2.8 (Common Pool Resources and Negative Externalities)

Question 1

What are common pool resources?

Answer 1

Resources that are not owned by anyone, do not have a price and are available for anyone to use without payment. Their depletion or degradation leads to environmental unsustainability.

Question 2

What are examples of common pool resources?

Answer 2

• Clean air
• Lakes
• Rivers
• Fish in the open seas
• Wildlife
• Hunting grounds
• Forests
• Biodiversity
• The fertility of the soil that occurs in nature
• Open grazing land
• The ozone layer
• The stable global climate

Question 3

Define rivalrous.

Answer 3

The use of resources reduces the availability for others.

Question 4

Define non-excludable.

Answer 4

The resources can be used abundantly without restricitions, therefore may be overused and depleted.

Question 5

Define sustainability.

Answer 5

Maintaining the ability of the environment and the economy to continue to produce and satisfy the needs and wants into the future for future generations; depends crucially on the preservation of the environment over time.

Question 6

Define unsustainable production.

Answer 6

Production that uses resources unsustainably, leading to their depletion or degradation.

Question 7

What is market failure?

Answer 7

• Failure of the market to allocate resources efficiently.

* Too much or too little food/services are produced or consumed based on what is socially most desirable.

Question 8

Define over and under provision.

Answer 8

Overprovision: Too many resources allocated to production (overallocation).

Underprovision: Too few resources allocated to production (underallocation).

Question 9

Define an externality.

Answer 9

Occurs when the actions of consumers or producers giver rise to negative or positive side-effects on other people who are not part of these actions and whose interests are not taken into consideration.

Question 10

Define MPC, MSC, MPB and MSB.

Answer 10

Marginal private costs (MPC): refers to costs to producers of producing one more unit of a good.

Marginal social costs (MSC): refers to costs to society of producing one more unit of a good.

Marginal private benefits (MPB): refers to benefits to consumers from consuming one more unit of a good.

Marginal social benefits (MSB): refers to benefits to society from consuming one more unit of a good.

Question 11

State what happens at allocative efficiency, no externality and an externality.

Answer 11

Allocative efficiency: achieved when MSC=MSB.

No externality: the competitive free market leads to an outcome where MPC=MSC=MPB=MSB.

Externality: creates a divergence between MPC and MSC or between MPB and MSB.
In the free market leads to an outcome where MPB=MPC, but where MSB is not equal to MSC, indicating allocative inefficiency.

Question 12

List the four types of externalities.

Answer 12

• Negative production externalities
• Negative consumption externalities
• Positive production externalities
• Positive consumption externalities

Question 13

What are some things to bear in mind when thinking about externalities (effects- what does each create)?

Answer 13

• All negative externalities (of production and consumption) create external costs. When there are external costs, MSC > MSB at the point of production by the market.
• All positive externalities (of production and consumption) create external benefits. When there are external benefits MSB > MSC at the point of production by the market.
• All production externalities (positive and negative) create a divergence between private and social costs (MPC and MSC).
• All consumption externalities (positive and negative) create a divergence between private and social benefits (MPB and MSB).

Question 14

What are examples of negative production externalities?

Answer 14

Often pollution.

• Air pollution from factories.
• Pollution from fertilisers.
• Industrial waste.
• Noise pollution.
• Collapsing fish stocks.
• Methane emissions.

Question 15

Define S=MPC, MSC, Qopt and Qm.

Answer 15

• S = MPC reflects the firm’s private costs of production
• MSC represents the full cost to society
• Qopt is the socially optimum (‘best’) outcome
• Qm is the free market outcome

Question 16

What are negative production externalities?

Answer 16

• Negative externalities of production refer to external costs created by producers.
• The problem of environmental pollution, created as a side-effect of production activities, is very commonly analysed as a negative production externality.
• The free market overallocates the resources to the production of the good and too much is produced relative to the social optimum.

Question 17

Discuss welfare loss from negative production externalities.

Answer 17

• Whenever there is an externality, there is a welfare (deadweight) loss, involving a reduction in social benefits, due to the misallocation of resources.
• For all units of output greater than Q opt, MSC > MSB, meaning that society would be better off if less were produced.

Question 18

Outline market-based policies used to correct negative production externalities and prevent overuse of common pool resources.

Answer 18

* Indirect taxes: The government could impose a tax on the firm per unit of output produced. The tax results in an upward shift of the supply curve, from S = MPC to MSC (=MPC + tax). 
The optimal (or best) tax policy is to impose a tax that is exactly equal to the external cost, so the MPC curve shifts upward until it overlaps with MSC.

• Carbon taxes: A tax on carbon (or emissions generally) has the effect of creating incentives for producers to reduce the amount of pollution they create by purchasing less polluting resources. This reduces the size of the negative externality and increases the optimum quantity of output.
• Tradable permits: A policy involving permits to pollute issued to firms by a government or international body. These permits can be traded in a market. The supply of permits is perfectly inelastic, as it is fixed at a particular level by the government/authority.

Question 19

Evaluate market based policies.

Answer 19

Advantages:

• Both taxes and tradable permits have the effect of internalising the externality.
• Taxes on emissions superior to taxes on output. Taxes on output incentivise reduced output using the same polluting resources, whereas taxes on emissions create incentive to switch to less polluting resources.
• Tradable permits also creates incentives for firms to cut back on their pollution if they can do so at a relatively low cost, due to profit motive associated with selling excess permits.
• Firms that can convert to cleaner production options more cheaply will be those to do so.

