of others who are not compensated by the individual.

3. Positive production externality: When a firm’s production increases the wellbeing of others but the firm is not compensated by those others.

4. Positive consumption externality: When an individual’s consumption increases the well-being of others but the individual is not compensated by those others.

Solution to Externalities: Pigovian Tax and Subsidies

Pigovian Tax/ Corrective Tax:

A Pigovian tax is a tax levied on any market activity that generates negative externalities i.e., costs not internalized in the market price. The tax is intended to correct an inefficient market outcome, and does so by being set equal to the social cost of the negative externalities. In the presence of negative externalities, the social cost of a market activity is not covered by the private cost of the activity. In such a case, the market outcome is not efficient and may lead to over-consumption of the product. An often-cited example of such an externality is environmental pollution.

Figure 3

Let us assumed a paper producing industry causing negative externality. The government can achieve this outcome of internalizing the externality by taxing the paper producer an amount MEC for each unit of paper produced. The figure above illustrates the impact of such a tax. The paper market is initially in equilibrium at point E, where supply (MPC) equals demand (D=MB), and Q units of paper are produced at price P. Given the externality with a cost of MEC, the socially optimal production is at point E^*, where social marginal costs (MSC) and benefits (MB) are equal.

Suppose that the government levies a tax per unit of paper produced at an amount t = MEC. This tax would act as another input cost for the paper producer, and would shift its private marginal cost up by MEC for each unit produced. This will result in a new curve i.e., SMC which is equal to MPC+MEC. As a result, the tax effectively internalizes the externality and leads to the socially optimal outcome (point E^*, quantity Q^*). This type of corrective taxation is often called “Pigovian taxation,” after the economist A. C. Pigou, who first suggested this approach to solving externalities.

Pigovian Subsidy/ Corrective Subsidy:

A Pigovian subsidy is a subsidy that is used to encourage behaviour that have positive effects on others who are not involved or society at large. Behaviors or actions that are a benefit to others who are not involved in the transaction are called positive externalities. Pigovian subsidies are closely related to Pigovian taxes, and are typically provided by governmental or regulatory bodies.

Figure 4

Not all externalities are negative, in cases such as industry supplying smallpox vaccinations, externalities can be positive. The government can internalise this externality by making a payment, or a subsidy, to the industry supplying vaccinations. The amount of this subsidy would exactly equal the benefit to the other industry and would cause the producers to produce more vaccinations since his cost per vaccine has been lowered. The impact of such a subsidy is illustrated in Figure, which shows once again the market for vaccination. The market is initially in equilibrium at point E where MC = PMB, and Q of vaccine are produced at price P. Given the positive externality with a benefit of MEB, the socially optimal production is at point E^*, where marginal social costs (MSC) and benefits (MSB) are equal.

Suppose that the government pays a subsidy per quantity of vaccine produced of Subsidy = MEB. The subsidy would lower the marginal cost of vaccine production, shifting the marginal cost curve down by MEB for each unit produced. The subsidy has caused the market moves from a situation of underproduction to one of optimal production. This type of corrective subsidy is often called “Pigovian subsidy,” after the economist A. C. Pigou, who first suggested this approach to solving externalities.

Environmental goods

Environmental goods are typically non-market goods, including clean air, clean water, landscape, green transport infrastructure (footpaths, cycleways, greenways, etc.), public parks, urban parks, rivers, mountains, forests, and beaches. Environmental goods are a sub-category of public goods. Concerns with environmental goods focus on the effects that the exploitation of ecological systems have on the economy, the well-being of humans and other species, and on the environment. Users not having to pay an upfront cost and external factors like pollution that can damage environmental goods indefinitely are some of the challenges in protecting environmental goods.

There have been many efforts to place an economic value on environmental goods, but no consensus yet exists on the method of valuation. The challenges in the way of obtaining these economic values include the free-rider problem, difficulties in assigning ownership, and the non-divisibility of environmental goods.

If A is a matrix and A^(−1) is its inverse, then their product must be equal to the Identity matrix

 

Inverse of a Matrix | Additional Problem - 1

Properties of Determinnats