1. 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

2. 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.

3. 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

4. (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

5. (a) External Costs a negative production externality42
MSC = MPC + MEC
S =MPC
p* = 26
pm = 22 10
D = MPB = MSB
128
160
q of paper q* qm
Review ECO324-Ch3

6. 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 in our text)
Wastes being dumped into a river by a company
Review ECO324-Ch3 and Ch15

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

8. (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

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

10. 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 ): 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

11. 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

12. 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

13. 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

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

15. 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

16. 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 = Q Q
= Q
Marginal Social Benefit (MSB) = MPB + MEB
Assuming no external benefits, MEB= 0, so MSB = MPB
Set MSC = MSB
Q = Q
--Solving: QE = 128 thousand; PE = $26/barrel

17. 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

18. 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