Market Failure
•Public
goods
•Common access resources and
the threat to sustainability
(Tragakes, 2012, pp. 119-130)
C. Bordoy
UWC Maastricht
Lack of Public goods

A private good has two characteristics:
1.
2.
Rivalrous: its consumption by one person
reduces its availability for someone else
(when you buy a t-shirt, another person
cannot buy it).
Excludable: It is possible to exclude people
from using the good. Normally achieved by
charging a price.
Most goods are private goods.
C. Bordoy
UWC Maastricht

A (pure) public good has the following
characteristics:
1.
2.
Non-rivalrous: its consumption by one
person does not reduce consumption by
someone else.
Non-excludable: it is not possible to exclude
someone from using the good.
Examples: lighthouse, police force, national
defence, non-toll roads, fire protection,…
C. Bordoy
UWC Maastricht
Why are public goods a type of market failure?



Private firms have an incentive to provide
excludable goods because they can charge
a price for them and cover their costs.
No profit-maximising firm is willing to
produce a good if it cannot charge a price
for it.
As a result, the market fails to produce
goods that are non-excludable →
misallocation of resources to the
production of public goods.
C. Bordoy
UWC Maastricht

Free rider problem: when people can
enjoy the use of a good without paying for
it. It arises from non-excludability.
Non-excludability
Impossibility to
charge a price
Underallocation of
resources
C. Bordoy
UWC Maastricht
Free rider
problem
Private firms
do not
produce them

Quasi-public goods (impure public goods):
1.
2.
Non-rivalrous
Excludable
Public museums that charge an entrance
fee, toll roads.
They could be provided by private firms but,
since they have very large positive
externalities, they are directly provided
by the government.
C. Bordoy
UWC Maastricht
Correction



Public goods are underprovided by the
market → the government must ensure
that the optimal level is produced.
Direct provision, financed out of tax
revenues. Made available to the public
(nearly) free of charge.
Decisions to be made:
1.
2.
Which public goods to provide
In what quantities
C. Bordoy
UWC Maastricht




Limited gov funds → opportunity costs
Need to decide which public goods will
provide the greatest social benefits.
Difficult to estimate these expected
benefits, as they do not have a market
price (which reflects the benefits to
consumers).
Information about demand gathered
through surveys of people and used in
‘cost-benefit analysis’.
C. Bordoy
UWC Maastricht


The goods should be provided if benefits
are greater than costs.
However, cost-benefit analysis is very
rough, as people tend to overvalue goods
they really want.
C. Bordoy
UWC Maastricht
Common access resources and market
failure



Common access resources are resources that
are not owned by anyone, do not have a price
and are available for anyone to use without
payment.
Examples: clean air, lakes, rivers, fish in the
open sea, forests, ozone layer,...
They are a type of market failure because:


They are rivalrous (characteristic of private goods)
They are non-excludable (characteristic of public
goods)
C. Bordoy
UWC Maastricht
Sustainability and common access
resources



Sustainability is the ability of something to
be maintained or preserved over time.
For the environment it refers to
environmental preservation.
For the economy it refers to the
preservation of humankind’s ability to
provide goods and services to satisfy
needs and wants in the future.
C. Bordoy
UWC Maastricht

Conflicts between environmental and
economic goals:

Economic goals involve
efforts to increase the quantities of output
produced and consumed, but
 focusing in economic goals while disregarding the
environment may result in its destruction.


Environmental goals involve
the preservation of the environment, but
 focusing on environmental goals while disregarding
the economy may result in humankind’s inability to
satisfy needs and wants.

C. Bordoy
UWC Maastricht


Balance between both goals: Sustainable
development, ie, development that
meets the needs of the present without
compromising the ability of future
generations to meet their own needs.
Society should pursue economic growth
that does not deplete or degrade natural
resources.
C. Bordoy
UWC Maastricht
Pollution of affluence and pollution of
poverty

Two types of environmental damage:
1.
2.
Pollution of affluence. It arises from
industrial production and high-income
consumption patterns that involve the heavy
use of fossil fuels, using up open access
resources and leading to climate change.
Pollution of poverty. It arises from
production and consumption activities that
are due to poverty. Due to economic
activities by very poor people in an effort to
survive.
C. Bordoy
UWC Maastricht


Overuse of common access resources and their
depletion are the external costs of industrial
production and high-income consumption
activities, both based on use of fossil fuels.
Difference between MPC and MSC curves
represents the external costs in terms of overuse
of common access resources:


Social cost arising from the cement factory’s overuse
of clean water, sea life and ozone layer,
The cost to society of causing global warming
C. Bordoy
UWC Maastricht
Illustrating overuse of common access resources

