SECTION III
General Natural Resource Issues
Chapter 6
Markets and Efficiency
Ch6: positive economics; how markets function
in the case of natural resources
Ch7: normative economics; public policy
1
1. Market Demand and Supply
• Demand curve
– downward slope illustrates diminishing marginal
willingness to pay
– It reflects consumers’ incomes, tastes, and other
economic factors
• Supply curve
– upward slope reflects increasing marginal production
costs
– Its exact shape is related to input prices,
technologies, etc.
2
2. Markets and Static Social Efficiency
• If a market equilibrium means social efficiency,
– then market demand curve = MSB curve: there are
no sources of social value that are not registered by
market participants themselves
– and market supply curve = MSC curve: there are no
sources of cost to members of society that are not
registered in those private cost/supply curves
3
(a) External Costs
a negative production externality
• Consider a collection of paper mills located on a
river
– They produce paper: marginal supply curve is
marginal private costs (MPC) curve
– Paper mills emit residuals into the river which lead to
damages suffered by downstream communities:
downstream external costs (EC)
– Marginal social costs (MSC) = MPC + EC
– Socially efficient quantity and price are q* and p*;
competitive market outcome is qm and pm (qm > q* ,
market quantity is too high; pm < p*, market price is
too low)
Page 91: Figure 6-3
4
(a) External Costs
a negative production externality
p
42
MSC = MPC + MEC
S =MPC
p* = 26
pm = 22
10
D = MPB = MSB
0
Review ECO324-Ch3
128 160
q* qm
q of paper
5
Consumption externalities
Production externalities
(c)
Positive
(d)
Negative
(b)
Positive
(a)
Negative
The benefits to
the rest of
society of
people being
vaccinated
before traveling
abroad
Noise
pollution
from using
car stereos
The benefits to
the environment
that arise from
the planting of
woodland by a
forestry company
Wastes
being
dumped
into a river
by a
company
Review ECO324-Ch3 and Ch15
(and pp.92-93 in our
text)
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(b) External Costs
a positive production externality
MPC
a
MSC = MPC + MEC
b
MPB = MSB
0
qm
q*
Review ECO324-Ch15; and pp.92-93 in our text
q
7
(c) External Benefits
a positive consumption externality
($ millions)
MSC
K
p* = 175
MSB=MPB+MEB
pm = 170
L
MPB
0
Review ECO324-Ch15
qm = 200
q* = 210
q
8
(d) External Benefits
a negative consumption externality
MSC
MPB
0
Review ECO324-Ch15
q*
qm
MSB = MPB + MEB
q
9
Open-Access Resource
• The resource that is open to unrestricted use by
anyone who might wish to utilize it: ocean
fishery, hunting, public parks…
• “The Tragedy of the Commons” (Garrett Hardin,
Science, Vol. 162, 1968, pp. 1243-1248): Openaccess externality that leads to overuse of the
resource is the diminution in the quality of the
pasture as more and more animals are out on it
• Page 95, Table 6-2, public beach: the fifth visitor
reduces the value of the beach to the four
already there, from $20 to $18 for each one
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Open Access and the Dissipation of Resource Rent
• Public beach example: efficient visitation level is
4 visitors; benefits – costs = $80 – $48 = $32
• $32 is a return attributable to the resource itself
(the beach); this is the resource rent produced by
the beach
• If visitation level had risen to 8 people, then
benefits – costs = $96 – $96 = $0; open access
had led to the dissipation or disappearance of all
natural resource rent
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Review ECO324 (slides 12-18)
Chapter 3 Modeling Market Failure
FYI
5. Environmental Damage:
A Negative Externality
• Environmental economists are interested in
externalities that damage the atmosphere,
water supply, natural resources, and overall
quality of life
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Modeling a Negative Environmental
Externality
FYI
• Define the market as refined petroleum
– Assume the market is competitive
– Supply is the marginal private cost (MPC)
– Demand is the marginal private benefit (MPB)
– Production generates pollution, modeled as a
marginal external cost (MEC) water pollution
• Problem: Producers (refineries) have no
incentive to consider the externality
• Result: Competitive solution is inefficient
13
Finding a Competitive Solution
Refined Petroleum Market
FYI
• S:
• D:
P = 10.0 + 0.075Q
P = 42.0 - 0.125Q, where
Q is in thousands of barrels per day
• Since S is MPC and D is MPB, rewrite as
MPC = 10.0 + 0.075Q
MPB = 42.0 - 0.125Q
(P means private)
• Find the competitive solution and analyze
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Competitive Solution
FYI
• Set MPB = MPC
42.0 - 0.125Q = 10.0 + 0.075Q
• Solve:
QC = 160 thousand; PC = $22 per barrel
(C means competitive)
• Analysis:
– This ignores external costs from contamination
– QC is too high; PC is too low
15
Finding a Socially Efficient Solution FYI
Refined Petroleum Market
• Let Marginal External Cost (MEC) = 0.05Q
• Marginal Social Cost (MSC) = MPC + MEC
– MSC = 10.0 + 0.075Q + 0.05Q
=
10.0 + 0.125Q
• Marginal Social Benefit (MSB) = MPB + MEB
– Assuming no external benefits, MEB= 0, so MSB =
MPB
• Set MSC = MSB
--10.0 + 0.125Q = 42.0 - 0.125Q
--Solving: QE = 128 thousand; PE = $26/barrel
16
MSC, MPC, MPB Graph
P ($ per barrel)
42
FYI
Page 67
MSC = MPC + MEC
S =MPC
PE = 26
PC = 22
10
D = MPB = MSB
0
128 160
QE QC
Q (thousands)
17
• Results of negative externality
FYI
--QC (160) is higher than QE (128), since the firm
does not bear the full cost of its production,
and so will produce more than the socially
efficient quantity (overallocation of resources)
--PC (22) is lower than PE (26), since MEC is not
captured by market transaction
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