Markets and Efficiency SECTION III General Natural Resource Issues Chapter 6 Markets and Efficiency Ch6: positive economics; how markets function in the case of natural resources Ch7: normative economics; public policy

1. Market Demand and Supply Demand curve downward slope illustrates diminishing marginal willingness to pay It reflects consumers’ incomes, tastes, and other economic factors Supply curve upward slope reflects increasing marginal production costs Its exact shape is related to input prices, technologies, etc.

2. Markets and Static Social Efficiency If a market equilibrium means social efficiency, then market demand curve = MSB curve: there are no sources of social value that are not registered by market participants themselves and market supply curve = MSC curve: there are no sources of cost to members of society that are not registered in those private cost/supply curves

(a) External Costs a negative production externality Consider a collection of paper mills located on a river They produce paper: marginal supply curve is marginal private costs (MPC) curve Paper mills emit residuals into the river which lead to damages suffered by downstream communities: downstream external costs (EC) Marginal social costs (MSC) = MPC + EC Socially efficient quantity and price are q* and p*; competitive market outcome is qm and pm (qm > q* , market quantity is too high; pm < p*, market price is too low) Page 91: Figure 6-3

(a) External Costs a negative production externality 42 MSC = MPC + MEC S =MPC p* = 26 pm = 22 10 D = MPB = MSB 128 160 q of paper q* qm Review ECO324-Ch3

Consumption externalities Production externalities Positive (d) Negative (b) (a) The benefits to the rest of society of people being vaccinated before traveling abroad Noise pollution from using car stereos The benefits to the environment that arise from the planting of woodland by a forestry company (and pp.92-93 in our text) Wastes being dumped into a river by a company Review ECO324-Ch3 and Ch15

(b) External Costs a positive production externality $ MPC a MSC = MPC + MEC b MPB = MSB qm q* q Review ECO324-Ch15; and pp.92-93 in our text

(c) External Benefits a positive consumption externality ($ millions) MSC MPB MSB=MPB+MEB qm = 200 q* = 210 pm = 170 p* = 175 q K L Review ECO324-Ch15

(d) External Benefits a negative consumption externality $ MSC MPB MSB = MPB + MEB q* qm q Review ECO324-Ch15

Open-Access Resource The resource that is open to unrestricted use by anyone who might wish to utilize it: ocean fishery, hunting, public parks… “The Tragedy of the Commons” (Garrett Hardin, Science, Vol. 162, 1968, pp. 1243-1248): Open-access externality that leads to overuse of the resource is the diminution in the quality of the pasture as more and more animals are out on it Page 95, Table 6-2, public beach: the fifth visitor reduces the value of the beach to the four already there, from $20 to $18 for each one

Open Access and the Dissipation of Resource Rent Public beach example: efficient visitation level is 4 visitors; benefits – costs = $80 – $48 = $32 $32 is a return attributable to the resource itself (the beach); this is the resource rent produced by the beach If visitation level had risen to 8 people, then benefits – costs = $96 – $96 = $0; open access had led to the dissipation or disappearance of all natural resource rent

5. Environmental Damage: A Negative Externality FYI Review ECO324 (slides 12-18) Chapter 3 Modeling Market Failure 5. Environmental Damage: A Negative Externality Environmental economists are interested in externalities that damage the atmosphere, water supply, natural resources, and overall quality of life

Modeling a Negative Environmental Externality FYI Modeling a Negative Environmental Externality Define the market as refined petroleum Assume the market is competitive Supply is the marginal private cost (MPC) Demand is the marginal private benefit (MPB) Production generates pollution, modeled as a marginal external cost (MEC) Problem: Producers (refineries) have no incentive to consider the externality Result: Competitive solution is inefficient water pollution

Finding a Competitive Solution Refined Petroleum Market FYI Finding a Competitive Solution Refined Petroleum Market S: P = 10.0 + 0.075Q D: P = 42.0 - 0.125Q, where Q is in thousands of barrels per day Since S is MPC and D is MPB, rewrite as MPC = 10.0 + 0.075Q MPB = 42.0 - 0.125Q (P means private) Find the competitive solution and analyze

FYI Competitive Solution Set MPB = MPC 42.0 - 0.125Q = 10.0 + 0.075Q Solve: QC = 160 thousand; PC = $22 per barrel (C means competitive) Analysis: This ignores external costs from contamination QC is too high; PC is too low

Finding a Socially Efficient Solution Refined Petroleum Market FYI Finding a Socially Efficient Solution Refined Petroleum Market Let Marginal External Cost (MEC) = 0.05Q Marginal Social Cost (MSC) = MPC + MEC MSC = 10.0 + 0.075Q + 0.05Q = 10.0 + 0.125Q Marginal Social Benefit (MSB) = MPB + MEB Assuming no external benefits, MEB= 0, so MSB = MPB Set MSC = MSB --10.0 + 0.125Q = 42.0 - 0.125Q --Solving: QE = 128 thousand; PE = $26/barrel

FYI MSC, MPC, MPB Graph P ($ per barrel) Page 67 42 MSC = MPC + MEC S =MPC PE = 26 PC = 22 10 D = MPB = MSB 128 160 Q (thousands) QE QC

FYI Results of negative externality --QC (160) is higher than QE (128), since the firm does not bear the full cost of its production, and so will produce more than the socially efficient quantity (overallocation of resources) --PC (22) is lower than PE (26), since MEC is not captured by market transaction