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A. Alchian 1998
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Armen Alchian 1999
The preceding examples of market exchanges were “I give you this and you give me that. And that’s the end of our obligations to each other.” That is an appropriate simplification to show the source of gains from exchange and how markets and market prices control competition for goods. But for an understanding of a wider range of actions, first we must first recognize that often we use resources over which no one has private property rights. Market exchanges won’t be available. Second, not everyone acts in a completely reliable way. Guile and deception must be restrained. Because market transactions typically involve promises of future actions, assurance of reliability of promised performance is desired. Third, we are social animals, We often help others even at an immediate sacrifice to ourselves. In this chapter, we’ll explore how resources that are not controlled by private property rights are subjected to excessive environmental pollution and abuse. We’ll also explore some ways that guile and deception in fullfilling promises is deterred.
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Many resources, not held under private property rights, are controlled by governments and some like the air, oceans, lakes, river water, and wild animals are owned and controlled by no one. Apples on an apple tree in a public park are pciked before they are ripe. Paper and cans litter public beaches. Garbage is dumped into the ocean. Cities and individuals use and then leave polluted, or depleted river water for downstream users. Emitters of airborne pollutants abuse the air that other people use too.. These unfortunate results are known as “the tragedy of the commons”, and sometimes misleadingly called
"failures of the market." That label is misleading because the effect – pollution – is not a failure of the market. They are failures to have a market – a failure to have defined and enforced private property rights for those resources at an acceptable cost. Taking account of that absence of private property rights will explain pollution, why it occurs, some methods to determine how much pollution to tolerate, how to control its extent, and some methods of making the existing degree of pollution less damaging. The analysis often appears astonishing. Yet, you’ll quickly see that it’s simple and straightforward.
The startling idea of an optimal or desirable amount of pollution may seem shocking. But it’s merely a way to emphasize that if we decrease pollution of the air, we'll have to give up more of other desirable goods and services. It’s like the desirable amount of sweat and work. It’s desirable because of what is produced with that “hard work.” Of course, the extra output may not be worth the increased work. But that's the whole point with pollution. Other goods and services must be forsaken or used in order to reduce pollution, but more of those other goods are always desired. Zero pollution, like zero accidents or zero sweat and

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A. Alchian 1998 2 toil, is a romantic ideal. Our startling way of expressing the issue – an “optimal amount of pollution" – purposefully attracts attention to the inescapable fact of scarcity. The question is, “How much of the other desired goods and services should we sacrifice in order to get a better environment with less pollution?”
That's what is meant by the "optimal" amount of pollution – an amount such that reducing pollution even further would cost more than the worth of the other goods and services that will have to be given up in order to have less pollution. That is no different than asking how much you should spend on gasoline – where you weigh the costs of more with the worth of having more.
Why Pollution? Costs of Establishing and Enforcing Private Property Rights
The problem of controlling pollution is a problem that arises because of the difficulty of establishing and enforcing tradable private property rights over resources. Where those rights are absent or weak or not enforced, pollution will occur. Resources will be abused. At the simplest level of pollution – as a form of abuse of resources – theft is an example of pollution. You could consider the environment as being stolen by the abusers. Many such forms of abuse are avoided by devices like locks, fences, burglar alarms, safes, barred windows, home and office security devices, private watchmen, security services. These devices are designed to increase security and thwart theft. The police and courts are not cheap.
Maintaining reliable records of title to economic goods and financial claims, like land and stocks and bonds, is not free. At the other end of the range is the protection that you and I provide when, like good
Samaritans, we prevent theft of someone else's property.
The higher the potential value of some resource, the greater is the cost worth incurring to control it as private property. For example, hardly anyone bothers to enforce or police parking time on low-valued land
(in suburban shopping areas). But for downtown parking a price is charged and spaces and times are monitored. Most streets are "free", but some superhighways and bridges are toll-ways. Some formerly almost free resources are becoming more valuable as populations increase. Large lakes, rivers and oceans, and the air are prime examples, and as a result they are being subjected to more extensive controls. As the effective range of surveillance over the ocean increases, greater distances from shore (200 miles instead of the old 3 miles) are claimed by nations as their property. Peru, Chile, Mexico, Iceland,
Norway and England, to name a few examples, claim an exclusive right to resource use (including fish) within this 200 mile zone. Those enforceable claims create incentives to prevent "over-fishing" (to be defined later), just as private ownership controls land use. Whether future claims to currently disputed areas (for example, deep-sea floor minerals and Antarctica) will be established as private property or as government property of one or more nations remains to be seen.
Where private property rights are weak or non-existent over some resources, control over them is are likely to be by governments. And governments may even dispute among themselves. For example, the western states in the United States sue one another in federal courts for Colorado River water rights and surely would use military action if the states were separate nations. When resources (air and water, for example) are managed by governments, the results often compare unfavorably to the way markets control private

