Lecture 3: Laissez-Faire
Readings:
1. Ibbott, Chapter 3
2. Leach, Chapter 8 pp.123-128
3. H Scott Gordon “ The Economic Theory of a Common Property
Resource: The Fishery in the JPE, 1954 which can be downloaded
at http://www.jstor.org/stable/1825571
4. Garrett Hardin “The Tragedy of the Commons” Science
Magazine, 1968 which can be downloaded at
http://www.sciencemag.org/content/162/3859/1243.full
Laissez-Faire
• We have had examined views of the state
– Hobbes: The visible hand of the State’s sovereign power creates the
peace necessary for prosperity.
– Smith: The invisible hand of the marketplace is superior to the State in
allocating scarce resources.
• The Political Left is panicked by the apparent movement towards a
laissez-faire world in which global markets reign supreme. The state
seems to be in retreat.
–
–
–
–
Neo-liberal Think Tanks, Tea Party, Libertarianism
Existing Agreements: NAFTA, MERCOSUR, EC, etc.
Proposed Agreements: APEC, FTAA, etc.
UN Treaty Organizations: GATT, WTO, etc.
• Will a spontaneous and benevolent social order will emerge if the
state is severely limited so that the invisible hand of a global market
can do its magic?
• Is the coercive Power of the State only useful in creating peace?
Laissez-Faire
• A political movement known as Anarchism suggested
that the elimination of the state would usher in a
golden age of peace and prosperity. There are two
branches of anarchism.
• Anarchists see no role for the state, and in particular
wish to eliminate the state’s role in defining and
defending private property. With no state a benevolent
social order will spontaneously emerge.
• Libertarians see the state having only one role – the
creation and defense of private property. With private
property in place, the marketplace will create a
benevolent social order.
Laissez-Faire
Q: What is property?
A: In Common Law systems, property is usually understood to be
comprised of real property (land and land improvements from buildings
to machinery sited on land) and personal property (tangible assets such
as goods and money and intangible assets ranging from financial
securities to patents, copyrights, and trademarks and other registered
forms of intellectual property). In Civil Law systems, property is usually
classified in a similar way as either immoveable or moveable.
Q: What is private property?
A: Private property is usually understood as a bundle of individual rights
over property. It is a bundle of rights over real property and personal
property that includes:
1.
2.
3.
the right to use and enjoy all permitted uses and benefits from your
property,
the right to exclude others from using your property,
the right to transfer or sell these rights.
Laissez-Faire
• Without these individual rights, property would
be worthless and markets, which serve the
purpose of transferring property rights, would
cease to function.
• Would private property rights spontaneously
emerge without a state?
• Is private property really necessary for a good
social order to emerge?
– Plato vs. Aristotle
– Aquinas vs. Thomas More (Utopia)
– Locke vs. Proudhon
Laissez-Faire
• What does economics have to say about private property?
• Until recently, private property was simply assumed and
was not examined. This changed when Scott Gordon
(Canadian Economist) introduced his model of the fishery
which was generalized by Garrett Hardin (American
Ecologist) as the “Tragedy of the Commons”.
• This model opens up private property to examination as
one of many possible social arrangement for rationing
community access to a common pool or common resource.
• This has been deeply explored by Elinore Ostrom
(American Political Scientist) who won the 2009 Nobel
Laureate in Economics for her work examining the different
ways that human society has dealt with the tragedy of the
commons.
Laissez-Faire
• Model: Assume that there is a community with a lake that
has a valuable fishery, and that the lake is common
property for the community.
– Members of the community have to make the choice of
whether to go fishing for the day or to work for a daily wage of
‘w’ (the opportunity cost of going fishing is w).
– The total value of the fish caught rises as more and more people
go fishing, but there are diminishing returns.
– At some point, a maximum catch value is reached, and the
addition of any fishers beyond this point will cause the catch to
fall from over-fishing.
• The total social benefits (TSB) and total social costs (TSC) to
the community from fishing are illustrated in figure 3.1.
Notice that the slope of the TSC curve is w.
