1. Tragedy of the Commons; Environment; Safety Today: Three applications of market failure without government intervention

2. For the rest of the quarter We will cover various topics Each topic will be its own “mini-lecture” Today: Three mini-lectures Tragedy of the Commons/Property rights Environmental regulation Safety regulation

3. Tragedy of the Commons/ Property rights Property rights are important in order for a person or firm to efficiently use its resources Classic example Lack of property rights in a grassy field Total benefit of the grassy field is zero without property rights

4. Our example today Two investment options A safe stock that always sells for $20 in equilibrium Pays $1 per year every year forever Buy a 1-year-old calf today for $100 Able to sell at two years old The more calves on the grassy field, the less each will be worth at two years old

5. What is the return on the safe stock? Recall from earlier in the quarter The present value of a permanent annual payment PV = M / r PV = $20 M = 1 This implies that r = 0.05, or 5%

6. Income from calves: # of calves on the commons Price per 2- year-old cow sold ($) Income per cow ($ per year) 113030 212020 311414 411111 51088 61055 71022

7. What will happen w/o property rights? People will buy calves as long as the return on the commons is at least 5% $5 return for the $100 investment

8. Income from calves w/o property rights: Rate of return of 5% # of calves on the commons Price per 2- year-old cow sold ($) Income per cow ($ per year) 113030 212020 311414 411111 51088 61055 71022 Equilibrium w/o property rights

9. What will happen w/o property rights? People will buy calves as long as the return on the commons is at least 5% $5 return for the $100 investment This is not efficient, however No gain versus the safe stock investment Similar to the no-toll situation on congestible routes

10. What is efficient? We need marginal analysis Find marginal income of each calf If marginal income is at least $5  invest in another calf If marginal income is less than $5  stop investing

11. Income from calves with property rights Invest as long as marginal income is at least $5 # of calves on the commons Price per 2- year-old cow sold ($) Income per cow ($ per year) Total calf income ($ per year) Marginal income ($ per year) 30 113030 10 21202040 2 31141442 2 41111144

12. Income from calves with property rights Invest as long as marginal income is at least $5 >$5  INVEST <$5  STOP! # of calves on the commons Price per 2- year-old cow sold ($) Income per cow ($ per year) Total calf income ($ per year) Marginal income ($ per year) 30 113030 10 21202040 2 31141442 2 41111144 >$5  INVEST

13. What is the commons worth as a private good? An optimal investor (with property rights) will invest to maximize the value of commons Suppose that someone has $1000 to invest What is each person’s willingness to pay for the commons? How much will be invested in: Stocks? Calves?

14. Investment analysis A person that owns the commons will buy 2 calves $200 invested $40 return Could get $10 return on the safe stock instead $30 extra in return Willing to pay $600 to purchase the commons Note that the commons can be used every year

15. Investment decision for the commons owner Investment decision of the person buying the commons $600 to buy commons $200 to buy two calves $200 in safe stocks Total returns: $50 Commons $40 for two calves Stock returns $10 in payments This is equilibrium, since any person will be indifferent between investing in the commons and in stocks

16. Summary: Tragedy of the Commons Without private ownership, use of commons leads to no gain to society, relative to safe investments With private ownership, the land has a positive value

17. Environmental regulation Environmental quality is a good that people want Problems with providing environmental quality Goods without markets (air quality, global temperature, rivers) Goods that governments own (parks)

18. Environmental regulation and externalities Recall externalities chapter With negative externalities, too much of some goods are produced, relative to efficient outcomes possible Three ways of reducing pollution Taxes Pollution permits Arbitrary controls (also known as “command and control” methods)

19. Environmental regulation and efficiency Assume we are trying to find efficiency in an air-polluted city To reach the efficient level of pollution, we need to find firms with the lowest cost to abate pollution

20. Environmental regulation and efficiency Example with 3 firms Efficient level of pollution, as determined by the government: 5 tons of smoke per day One of the two approaches (taxes or permits) is needed to solve for the optimal distribution of pollution We do not spend much time on “command and control” methods since it is often sub- optimal