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A. Alchian 1998 property resources. Abuses of government resources, such as streets and parks, are commonplace, much more than with privately owned resources. The reason is that abuse of a privately owned resource is more clearly felt by the owner, who has more to lose than does a government agent. But that does not mean government agents are lazy, incompetent or acting improperly. Instead, no known feasible methods exist for duplicating the way that people with private property rights would control and protect those resources.
That's the problem – the costs of establishing effective private property rights are often prohibitive.
Consider water as an example. You can be sure that the supply of water will not increase as rapidly as the demand for water does. Shortages will occur if the price of water is not raised to clear the market. And it is less likely to be raised if the water is not held as private property that can be sold. Without private property rights to water, the controllers have more incentive to allocate it by other means. One reason is that the advantages to the political agents of having authority to ration the water are very attractive – to them. The incentive to raise the price to ration and allocate the water will be much weaker than if the water were owned as private property. An owner would be able to obtain more wealth by raising the price.
Where technology and the law has actually enabled more enforceable private property rights, the allocations of resources in accord with revealed market prices is stronger, and political forces are less influential. Some examples are: airport landing rights and moving cocoons of airspace for commercial flights are bought and sold among airlines; and some rights to emit air pollutants are bought and sold among firms, as we will explain. But, first, we emphasize that we don't want to mislead you. None of the preceding implies that all the water ought to be owned as private property. The costs of such a system are today prohibitively high, so it's impossible. What is impossible is not a useful criterion against which to judge what ought to be.
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Control of Pollution of Air and Water: The Worth vs. The Cost (Worth of What's Foregone)
For resources such as air and water, over which private property rights have been very expensive to establish, some governmental arrangements for control have evolved. Two problems have been tackled.
"How is the degree of pollution to be controlled?" and "How much pollution is appropriate – the optimal amount?" When political authorities deliberate, they often (but not always) appear to be trying to emulate what exchangeable property rights would have achieved. Nevertheless, the principles and rationale that the government agencies apply depend upon the relative political power of special interest groups competing for preferred arrangements, regulations and laws. In the political arena, the criteria for allocations are less definitely known and are more varied from agency to agency. The process is riddled with assertion, contention, persuasion and differences of personal opinions.
For example, Congress has authorized the expenditure of substantially more than $100 billion every year, divided about equally for (a) cleaner water, (b) cleaner air and (c) reduced hazardous wastes. Is the cleaner air and water and reduced hazardous waste worth the $100 billion of other things that could instead

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A. Alchian 1998 4 be produced for consumers? Let's digress for a moment to try to grasp how much $100 billion every year represents. A standard house for a family of four can be built for about $100,000. That means 100,000 houses could be built for 300,000 people every year (about 3 people per house.) Or 1,000,000 compact cars (at $10,000 each) could be built annually. Or $400 could be given to every person annually forever in the United States. Or $1,000 could be given every year to every family in the US. [Editor’s note:the above figures, and those cited in the next paragraph, were derived in the mid-late 1990’s. To bring those figures into current perspective, roughly double the dollar amounts.]
Don't misunderstand our intention in trying to convey some idea of what $100 billion annually for cleaner air and water means. It says nothing about whether the amount is too large or too small! That depends in part on what the benefits are worth to the public. Maybe more should be spent. If another billion resulted in more than a billion worth of additional benefits, spend more. If a billion less would reduce benefits by only less than a billion, spend less. Those are tough issues to address because they are not like the decisions involved in making cars, where the added worth is revealed objectively by what people will pay to get a car.
People do not have to reveal their own worth as a condition of getting cleaner air or safer environments, so other people must try to estimate—and argue about—what those worths might be. So, what is estimated to be the worth of what is achieved by the $100 billions annually? We can only refer to some cost-benefit studies made by the US Government’s Office of Technology Assessment. It estimated the value of annual benefits from air quality control at between only 5 to 25 billion dollars annually, generated at a cost of 100 billion dollars. But who knows for sure? And it's the marginal effects of marginal dollars that tells whether more or less should be spent.
Suppose, as is the actual case, a new law requires producers of paint to install pollution control devices for cleaner air in the surrounding area. Who pays for the devices? (Actually, this analysis applies to any law requiring any pollution control devices.) It's tempting to say the paint producer pays, since the producer has to install new, expensive pollution control equipment. That's correct, in part. The common stock price of that producer, if it's a corporation, would drop when the law was promulgated. The stock price drops by about the cost of the pollution control equipment and by the increased costs of current and future operations, because revenues will not increase. That stock price fall is a measure of the higher costs of pollution abatement, and is borne by the investors who own the corporate stock at the time the stock price fell. A major portion of the stockholders are employee pension investment funds and other investment funds in which the public invests. Hence, the decline in the value of the stock will affect future retirement benefits, or is borne by employees who retire later – not by some inanimate thing called the "corporation".
But, in time, as the existing paint producing facilities wear out, they will be replaced only if the price of paint has increased enough to cover the continuing higher costs of pollution abatement devices. And the price will be higher because the paint producing capacity will not be replaced until the output is reduced enough to get that higher price. Any producer who enters the business or invests in equipment after the law is passed will not suffer a loss of wealth. The consumers of the goods will bear the cost in higher prices –