P
MSC
External cost
S=MPC
Popt
Pm
D=MPB=MSB

Qopt
Qm
Q
MPC: private costs of a
cement factory. External
costs can be interpreted as
the social cost of overuse
of clean water, sea life and
ozone layer or as the cost
to society of causing global
warming.
Burning of fossil fuels
causes overuse of
common access resources,
an external cost.
C. Bordoy
UWC Maastricht


If the cement factory payed for the
overuse of these resources, the producer
would not stop using common access
resources but he would stop overusing
them, leading to a sustainable use.
Overuse of common access resources can
also result from negative consumption
externalities (example: heating oil).
C. Bordoy
UWC Maastricht
Poverty as a threat to sustainability

Poverty is the most important cause of
environmental destruction, according to the
Brundtland report. Two examples:



Lacking modern agricultural inputs, poor people
deplete soil’s natural minerals, making them less
productive.
The pressure to open up new land for agriculture,
causing deforestation.
These production and consumption activities of
very poor people can also be interpreted as
negative externalities involving overuse of
common access resources.
C. Bordoy
UWC Maastricht
Government responses to threats to
sustainability
1.
Legislation. Examples:






restrictions on emissions from cars
restrictions on emissions from factories
requirements to install devices that reduce
air pollution
issuing licences or permits for fishing and
hunting
restrictions in the form of quotas for fishing
establishment of protected areas for the
protection of biodiversity and endangered
ecosystems
C. Bordoy
UWC Maastricht

Advantages:
1.
2.
3.

Simplicity
In most cases, they can be very effective.
In the case of emissions industrial
production, they avoid the technical
difficulties of market-based solutions.
Limitations:
1.
2.
3.
In the case of pollution, they do not offer
incentives to reduce emissions.
Cannot distinguish between high and low
cost polluters.
Costs of monitoring to detect violations.
C. Bordoy
UWC Maastricht
The following two measures deal with
the problem of carbon dioxide emissions.
2. Carbon taxes. They aim at taxing the
use of fossil fuels in accordance with the
amount of carbon each ones emit.
Hence, users face the incentive to swtich
to fuels that emit less (or no) carbon.
Denmark, Finland, France, Ireland, NL,
Poland, Sweden, some states in Canada
and the US.

C. Bordoy
UWC Maastricht
3.
Cap and trade schemes. Permits to
release carbon dioxide are distributed to
producers, and they can be bought and
sold in the market. (EU ETS)
C. Bordoy
UWC Maastricht
Evaluating carbon taxes and cap and
trade schemes


Carbon taxes fix the price of the pollutant
in the form of a tax, and allow the
quantity to vary.
Cap and trade schemes fix the quantity of
the permissible pollutant and allow its
price to vary according to supply and
demand.
C. Bordoy
UWC Maastricht

1.
2.
3.
Carbon taxes are preferred because:
They make energy prices more
predictable, benefitting firms, which
need to plan their costs ahead of time.
Easier to design and implement, unlike
cap and trade schemes, which require to
set the cap at the right level and
distributing the permits.
Can be applied to all users of fossil fuels.
C&T schemes target one particular
industry or small group of industries.
C. Bordoy
UWC Maastricht
4.
5.
6.
7.
Do not allow for manipulation by governments
and interest groups.
Do not require as much monitoring and
enforcement.
C&T schemes face strong political pressures to
set the cap too high.
Carbon taxes are less likely to be used to
restrict competition between firms. Some firms
could buy up more tradable permits than
needed and drive up their price in order to
prevent new firms from entering the market.
C. Bordoy
UWC Maastricht

Arguments in favour of C&T schemes:
1.
2.
3.
4.
Carbon taxes may be too low. Gov may be unwilling
to set carbon taxes high enough for these to
provide the necessary incentives.
Carbon taxes cannot target a particular level of
carbon reduction, leading to uncertain carbonreducing outcomes.
Carbon taxes are regressive, as lower income
consumers wuld be affected proportionately more
than higher-income consumers.
Carbon taxes must be adjusted for inflation,
whereas adjustment is automatic with C&T
schemes.
C. Bordoy
UWC Maastricht
Funding for clean technologies.
Clean technologies aim towards a more
responsible and productive use of natural
resources , reducing negative
environmental impacts. Ex: wind power,
solar energy, biofuels, recycling...
It is important that both private firms and
governments be involved in activities
leading to innovation and development
of clean technologies. However, funding
is insufficient.
4.
C. Bordoy
UWC Maastricht

Funding for clean technologies has
opportunity costs. However, governments
should make a greater effort to allocate
resources to this area and to promote
private sector funding and participation.
C. Bordoy
UWC Maastricht