Environment and market limits

Question 1

What is the economic problem?

Answer 1

The economic problem facing a human society is often stated as three questions:

1. Which commodities to produce and in what quantities?
2. How, in terms of quantities of inputs, to produce the commodities?
3. How to share the produced commodities between the individual members of the society?

An economy where some authority determines the solution to the economic problem is known as a command economy. At the opposite extreme to a command economy is a pure market economy where economic decision making and activity are completely decentralized.

Question 2

Explain the Invisible Hand.

Answer 2

The invisible hand, metaphor, introduced by the 18th-century Scottish philosopher and economist Adam Smith, that characterizes the mechanisms through which beneficial social and economic outcomes may arise from the accumulated self-interested actions of individuals, none of whom intends to bring about such outcomes.

The core of modern welfare economics is a rigorous examination of this claim that the pursuit of self-interest promotes the interest of society.

Given certain conditions, it can be proved that in a market economy:
1. there will exist a general competitive equilibrium, that is a state of affairs where the markets for all commodities and all inputs to production are in equilibrium;
2. if such a general competitive equilibrium exists, it will be an efficient (Pareto optimal) allocation.
↘ Generally, an allocation is efficient if there is no possible rearrangement of inputs to production, levels of production or share-outs of what is produced that could make somebody feel better off without making anybody else feel worse off → market in equilibrium.

BUT

The invisible hand does not exist in actual economies –> market failure.

Question 3

What is market failure?

Answer 3

All economists recognise that market failure - violations of the conditions under
which markets deliver allocative efficiency - is pervasive in actual economies.
↘ missing markets are very common in regard to the services that the environment provides to economic activity.
↘ the centrality of efficiency considerations is questioned by ecological economists who believe that correcting market failures is not an efficient and effective
approach to sustainability

Question 4

Explain the doctrine of consumer sovereignty.

Answer 4

Individuals should, as far as possible, get what they want, and the proper measure of economic performance is the preferences of individuals as expressed in willingness to pay. • allocative efficiency is based upon individuals’ self-assessments of their state of
well-being, but evidently not always true:

is it worth to override consumers’ preferences if they represent a threat for
sustainability?

Question 5

Private vs common property rights.

Answer 5

Private property rights are held by individuals and firms, and are transferred between them, usually for money. Without them, markets cannot exist.

Common property rights are held by collectives of individuals. In a modern economy, common property rights are mainly held by the government (e.g. coastal sea). Government can allow use of its property by individuals and firms (e.g. coastal fishing and overflying).

In some cases, property rights do not exist and the good access and use is totally unregulated: free access, or open access.

Question 6

What is an externality?

Answer 6

An externality, or an external effect, is said to exist when the actions of one agent have an unintended effect on some other agent or agents. The terminology arises because the effects involved are ‘external’ to the operation.

• The unintended effect may be beneficial or harmful.

An externality is a market failure in that it does not comply with allocative efficiency: more of it, in a harmful case, or less of it, in a beneficial case.

The lack of intentionality is due to the fact that there is no bargaining about the effect, which is in turn due to the fact that there are no property rights in it.

Externality problems arise because of incomplete private property rights, on account of which absence there can be no market trading or other bargaining.

Question 7

Coase Theroem

Answer 7

Roland Coase (1960): without a clear definition and allocation of property rights the market cannot work.
According to Coase, the problem with external benefits or external costs is not that they are external, but rather that property rights in these cases are vague and uncertain, plus transaction costs are high. 

↘When those rights are allocated, the market (the place in which such rights are traded) will bring to an efficient use of resources
↘Externalities are to be considered as the outcomes of limited/unclear allocation of property rights

Pollution: has an external cost, but on who and how much. Who has the rights: should the factory pay the bystanders to compensate the cost, or should the bystanders pay the factory to leave/stop polluting?

1. Case 1: property rights allocated to sufferers: Polluters may be willing to pay for maintaining the polluting economic activity and those who suffer the consequences of pollution may be willing to accept a compensation to bear the related damages.
2. Case 2: property rights allocated to polluters: Polluters may ask for a compensation to give up with polluting activities and the sufferers may be willing to pay not to be anymore exposed to the damages.

↘ Case 1: polluters will pay until compensations equal their private marginal benefits (PMB) → QE
↘ Case 2: Sufferers will pay until compensations equal the marginal costs associated to the damages experienced → QE
↘ QE = social optimum

Question 8

Non-rivalrous vs non-excludable commodities

Answer 8

A commodity is non-rivalrous if an increase in one agent’s consumption does not reduce the consumption of other agents.

A commodity is non-excludable if an agent cannot be prevented from consuming or using it.

1. Private goods are rivalrous and excludable.
2. Public goods are non-rivalrous and non-excludable in consumption.