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A. Alchian 1998 5 because the higher costs will be taken into account when the producers decide whether it pays to make the investment under the new conditions.
A direct method for government agencies to choose the degree of pollution is suggested by a mindstretching analysis of smoking in restaurants. Suppose cigarette smokers owned the rights to smoke. In other words, they own the rights to determine the degree of pollution in the restaurant. Suppose that nonsmokers could buy air rights to cleaner air from smokers, exactly as one buys or rents office space from the building owner. Further suppose that non-smokers placed a worth on smoke-free air of $8 per hour, while smokers judged the worth of smoking to be $5. The non-smokers could pay the smokers up to $ 8, which is $3 more than the smoker's worth of smoking, so there would be no smoking. Even if, on the other hand, the non-smokers owned the rights to control the air quality, the end result would still be no smoking:
Because the smokers have a lower worth for smoking ($5) than the non-smokers do for the cleaner air ($8), smokers would not be willing to pay enough to non-smokers to relinquish their rights
Alternatively, let's turn the worths around. Suppose the smokers' worth of the right to smoke was $8, with
$5 being the amount non-smokers would pay for clean air. Now, smoking would occur, and it would occur no matter who owns the rights.
If non-smokers own the rights, smokers would pay them more (up to $3 more) than the cleaner air is worth
($5) to the non-smokers. Or, if the rights belonged to smokers, non-smokers would prefer the less clean air to the $8 they would have to pay to induce smokers to desist. No matter who owns the initial tradable rights to the interior air, the outcome depends only on who has the higher worth for the air quality.
The initial assignment of rights affects only the distribution of wealth of the two parties, not the
extent of smoking.
There is a third alternative, a realistic one widely used. The restaurant-building owner, and not the patrons, may own the interior air. Then the owner of the building could decide. If smoking is more valuable to people who want to use the building, it will be allowed. If it's less valuable, it will not be allowed. In fact, in some states smoking in “bars” has been prohibited, but the owners of bars in which the demand for smoking exceeds the demand for non-smoking, the owners refuse to enforce the law against smoking. In bars in which customers prefer non-smoking, the owners enforce the law. The owner collects a payment in

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A. Alchian 1998 the higher prices or rents paid for the resultant more highly valued environment. The payment represents the worth of what is paid or received in exchange. That's a way to "rent" the air rights – just exactly as is done when you pay more for a fancy, luxurious interior (including air conditioning and clean air) or less for eating in places that don't have those amenities. You can spread the net further by applying the same thoughts to renting office space in a building.
This example illustrates the principle that the ability to buy and sell enforceable private property rights pushes resources to the highest personal worths no matter who owns them initially ... whether the resources be land, automobiles, oranges, or labor services. So long as someone owns them, the highest known valued use would be chosen. The wealths of the owners will be affected by the initial allocation of those rights, but the ultimate uses of the resources will be unaffected. This is an important principle with wide relevance.
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As soon as someone mentions buying rights to pollute something, the usual response is, "You can't place a price on the environment. You economists assert everything can be reduced to money – that monetary values can be placed on aesthetics and the environment. In fact, you economists are wrong." But, look at the inserted news item.
Insert here, Item from London Financial Times of October 1995 about prices in the market for pollution rights.
Trade-Offs Everywhere
Because there is scarcity of goods (as well as a scarcity of desired environmental features), we all engage in trade-offs among scarce goods and services. Many of those tradeoffs don't involve money directly.
There are choices like that of studying Economics instead of watching TV for the next two hours. The point is that the chosen rates of trade-offs necessarily reflect valuations of the features – whether they are aesthetics, food, clothes, etc. When we make choices, we are implicitly pricing (place a worth on) aesthetics, along with other features of our choices, everyday. That's what we do when we decide whether some more elegant clothes are worth the dollar price of $800. If we don't buy the fancier clothes or homes or art, we have decided that improved aesthetics aren’t worth the price, measured at the equivalent of $800 of other marketable goods. What's different is that you probably are not used to thinking about your choices in this way. As another example, we don't wash and shine our cars every day because the cost is too high. In making decisions about whether to buy works of art for our homes, we are pricing aesthetics. It

