|Market Failure & Environmental Protection
efficiency rule – produce the quantity of output where marginal
social benefit equals marginal social cost.
Market failure – occurs
when the market does not produce the optimal quantity of output.
One cause of market failure is a lack of perfect competition.
Externality – a benefit
or a cost of an activity that affects third parties.
- When an externality is generated, the private market will
fail to produce the optimal quantity.
- Private market equilibrium will occur where the private
market demand curve intersects the private market supply curve (where
marginal private benefit equals marginal private cost).
- If there are no externalities, the private market
equilibrium is also the optimal quantity.
- If a market generates an external benefit, the private
market will underproduce compared to the optimal quantity. The
private market equilibrium (where MPB = MPC) will be less than the
optimal quantity (where MSB = MSC).
- If a market generates an external cost, the private market
will overproduce compared to the optimal quantity. The private
market equilibrium (where MPB = MPC) will be greater than the optimal
quantity (where MSB = MSC).
Externalities can also be controlled through government regulation of
the externality producing activity.
<>Establishing private property rights and reaching voluntary
agreements. Whichever party is assigned the property rights, a
more efficient solution can be worked out.
- Taxes and
subsidies. The tax (subsidy) needs to be equal to the external
regulation of externalities may result in costs that exceed benefits:
Pollution – any undesired byproduct of production.
- Regulations are generally imposed on a blanket basis (or
“one size fits all”).
- Regulations are sometimes imposed without careful
comparison of costs and benefits.
- Regulations are costly.
Methods of pollution control:
- The ideal level of pollution is usually not zero. The
cost of reducing pollution to zero is usually greater than the benefit
of achieving zero pollution.
- Pollution control should be pursued up to the point where
the MSB of control equals the MSC.
- Regulatory standards. May result in costs that exceed
- <>Market environmentalism. Achieve
goals through the use of the market. Allows for pollution control
at the lowest possible cost.
goods – nonrivalrous in consumption and nonexcludable.
A good is rivalrous in
consumption if consumption by one person prevents or interferes with
consumption by another person.
A good is nonrivalrous in
consumption if consumption by one person does not hinder consumption by
A good is excludable if
nonpayers can be excluded from consumption.
A good in nonexcludable if
nonpayers cannot be excluded from consumption.
Because a public good is nonexcludable, consumers can obtain the
benefit of the good without paying for it. This is the free rider problem. Thus,
public goods must be produced by government.
failure can also be caused by:
<>Adverse Selection - a party is confronted with a different
selection than expected
Asymmetric information – when a party to an exchange has information
that the other party doesn’t have.
<>Moral hazard – one party to an exchange changes their
behavior in a way unexpected by and detrimental to the other party.
| The Environmental Threat
- We have come to recognize that pollution impairs health,
life expectancy, and thus reduces labor-force activity and output.
- People in the nation’s most polluted cities are 15 to 17
more likely to die prematurely than those in cities with the cleanest
Pollution entails real costs, as measured by impaired health, reduced
spans, and other damages.
- Air Pollution
- Acid Rain
- Sulfur dioxide (SO2) is an acrid, corrosive,
and poisonous gas created when high-sulfur fuels are burned.
- Sulfur dioxide emissions contribute to the formation of
acid rain that destroys vegetation and forests.
- Coal burning alone accounts for about 60 percent of all
emissions of sulfur oxides.
The Greenhouse Effect
- Nitrogen oxides (NOX), another ingredient in
the formation of acid rain, are also a principal ingredient in the
formation of smog.
- Automobile emissions account for 40 percent of urban
- Bakeries, dry cleaners, and production of other
consumer goods account for an equal amount of smog.
- Excess buildup of carbon dioxide is creating a gaseous
blanket around the earth.
- The potential effects of this blanket are intensely
- Everyone agrees that the burning of fossil fuels is a
significant source of CO2.
- The destruction of rain forests, which absorb CO2,
also contributes to the greenhouse effect.
- Organic Pollution
Thermal Pollution is an increase in the temperature of
waterways brought about by the discharge of steam or heated water.
- The most common form comes from the disposal of organic
wastes from toilets and garbage disposals.
- Sophisticated waste-treatment plants can reduce organic
pollution up to 99 percent.
- Inadequate treatment systems often result in the
closure of waterways and beaches.
- The 7.5 billion chickens and 161 million cows and hogs
each year generate 1.4 billion tons of manure. If improperly
that organic waste can contaminate water supplies and trigger algae
that choke waterways and kill fish.
- According to EPA estimates, we generate over 5 billion
tons of solid waste each year.
- Most solid wastes originate in agriculture and mining.
- The smaller amount of solid waste originating in
and commercial use is considered more dangerous, however, simply
it accumulates where people live.
|The Cost of Pollution
- Some monetary measure of environmental damage is important
to our decision making.
- We won’t get clean air unless we spend resources to get it.
- Assigning Prices.
- In some cases it is fairly easy to put a price on
In other cases, measuring the cost is difficult at
best. For example, it is difficult to measure the value of lost
- Scientists can measure increases in cancer, heart
attacks, and other disorders.
- Economists can estimate the dollar value of damage by
the economic value of lives, forests, lakes, and other resources.
- Views of sunsets.
- Recreation opportunities.
- One of the most frustrating things about all of this
environmental damage is that it could be avoided.
- The EPA estimates that 95 percent of current air and
water pollution could be eliminated by known and available technology.
- Pollution control measures include: auto-emission
smokestack cleaners, improved sewage and waste-treatment facilities and
towers for electric power plants.
- Solid waste can be reduced by less packaging, recycling
more materials or transforming garbage into a useful energy source.
- Market incentives play a major role in pollution behavior.
- The Production Decision
- Business managers seek to make a profit-maximizing
- Production Decision – The selection of the short-run rate
of output (with existing plant and equipment).
- The rate of output which maximizes profits is where MR =
- The Efficiency Decision
- Efficiency Decision – The choice of a production process
for any given rate of output.
- The efficiency decision requires a producer to choose
production process that minimizes costs for any particular rate of
- Unfortunately, this efficiency decision does not lead to
a low production of pollution.
- Pollution abatement can be achieved, but only at
significant cost to the plant.
- The behavior of profit-maximizers is guided by
of revenues and costs, not by philanthropy, aesthetic concerns, or the
of the environment.
|Market Failure: Externalities
- Pollution does not generally appear on the profit-and-loss
statement for a firm.
- These external costs (pollution) are called externalities.
- Externalities – Costs (or benefits) of a market activity
by a third party: the difference between the social and private costs
of a market activity.
- Whenever external costs exist, a private firm will not
its resources and operate its plant in such a way as to maximize social
- Social Costs – The full resource costs of an economic
activity, including externalities.
- Private Costs - The costs of an economic activity
borne by the immediate producer or consumer (excluding externalities).
- When social costs differ from private costs, external costs
In fact, external costs are equal to the difference between the social
- When external costs are present, the market mechanism will
allocate resources efficiently. This is a case of market failure.
- If pollution costs are external, firms will produce too
much of a polluting good.