Externalities and Market Failure Let s just rely on the free market to solve environmental problems right Setup Motivation What makes an environmental issue an environmental problem When one party s actions affect another party without compensation Think of the physical stuff that makes up the environment as goods and bads Goods clean air fuzzy critters safe water Bads NOx CO2 oil slicks harm to species A large part of economics is to classify and design inform regulation of goods and bads Characteristics of goods bads drives policy design Characteristics of goods I Excludability A good bad is excludable if it is feasible and practical to selectively allow consumption of the good Examples excludable Harvest of a particular fish Hamburger Air pollution in LA 3 Characteristics of goods II Rivalry A good bad is rival if one person s consumption reduces amount available to others holding supply fixed Examples rival A particular fish Hamburger Space on an uncongested freeway A nonrival good can be simultaneously consumed by many people Nonrival goods can become congested 4 Characteristics of goods III Externalities An externality exists when one person or firm controls something I consume or that affects my consumption or well being Smoke Snowmobiling in Yellowstone Biodiversity loss 5 Importance of rivalry and excludability Excludability necessary for price system to be used why Rivalry necessary for efficiency of price system why 6 Importance of rivalry and excludability Excludability necessary for price system to be used why If cannot exclude nobody will pay Rivalry necessary for efficiency of price system why If non rival people will free ride 7 A taxonomy 8 Examples 9 Examples Markets work fine 10 Examples Markets work but poorly 11 Examples Markets don t work 12 More examples Rival Excludable Prairie before invention of barbed wire Litter before anti littering laws Municipal garbage Fisheries subject to ITQs An important finding Excludability can be changed with technology Rivalry a fundamental characteristic 13 Why important Important for diagnosing problems If we can rely on markets it is much easier If we know the market cannot work we should expect things to need fixing Important for fixing problems If we can use technology to make an open access resource excludable we know we can fix 14
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