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A. Alchian 1998 is incorrect to say that aesthetics and environmental features can't be priced, or valued, or traded. Every day that's what we do with respect to goods that are priced as private property. Implicitly we do the same thing with environmental features. The reason the environmental aesthetics are not so well controlled is that costs of defining and enforcing property rights are too high. That's why the environment is not used in ways that more acutely reflect the value of the aesthetic features of the environment.
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The example of tradable smoking rights in a restaurant helps you see that there is a way to assess the worth of less-polluted air. In major metropolitan areas, Air Quality Control Commissions monitor the amount of pollutants – such as sulfides – emitted from individual refineries, commercial manufacturers of paint, dry cleaning firms, and other stationary sources of pollutants. In some metropolitan areas, the entire area is defined in terms of a "bubble" of airspace, within which the objective is not to determine the optimal amount of pollution. The existing amount of pollution is not going to be changed. The objective is to maximize the value of the production of goods and services, without increasing the total amount of pollution. To do this, rules are established so that any firm that wants to emit more pollutants can buy some emission rights from other firms that have been allocated rights to emit pollutants. We know the firm that can produce a greater value of output with an extra unit of pollutant emission will be able to buy the rights from another firm that cannot use the pollutant rights in such valuable ways.
The federal government established and sold some tradable pollution rights a few years ago. You can buy one of them if you wish from a current holder. You might buy one now in the belief that it will be worth a lot more in the future. Indeed, you can buy some from current polluters and "retire them" – never resell them.
That will reduce the amount of pollution. How much would you pay for the right to emit 100 tons of specified noxious agents annually?
You can probably guess correctly that this is nothing more than the same idea used in the earlier analysis of egg trading between Ted and Rae in Chapter 8. We merely replace "eggs" with "pollutant rights" and we have exactly the same analysis, the same principle, the same conclusion – if the rights are tradable.
Figure 1 shows a hypothetical example for two firms emitting pollutants in the process of manufacturing products. One firm is Martin Refining and the other is Clarkson Paint Co. The vertical axis measures the values of rights to emit units of pollutants. The curves represent the "marginal values of the right to emit pollutants" at the alternative amounts of total pollutants emitted (measured on the horizontal scale.) These curves are demands for rights to emit pollutants.

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P*
Dc
Dm
Dc + Dm
28 12 40
Figure 1: Aggregated Demands for Rights to Emit Pollutants
The heights of the demand curves, one for Clarkson and one for Martin, measure the marginal worths of other products that can be produced with the degrees of resultant pollution, which is measured on the horizontal axis. If a firm polluted less, less would be produced. Combining the two demands horizontally gives an aggregate demand curve expressing the marginal worths (of other goods produced) at alternative aggregated amounts of pollutants. The intersection of the aggregated demand curve with the permissible total emission of pollutants, reveals the market value (value of other goods that could be produced) with one more unit of emitted pollutants.
A Rearranged Diagram for the Same Question
Now look at Figure 2, which represents the same situation, in a slightly revised format. What is unusual about this diagram is that instead of both demand curves starting at the left side and reading toward the right, one of them is turned around and read from right to left.

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A. Alchian 1998 10
P*
Dm
Dc
28 40
Figure 2: Competing Demands as Demand and Supply
The format of Figure 2 differs from Figure 1 in two ways. The first difference is that Martin's demand curve for rights to emit pollutants has been turned around and placed on the diagram to read from right to left, rather than left to right. The right, not the left, side of the diagram represents a zero amount of pollutant emission by Martin. For Clarkson, the other demander, the demand curve remains where it was, reading from left to right. The second difference is that the length of the horizontal base of the diagram is now a fixed distance -- measuring the given total amount of pollution emissions now permitted. The fixed horizontal length of the base of the diagram is a measure of the fixed total amount of pollutants that can be emitted by Clarkson and Martin.
Martin's demand curve has been turned around to read in the reverse direction -- from right to left. It is lower at larger amounts of pollution by Martin -- right to left. The total length of the horizontal axis, which measures the amount of permissible pollutants, is arbitrarily measured as 40 units. If Clarkson had the right to emit all the pollutants, and Martin had none, that would be represented by a point at the extreme right hand side of the diagram. All the other possible divisions of the rights to the 40 units are represented by points along the bottom axis between the left and right borders. As we move toward the left edge, Clarkson