21. Example Three firms produce light bulbs With no abatement technology, each firm produces 4 tons of smoke per day 12 tons of smoke with no regulation To reach efficient level of 5 tons, 7 tons need to be abated Some firms can more easily abate pollution than others If firms with low abatement costs abate the most, we can get an efficient result

22. Example Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 Notice that marginal abatement costs increase as more is abated Firm A: $14 MC to abate 1 st unit; $16 for the 2 nd unit; $20 for the 3 rd unit; $25 for the 4 th unit

23. Example Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 We need to find the 7 tons with the lowest abatement MC Let’s start by adding arrows to abatement MC of $20 per ton or less Not enough: Only 4 tons abated

24. Example Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 Let’s try $30 abatement MC or less 7 green arrows We now have reached the efficient level of 5 tons of emissions

25. Our two methods to reach an efficient result Pollution tax Find a tax such that exactly 7 tons of pollution will be abated Sell pollution permits Find a price such that exactly 5 tons of pollution permits are demanded

26. Pollution tax Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 Let’s try a $30 tax Firm A will abate all 4 tons of smoke, since abatement cost is lower for each ton of smoke removed Firm B will abate 2 tons and pollute 2 tons Firm C will abate 1 ton and pollute 3 tons

27. Pollution tax Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 7 tons abated 5 tons polluted We have found a tax that leads to the efficient pollution level

28. Pollution permits Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 What if you need a permit to pollute? What if we sell permits for $30 each? Firm A will demand no permits (and abate 4 tons) Firm B will demand 2 permits (and abate 2 tons) Firm C will demand 3 permits (and abate 1 ton)

29. Pollution permits Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 7 tons abated 5 tons polluted We have found a price for permits that leads to the efficient pollution level

30. Alternative to taxes and permits: Command-and-control methods An alternate method to control pollution is for the government to dictate that each firm reduce its pollution by a given percentage Example: Each firm must reduce emissions by 25% Problem: Usually not efficient

31. Alternative to taxes and permits: Command-and-control methods Tons of smoke emitted per day43210 Total abatement cost, firm A$0$14$30$50$75 Total abatement cost, firm B$0$20$45$80$120 Total abatement cost, firm C$0$25$60$100$150 Example: Each firm must abate 1 ton Total cost: $59 (see red arrows) Total cost if firm A abates 2 tons and firm B abates 1 ton: $50 (see green ovals)

32. Summary: Environmental regulation Markets with externalities usually require government intervention to have optimal outcomes to occur Taxes: Efficient (with the right tax) Permits: Efficient (if permit price leads to an efficient amount of pollution) “Command and control” methods: Almost never efficient

33. Workplace safety In a perfectly competitive labor market… Firms will provide the optimal amount of safety Workers will be hired by a firm Threat to leave firm will prevent the firm from lowering safety standards

34. The real world Many countries have laws dictating a minimum level of safety to workers Why? Although most labor markets are competitive in the long run, there are frictions in the short run that prevent immediate job movement

35. What else is going on? Today’s work affects the company today, but the worker for a lifetime  Workers value safety Example: Lose an arm  Firm lays you off; lower worker productivity for a lifetime Firm does not care about future earnings of the worker In many countries: Government support needed if the worker is unable to find a job

36. Unions and workplace safety Note that unions not only fight for high wages, but also working conditions Unions can be beneficial in determining the optimal amount of worker safety

37. Other methods to increase safety Offer financial incentives Higher safety  Bonuses (money, gift certificates, tickets for prize giveaways) Increased training Shorter work days Tired people are more likely to be clumsy and inattentive Workers’ compensation Insurance system for those injured while working

38. Safety outside of the workplace Many safety laws exist that are not related to workplaces These laws often affect children, who are “unable to fend for themselves” Child seats in cars Crib safety Reduced speeds near schools Some speed limits near schools are now 15 miles per hour

39. Summary: Workplace safety Workplace safety laws try to establish an efficient amount of worker safety Other attempts to increase workplace safety: Unions, financial incentives, increased training, shorter work days, and workers’ compensation programs

40. Monday Health care Information topics Reading Pages 295-305

41. Enjoy life, take a deep breath