Chapter 10: Market Failures
Ecological Economics: Principles
and Applications
Herman E. Daly and
Joshua Farley
Chapter Overview
• Market Constraints
– Excludability
– Rival/non-rival
– Congestion
• Public Goods
• Open Access
Regimes
• Coase Theorem
– Transaction costs
• Missing markets
– Intertemporal
discounting and net
present value
Market Constraints: Necessary elements for affective market forces
“One of the underlying assumptions of ecological economics is that many
of the scarcest and most essential resources are public good (services
provided by natural resource funds), ye the existing economic system
only addresses market goods.” page 172
-Goods and resources must be both excludable and rival
- Market actors must be able to make transactions with zero
cost
- People must have perfect information concerning all the
costs and benefits of every good
Market Constraints: Necessary elements for affective market forces
- An excludable resource is one for which exclusive
ownership is possible.
- A rival good is one for which use of a unit by one person
prohibits use of the same unit at the same time by another.
- Congestibility is an issue of scale. At a particular threshold
some nonrival goods acquire attributes of rival goods.
The Market Relevance of Excludability, Rivalness, and Congestibility
Excludable
Nonexcludable
Rival
Market goods: food, clothes, cars,
houses, waste absorption capacity
when pollution is regulated
Open access regimes, e.g., ocean
fisheries, logging of unprotected forests,
air pollution, waste absorption capacity
when pollution is unregulated
Nonrival
Potential market good, but if so, people
consume less than they should (i.e.,
marginal benefits remain greater than
marginal costs); e.g., information, cable
TV technology
Pure public good, e.g., lighthouses,
streetlights, national defense, most
ecosystem services
Nonrival but
congestible
Market goods, but greatest efficiency
would occur if price fluctuates according
to usage; e.g., toll roads, ski resorts
Nonmarket good, but charging prices
during high-use periods could increase
efficiency: e.g., non-toll roads, public
beaches, national parks.
Market Failures: When goods and services aren’t market players
-Market failures occur with goods and services outside the
narrow constraints of functioning market services.
-Monopolies - the absence of competition
-Patents - arguably stifles innovation
-Public goods - nonrival and nonexcludable
Public Goods: Open Access Regimes
The open access problem
Garret Hardin’s “Tragedy of the Commons”
- Rational self-interest creates short term personal gain for long
term collective degradation and loss.
- It assumes no regulation at any level
- Can result from a lack of enforceable property rights but for many
resources property rights would not lead to efficient outcomes.
Public Goods: Open Access Regimes
- A market failure
Examples of the open access problem
-The tale of 100 Cows
-The Atlantic Cod Fishery
-The difficulty of property rights
-Overpopulation as “tragedy of the commons”
Excludable and Nonrival Goods: a market failure
Information
Patents
- Quell the incentives to the money driven
- Disallow participation by everyone else
Examples
- GMOs (and naturally occurring plants)
- Pharmaceuticals
- Linux Operating System - open source
Pure Public Goods: a market failure
- Can be used by anyone regardless of who pays for it.
- Nonrival and nonexcludable
Three challenges for market based solution
1) Ecosystems services values - most people ignorant
2) The Free-Rider Effect - beneficiaries acting in self interest
3) Currently no institutions suitable for transferring resources
from the beneficiaries of ecosystem services to the farmer
who suffers
Public Goods and Substitution: a market failure
The market is poor at assigning a value to public goods
- It will not be able than to function correctly concerning
scarcity
Externalities: a market failure
An externality occurs when an activity or transaction by some parties
causes an unintended loss or gain in welfare to another part, and no
compensation for the change in welfare occurs.
The marginal external cost is the cost to society of the negative
externality that results from one more “unit” of activity by agent
Example: Farmer’s Cows in the stream
Addition of pollutants
Adverse change to flow
Deforestation of riparian zone
Externalities: a market failure
Coase Theorem - Market based balance of welfare from externalities
The coal plant and the air-drying laundry service
Laundry service needs a specific level of air quality
Coal Plant needs to burn coal
The Coase Theorem predicts these two parties will come to an agreed
upon level for emissions levels that is mutually benifical.
It assumes equal standing between the two businesses.
High transaction costs could justify government intervention.
Missing Markets: a market failure
A missing market is when a population with a vested interest is not able to
affect the market price.
i.e. Future generations and ecosystem services - Markets do not account
for future generations.
Intertemporal Discounting - the process of of systematically weighting
future costs and benefits as less valuable than present ones. (more in
Chapter 15)
Conclusions: on market failure
Markets only balance supply and demand under a very restrictive
range of assumptions.
The market doesn’t understand the ecosystem nor its services.
It will take more than consumer self interest and purchasing power
to conserve ecosystem services.