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A. Alchian 1998 11 would have fewer rights for pollutant emissions with correspondingly more for Martin. At the extreme left edge all the rights would belong to Martin.
It is apparent that if Clarkson had all the rights, Martin would find it profitable to buy some from Clarkson.
Martin places a higher marginal worth on the right to emit a unit of pollution than does Clarkson, when
Clarkson has all the rights. At the other extreme, if Martin had all the rights, Clarkson would buy some from
Martin.
This diagrammatic way of presenting and comparing demands has three advantages. (1) It emphasizes that only by attracting goods away from other people can one get some of the goods. Each person must compete against the demands of all other people for that same good. (2) It emphasizes that trade equalizes the marginal worths over all people, thereby maximizing the aggregated personal worth. (3) It indicates that the worth of one more unit of pollution being allowed in the metropolitan air space is the marginal worth of the current right to emit pollutants. In other words, the price that one firm pays another for a unit of pollution rights is a measure of the value of the additional output that is produced by being allowed to emit that unit of pollution.
The two firms will trade pollution rights to where the marginal worths of a unit of pollution are equal. So long as they are unequal, it will pay the firm with the higher marginal worth to buy a unit of pollution rights from the lower marginal worth firm. As the rights are traded, the firm selling some polluting rights will move toward higher marginal worths until it equals the falling marginal worths of the buying firm. The point where the two demand curves cut each other indicates the equilibrium allocation of the pollutant rights. In the diagram that's indicated at 10 units for Martin and 30 for Clarkson. No matter who initially has any or all the units of the 40 total allowable units of pollution rights, if trade is permitted, Martin will end up with 10 and
Clarkson with 30.. The only difference is in who would be richer because of initially having the right to pollute. That's a question of the distribution of wealth, not of the amount of permitted pollution. Don't confuse the two.
As can be readily summarized with aid of the graph in Figure 2, at any division where the heights of the two marginal value curves are not equal, a transfer of some rights from the lower to the higher valuing firm would benefit both. And that would (unintentionally) increase the total worth of the outputs, with no change in the amount of pollution. Clearly, the difference in marginal values is a measure of the increase in total product value achievable by assigning a unit of pollutant to the higher, from the lower marginal value producer.Trading pollution rights can reduce aggregate pollution as well as reduce the cost of production of desired goods and services.

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Knowing that value of the otherwise foregone production is one element in determining the optimal degree of pollution. That's analogous to determining the worth of another hour of labor (which “pollutes one’s pleasure”). It’s the same as the worth of some smoking in the earlier restaurant example. That can be done by the restaurant owner, who can control the quality of air by regulating the permissible extent of smoking.
The effects on business income serves as a measure of how much the customers are willing to pay for cleaner air. But evaluating that for many other situations is prohibitively costly. Determining that in a metropolitan area with thousands or millions of people is a much more difficult problem. But there is one possible clue worth thinking about. What about the differences in values of land that vary in the degree to which the air over those areas is polluted? We leave that for future more advanced courses in Economics!
There is one more feature implied by the purchase and sale of "air bubble" pollution rights. A firm can either buy pollution rights or it can install devices to reduce the pollution. The ability to trade rights forces the firm's owner to compare (a) the cost of buying more “rights” to pollute with (b) the cost of equipment to reduce its own pollution. The technology for reducing pollution is flexible. A polluter is allowed to use whatever method of pollution-control is cheapest. This is more economical than specifying a particular technological method that must be used by all,
Nevertheless, there is a surprising source of objection to allowing this flexibility and use of more economical methods of controlling pollution. Firms that use high-sulfur, high-polluting coal would switch to low-sulfur coal or other less polluting sources of power. That reduced demand for high sulfur coal would reduce the wealth of owners of high-sulfur coal mines. They managed to hve restrictions imposed on the permissible extent of such trading and substitution. Politics and log-rolling are real.
Three False Issues
(1) Fairness and Amount of Wealth?
To show how far ahead of the rest of the public you now are in your understanding of the issue, what would be your response to the following objection? Opponents argue that the richer firms would get the pollution rights from the poorer ones, and that's unfair. This argument is based on the estimate that the benefited firms (presumably the richer ones), which bought pollution rights from the poorer firms, would avoid, for example, over $600 million in costs of controlling pollution, while the firms which sold the rights (presumably the poorer firms) would incur extra costs of, say, $350 million to reduce their pollution or the lost output value. But, if ever a contention was confused, this is it. What the estimates reveal is that the firm saving
$600 million would save more than enough to pay more than the $350 million loss incurred by the firms agreeing not to pollute. Both sets of firms would gain by a total shared cost reduction of $250 million
(=$600-$350 millions)! Don't be surprised that some people believe (or argue as if) trade benefits only one party at the loss of another. (You'll see the same illogical, incorrect argument in later chapters on international trade.) That's a reason for belaboring this point here. Obvious as it seems to you now, it is