Disadvantages:

• Implementing taxes and tradeable permits come with many technical difficulties.
• Practical difficulties associated with taxes
• What production methods produce pollutants?
• Which pollutants are harmful?
• What is the value of the harm?
• What is the appropriate amount of tax?
• How will consumers be affected?
• Carbon taxes are usually set too low. Pollution may still occur even with a tax in place.
• Practical difficulties associated with tradeable permits
• Who sets the cap?
• Is the cap appropriate?
• How are the permits distributed?
• Who profits/gains from trade?

Question 20

Outline government legislation and regulation and its impact.

Answer 20

• Government regulations to deal with negative production externalities rely on the ‘command’ approach, where the government uses its authority to enact legislation and regulations in the public’s interest.
• In a situation where firms are polluting the environment in the production process governments have several options via regulations/legislation:
• forbid the dumping of certain toxic substances into the environment (into the rivers, oceans, and so on)
• limit the emission of pollutants by setting a maximum level of pollutants permitted
• limit the quantity of output produced by the polluting firm
• require polluting firms to install technologies reducing the emissions
• Impact:
• Lowering the quantity of the good produced and bring it closer to Qopt in by shifting the MPC curve upward towards the MSC curve.
• Pollutant and output restrictions achieve this by forcing the firm to produce less.
• Requirements to install technologies reducing emissions achieve this by imposing higher costs of production due to the purchase of the non-polluting technologies.
• Ideally, the higher costs of production would be equal to the value of the negative externality.

Question 21

Outline rules of the theory of collective self-governance (common resources- 8).

Answer 21

1. Define clear boundaries of the common resource.
2. Rules governing the use of common resources should fit local needs and conditions.
3. As many users of the resource as possible should participate in making decisions regarding usage.
4. Usage of common resources must be monitored.
5. Sanctions for violators of the defined rules should be graduated.
6. Conflicts should be resolved easily and informally.
7. Higher-level authorities recognize the established rules and self-governance of resource users.
8. Common resource management should consider regional resource management.

Question 22

Outline education and awareness creation.

Answer 22

Education of the public and provision of information regarding the polluting activities of firms often makes consumers turn away from the products, with negative effects on the firms’ sales. As a result the firms are forced to take consumers’ opinions into consideration and change their production methods in order to reduce the externalities.

Question 23

Outline international agreements, give examples (3).

Answer 23

• Overuse of common pool resources very often have international repercussion, in which case co-operation among governments and international agreements are crucially important to control and prevent negative consequences on certain resources, such as the global climate and the ozone layer.

1. Montreal Protocol 1989 (Ozone layer depletion – phasing out ozone-depleting substances).
2. EU Emissions Trading System (EU ETS) 2005 (Tradable permit scheme for carbon).
3. Kyoto Protocol 2005-2012 (Signatory countries commit to reduce emissions of carbon dioxide/greenhouse gases to slow climate change).

Question 24

What are examples of negative consumption externalities?

Answer 24

• Vehicle pollution.
• Household waste.
• Noise pollution.
• Air pollution.
• Traffic congestion.
• Gambling addiction.
• Litter from tourists.
• Spillover costs from obesity.

Question 25

What are negative consumption externalities?

Answer 25

• Negative externalities of consumption refer to external costs created by consumers.
• When there is a negative production externality, the free market overallocates resources to the production of the good, and too much of it is produced relative to what is socially optimum.

Question 26

Discuss welfare loss from negative consumption externalities.

Answer 26

• The welfare (deadweight) loss resulting from negative consumption externalities represents the reduction in benefits for society due to the overallocation of resources to the production of the good.
• For all units of output greater than Q opt, MSC > MSB, indicating that too much of the good is produced.

Question 27

What are demerit goods?

Answer 27

• Demerit goods are goods that are considered to be undesirable for consumers, but which are overprovided by the market.
  E.g. cigarettes, alcohol and gambling.

Question 28

Outline policies to correct negative consumption externalities.

Answer 28

• Market based policies: Indirect taxes can be imposed on the good whose consumption creates external costs. Indirect taxes in the present context are intended to lead to allocative efficiency.
• Government legislation and regulation: Regulations can be used to prevent or limit consumer activities that impose costs on third parties, such as legal restrictions on activities as smoking in public places.
• Education and awareness creation: Education and awareness campaigns by the government can be used to try to persuade consumers to buy fewer goods with negative externalities, such as anti-smoking campaigns or campaigns to reduce the consumption of goods based on fossil fuel use.
• Nudges: Nudges can be used to encourage consumers to rely less on goods with negative externalities, for example places in less accessible places in shops, or graphic pictures of consequences of smoking places on cigarette packets.

Question 29

Evaluate the sugar tax.

Answer 29

Advantages:

• External costs of sugary drinks- a cause of market failure. Extra pressures on NHS from diabetes/tooth decay.
• Information failure- people lack awareness and under-estimate the private costs of addiction to high sugar drinks.
• Sugar tax raises extra revenue- this can be ring-fenced for other projects.
• Tax encourages producers to re-formulate drinks and bring healthier products to the market.

Disadvantages:

• Might be regressive on lower income families who will then have less income to spend on more nutritious food/drink.
• Shouldn’t rely on taxes alone to cut consumption. Sugar tax might be less effective than regulation/nudge theory.
• If drinks are taxed, then people might simply switch to other sugary products to get their daily ‘sugar fix’.
• Risk of thousands of jobs in pubs and shops that rely on drink sales for their revenue.