Laissez-Faire
Figure 3.1
$
Z
TSC
TSB
w
0
5
10
12
Number of
Fishers
Laissez-Faire
• Assume that the lake is currently being used by 12 fishers
and ask whether this is a social equilibrium given that there
is free community access to the common lake property.
• We can determine that each individual fisher’s opportunity
cost is w, the wage that she could earn in the next best
alternate activity.
• Her expected revenue from fishing is likely to be about the
average catch, or Z/12.
– If the private marginal benefit from fishing (Z/12) exceeds the
private marginal cost (w), then more people will be attracted
out of the alternative employment.
– If, the private marginal cost (w) exceeds the private marginal
benefit (Z/12) then people will tend to stop fishing and take up
the alternative employment.
– Only if the private marginal benefit equals the private marginal
cost (Z/12 = w) will the number of fishers be at an equilibrium.
Laissez-Faire
Figure 3.2
$
Z
TSC
TSB
0
1
5
10
12
15
Number
of Fishers
Laissez-Faire
Figure 3.3
$
Z
TSC
TSB
0
1
5
10
12
15 16 17
Number
of Fishers
Laissez-Faire
• The social equilibrium will occur when the use of the free
access lake attracts no additional fishers.
– For 15 or fewer fishers, the PMB>PMC and more people will
take up fishing.
– For 17 or more fishers, the PMB<PMC and people will give up
fishing.
– When there are 16 fishers, the PMB=PMC and there is no
incentive for anyone to take up fishing or leave fishing as fishers
and non-fishers earn the same income.
• The unique equilibrium for this community with open
access to the common property is therefore 16 fishers
earning their income from the lake while the remaining
members of the community earn their income in the
alternative employment activity.
• Notice that the common property equilibrium leads to
over-fishing. Fewer fishers would mean higher income from
the community resource.
Laissez-Faire
Q: What the best social outcome might be.
A: Limit the number of fishers to maximize the rent from the
community resource (MSB = MSC) and put all others to work
in agriculture.
Implications:
1. The maximum sustainable catch is too high.
2. Rationing access to common property resources is
essential for prosperity.
3. Anarchism will fail to provide a benevolent social order.
4. Civilizations will fall if the tragedy of the commons
destroys the basis of their prosperity.
Laissez-Faire
Figure 3.5
$
Z
TSC

Z*
*
12w
TSB
5w
0
1
5
10
12
16
Number
of Fishers
Laissez-Faire
• How can society optimally ration access to
property so that MSC = MSB?
• Several possible approaches:
– Community Values
– Public Property (State owned and managed)
– Private Property
Laissez-Faire
• A profit maximizing owner would seek to charge
fishers a price for the right to access to the lake.
• The problem for the owner then is what price to
charge for access. For a fisher who is considering
paying, the new private opportunity cost of
fishing becomes the sum of lost wages and the
new access price (w+p).
• A new line can be drawn to indicate the total
private cost of fishing which is equal to the
private opportunity cost times the number of
fishers. This is done in figure 3.6.
Laissez-Faire
Figure 3.6
$
TPC
TPC
*
Z
TSC

Z*
*
12w
TSB
5w
0
1
5
10
12
16
Number
of Fishers
Laissez-Faire
• When the fee for access is p=0, then the TSC curve is
also the TPC curve, and the equilibrium is 16 fishers.
• As the price for access rises, the TPC curve becomes
steeper, with the slope of the TPC curve being simply
w+p.
• As the price for access rises, the number of fishers in
equilibrium begins to fall and the profits rise.
• Total profit (B) for the landlord is the number of fishers
(F) times the price for access (p) so that B = F*p.
• This reaches a maximum when the number of fishers
falls to 5 at the price p* in the above diagram.
• If the price were to rise any higher, profits would fall
for the owner.
Laissez-Faire
There are two important implications of this analysis.
1. The first is that a private owner will automatically manage
the resource in a way which efficiently maximizes the total
social income.
2. The second implication is that the whole of the surplus
value is collected by the new owner of the resource.
While individual members of the community are no worse
off then they were under over-fishing (each person earns
w), all the benefits from more efficiently utilizing the
community’s resource goes to the new owner.
In other words, private property promotes efficiency
but at the expense of creating inequality.