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A. Alchian 1998 13 widely denied by important people. Another error in the contention was that the richer firms would buy from the poorer. That's wrong because the richness of a firm has nothing to do with the marginal value of pollution rights to the firm. A rich firm may already be polluting so much that the reduction of some pollution has only a trivial effect on its output value. In that case it will sell to a smaller firm that would gain with a right to emit more pollution. Greater wealth does not mean a person will foolishly spend more. The final lesson from this example is that the simplest economic principles have a broad range of applications.
(2) Growth vs. No-growth City Planning
Another source of misunderstanding arises with the so-called "no growth" advocates in city planning. "Nogrowth" advocates are not necessarily opposed to growth of population in some area. Instead, they oppose newcomers who don't pay for the costs of resources they use – especially for governmentally supplied nonpriced facilities. Typically, developers are required to pay special development fees – for parking spaces, street improvement, sewage, open space, housing for low and moderate income earners, etc. It might appear at first glance that existing landowners bear the burden of development fees (new land taxes), which would seemingly cause the value of their land to decline. In fact, the proceeds of those fees are used to make improvments (such as new roads and sewers) that have a value greater than the taxes used to pay for them. As a result, existing landowners may actually benefit from these development fees.”
If the latter were true, as it probably is, why do individual developers and single landowners not voluntarily make those tax-financed investments without compulsion? A single developer of a portion of the area might invest in the whole sewage system, or entire an system of roads, but neighboring landowners would then gain at no expense, and the costs would not be recovered by the landowner or developer. Government powers of compulsion can force the beneficiaries to share in the costs. The government acts somewhat as if it owned the whole area and the tax-payers were its land renters. The government "internalizes" the
"external" effects and approximates what private property rights would have been expected to accomplish, if the property rights hadn't been so dispersed or vague.
(3) Economics of the Environment: a Scarcity Issue -- Not Economics vs. Environments
The preceding exposition should expose the myth of a conflict between economics and the environment.
Actually there is no division of people into environmentalists and economists. Everyone is an environmentalist . Everyone prefers a cleaner, safer environment over a dirtier, more dangerous one – just as everyone prefers more economic income. Some people regard visits to the mountains, wilderness and communing with Nature more highly than do other people. People differ in their evaluation of the worth of the use of highly desired but scarce resources. (What Economics forces you to do – and which we usually don’t like to do – is to recognize that more of “this” means less of “that.” There’s a cost. Taking account of costs permits you to have a better life than if you ignored them. But who likes to be reminded of inevitable costs? Never forget scarcity! The arguments that persist are about whose assessments of the benefits and the costs should be dominant. People, like members of the Sierra Club and Audubon Society, would prefer (quite reasonably, given their preferences) to have more natural resources preserved for their preferred purposes. Others, less interested in "Nature in the Raw" relative to other things, would like to have more development for homes or easier access (roads rather than hiking trails) to, say, mountains.

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Economic analysis is neither biased for, nor against, more desirable environmental characteristics and effects, nor does it indicate what the relative preferences should be. Instead, it reveals that there is an inevitable scarcity – requiring a choice of more of this or more of that. More clean air and water means less of other desired things. More steel, golf courses or clothing means less of something else like housing, food, tennis courts, you can be sure. Only for an innocent child is the "tooth-fairy" real. We therefore defer further consideration of environmental issues to later chapters on governments, which in the absence of well defined, transferable rights to environmental resources, will act to control those resources.

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There’s ethical behavior as well as reputable behavior in markets. The economic analysis of ethics and of reputable behavior (the two are different) leads to some surprising, valuable implications. Consider an emergency. If you, a complete stranger to me, were to trip suddenly, fall and be injured, I might ask
"What's it worth to you for me to rush you to a doctor?", especially if I thought you were rich! Your astonishment and anger, and the scorn with which society would regard me, needs no elaboration.
Behavior such as hypothetically exhibited by me in this case is restrained both by "moral aggression" against those who might try to exploit a person in distress, and by one’s own personal compassion and sense of responsibility. So, instead of asking the dastardly question, I offer to help even though I might incur a greater cost, like missing the class I am on my way to teach. I would feel bad and ashamed if I had not stopped and helped – even if no one else ever knew I had not been the Good Samaritan, and even though the costs I imposed on students who waited for me exceeded the benefit rendered to you, the victim. This may appear to suggest a dilemma for an economist. If the benefit to the victim is less than the costs to me and students who missed a lecture, is this sensible? The total costs, including costs incurred by other people, exceed the benefits to the victim. Does ethical behavior thereby reduce the total value of output?
No. To see why, consider the consequences for the well-being of all people if opportunistic, unethical behavior were commonplace and no ethical behavior were expected to occur in emergency situations.
People would be more cautious and hesitant to take desirable actions that expose them to some risk of being caught in such emergencies. They would take more expensive safety precautions to avoid the risk of becoming dependent on one other person in the event of an emergency. They would travel less, and refrain from doing things that had such risks. Furthermore, they would take more expensive safety precautions.
People would travel less in the remote areas, or would carry extra repair supplies. The costs of the advance precautionary activities and also the value of forsaken "risky" activities would exceed the costs to people who provide emergency services in an ethical fashion. Relying on others to help in emergencies is less costly overall. Society -- all of us – would be poorer as a whole without ethical behavior. Whatever the emotive language, “decent” behavior saves resources and enables greater welfare.
Economics has not explained how this responsible, non-opportunistic, moral, and ethical behavior became inculcated in our social nature. We leave that as a problem to be answered by your anthropology, sociology and biology professors. The main point here is that economic principles do not rest on a presumption that people never incur costs in order to benefit others.
Ethical behavior is behavior which imposes a cost on a person but enhances the survivability or welfare of the social group to which that person belongs. Fighting for one's nation is an example. Observing the

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A. Alchian 1998 16 canons of etiquette is another. Though it is costly to you to act ethically and observe social “rules” of ettiquete and ethical behavior, you do so. And typically, you would “feel bad” if you didn’t. Imagine not immediately yelling "Fire" when you notice a fire. In an extremely personal sense you'd be better off quickly sneaking out of the building before telling everyone else to run (and thereby congest your path). You tell a cashier of a mistake, when too much money is returned in change. You return a "found" item, though no one would ever know that you kept it. You do that because you “feel” it is the “right thing” to do. And you do actually feel good emotionally when you do. Whether that behavior and internal emotional response is genetically inherent or is taught is irrelevant for our purposes. It's impossible to conceive of how a society could persist if everyone seized every opportunity to exploit someone else, ignoring ethics or etiquette.
And for your added private contemplation, consider the role of religion. Many religions are precepts for
“ethical behavior”, as well as for worship of a “superior being.” If you behave unethically, you’ll be ostracized socially, and spiritually. We all are members of "groups", from family, to classmates, to college, to firms in which you will work, to the city, the nation and even the world – against interstellar invaders. We live in teams with rules, even though the rules may at times be against our own personal interest.
Professional Codes of Ethics
Economic analysis can reveal where ethical behavior is more strongly emphasized. “High-trust professions” rely heavily on codes of ethical behavior. For some services, customers are in a position of (a) necessarily trusting the supplier with (b) a substantial part of their wealth or welfare. The customers cannot detect the quality of service at the time it is rendered, and they are unlikely to know, until it is too late, what was really done. The significance of the risk is not trivial like that when buying a head of lettuce or seeing a movie that may be a dud. There’s an old saying that mistakes of doctors are buried, and mistakes of lawyers are hanged. A doctor may be a charlatan and prescribe worthless medication. If the patient recovers, the patient never would know the prescription was worthless. There is a heavy reliance on the good faith of a supplier whose services cannot be economically evaluated sufficiently to know whether or not the service is good or bad. A surgeon’s patient may have recovered very slowly because of mal-performance or despite the best surgical service. The patient will not know. It's not just that the customer doesn't know at the time the service is rendered; it's that the customer is likely to never know whether or not the service was as promised.
Where the risks are high, the suppliers of the service (the persons relied upon), have an incentive to provide some assurance of the reliability of service. Physicians, engineers, dentists, architects, and lawyers
(and undoubtedly other groups) are considered to be in high-trust professions. One way to increase trust and reliability is to have competing members of the profession act as monitors and enforcers of reliable services. They have explicit, mutually supported "codes of ethics." The members of a profession will castigate or disavow members who are known to have violated the code of ethics. Though they have a strong interest in eliminating competitors (deficient or not), they also have an interest in assuring the public that they themselves will serve as promised. Governments permit and help enforce codes of ethics, even though the code might be (also) used for collusive purposes to control competition and prices.

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Unquestionably a very strong sense of morality and ethics is pervasive in society. A society couldn’t persist without a dominating sense of ethics, honesty and proper respect for other people in that society. Neither the capitalist system nor any other can survive without strong ethics or restraints and punishments for unethical behavior. (Note which systems have survived most successfully!)
Charity?
Economic principles apply to more than just market exchanges. It applies to charity, and it helps explain ethics. As we’ll see, though there’s no charity in the market, charity is almost everywhere else. "The market is not a place for charity!" That’s true by definition of an exchange. But, charity does occur almost everywhere else. It’s a form of helping other people with no expectation of receiving anything in return from the aided persons. We present gifts at birthdays and weddings – not in expectation that the recipients will reward us. Giving help to others does, however, give the giver a sense of personal pleasure – as you almost surely have discovered. That is not surprising, because at a basic level we are social animals, as are wolves and beaver. Group loyalty with charity to others is present. Over 10% of national income is given annually as charity and voluntary (non-governmental) aid to the poor – excluding intra-family aid to one's children. Table 1 presents some data about the extent, source, and allocation of philanthropic contributions, excluding gifts and inheritances to one's own family.

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Table 1
Philanthropic Contributions Categorized by Source, 1986
(Measured at 1992 dollar equivalent price level)
Total Amount ........... $125 billion
From: living people 82%
bequests
foundation gifts corporation gifts
7
6
5
100%
To:
religions 47
health institutions 14
educational institutions 15
human services 10
arts, culture 7
public, social benefit 3
other 4
100
18
(U.S. Statistical Abstract, U.S. Bureau of Census, 1988, Table 600)
Source: Virginia Ann Hodgkinson and Murray S. Weitzman
Dimensions of the Independent Sector: A Statistical Profile, Washington: 2nd ed., 1986, pp. 52-53 Tables
3.1 and 3.2

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Whatever the intent, a gift is equivalent to a sale at a price below the market-clearing price. Gifts "in kind"
(not in cash that you can spend however your wish) usually have some waste from the recipient's point of view. Intent does not necessarily determine consequences. Whatever the differences of opinion, the analysis does help reveal consequences that often appear to be widely ignored, as the following examples illustrate.
Foreign Aid: Annually, the US government has granted aid to foreign governments, ostensibly for specific purposes. If a foreign government is given $10 million to build a dam which it would have built or bought even without the gift, what has it gained? What it would have spent of its own funds is released for other purposes. As a result, the gift really enables the recipient government to have $10 million more to do whatever it wants.
TV Broadcasting Licenses: To operate a television station a license is required from the Federal
Communications Commission (FCC). The value of the license far exceeds its money price. Moreover the law forbids assigning licenses on a “first applier-first served” basis. The winner is the applicant deemed most fit (based on responsibility, dedication to public service and education, publicly-owned status, etc.)
Competition in establishing and comparing fitness is expensive; the combined costs of all competitors in that competition can even exceed the value of the license. Much is wasted in competing for the award – using lawyers, lobbyists, and political donations, because once obtained, the license is transferable at the market value, though, to hide the value of the gift: it is politically advisable not to sell the "nude" license alone – without the studio and broadcasting equipment.
Other examples are licenses to operate liquor stores, taxis, banks, dairy and tobacco farms. All these rights are salable once they have been awarded. In New York City the license to operate a taxi was reported in the 1990’sto be worth over $175,000 per cab. What do you think it would be worth now? (Try using your internet search skills and let us know!) That should give you an idea of what it would be worth paying to get a license.
Nontransferable Aid
Some aid cannot be legally reallocated or resold: examples are the right to enroll in a college or medical school, or enter the United States, or join some unions, or adopt a child, or camp in a national park, or bus rides to school. When children are bussed to school, who gets what? Parents otherwise would have either provided transportation at their own expense or made their children walk. Once relieved of buying transportation they otherwise would have provided, the parents are able to divert that expenditure to

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A. Alchian 1998 20 something else ... beer, travel, food, clothing, etc. The children whose parents would have had them walk get a gain in the form of a ride rather than a walk. Or, another obvious example ... if I were given a case of
Coke each month, which I would otherwise have purchased, the gift merely releases income that I can now spend on other things. The principle is simple: to the extent that recipients would have in any event purchased the services now provided at below cost, they are getting a gift of that much money for general purposes.
Municipal Target Financing
Another, perhaps less noticeable, variant on the same basic theme of substitutability is the following common situation. City officials often propose to raise taxes to increase some activity, say, police protection. But the city officials could have reduced other expenditures in order to purchase more police protection. If taxes are increased the proceeds defer that diversion from other activities, so that the taxes are really not for more police protection, but for more of everything the city buys, with a small portion going for police protection. So long as decisions can be revised about allocating money over various goods and services, an increased wealth available for one particular activity does not mean that particular activity will increase by that amount over what would have been spent on it without the gift. Substitution is virtually impossible to restrain. For example, the California lottery’s gain to the government is asserted to be for public schools, except that local authorities divert local funds to other purposes, an arguably sensible tactic.