Property rights

Question 1

Using an example, explain how people don’t fully take into account how their actions affect others when property rights aren’t set up correctly.

Answer 1

Imagine 2 pieces of land

1) Privately owned 2)Wilderness - free for everyone

If you wish to dump rubbish on the private land you must pay the owner but if you dump rubbish in the wild its free.

Natrurally, the difference in property rights leads to more dumping in the wilderness as this involves lower peronal costs. However, this decision creates lots of costs for others i.e. what could have became a nice park now is a big eye-sore and so bad property rights leads to bad outcomes.

Question 2

How do markets achieve socially optimal outcomes?

Answer 2

Markets achieve socially optimal outcomes by taking into account all the costs and benefits involved in any activity, regardless of who feels the effects of those costs and benefits.

Remember: the d curve captures all benefits, the s curve captures all costs and the market equilibrium ensures that only units of output for which benefits exceed costs are produced.

Question 3

Give an example of how property rights give owners control over their property.

Answer 3

You can paint your car any colour you want. You can modify the engine or the exhaust. You can install a sound system etc

However, property rights aren’t totally unlimited. Society does restrict what you can do to your car i.e. it must undergo an MOT, you can’t drive it too fast etc

Question 4

What is an externality?

Answer 4

An externality is a cost or a benefit that falls not on the person(s) directly involved in an activity, but on others. Externalities can be positive or neagtive.

Question 5

Give an example of a positive externality.

Answer 5

This a BENEFIT that falls on a person not directly involved in an activity. Think of A beekeeper. She raises bees in order to sell their honey to customers to pay for her house. But they also fly around pollinating flowers for local farmers, thereby increasing their crop yields and providing them with a postive externaltiy.

Question 6

Give an example of a negative externaltiy.

Answer 6

This is a COST that falls on a person not directly involved in an activity. Think of a steel mill that, as a by-product of producing steel, puts out lots of soot and smoke. The pollution is a negative externality that causes smog and pollutes the air breathed by everyone living near the factory.

Question 7

What is the key thing to understand about negative externalities?

Answer 7

The key thing is to understand about negative externalities is that goods and services that impose negative externalities on third parties end up being overproduced.

This overproduction happens because negative externalties and the costs that they impose on others aren’t taken into account when people make decisions about how much to produce.

Question 8

What situation causes the managers of the steel mill to only take account of their private costs of raw materials and running the plant?

Answer 8

This situation arises only because a poor property rights regime is in place.

If someone owned the atmosphere, the mill’s managers would have to pay for the right to emit pollution.

But because no mechanism is in place for making the managers pay for the costs of pollution the result is that the firm overproduces steel.

Question 9

Why does overproduction (of steel) happen?

Answer 9

Rememeber: a competitive firms’s supply curve = its MC curve.

Because the mill doesn’t take into account the MC’s that its production of steel imposes on others, its MC curve (supply curve) is too low and leads to an overproduction of steel.

Compare the firms PRIVATE MC curve with the SOCIAL MC curve below.

Question 10

What is the Social MC CURVE?

Answer 10

It captures all costs associated with producing steel - both the firm’s cost of making it and the costs imposed on others as negative externalities.

Question 11

What is the problem with producing all the units from q^soc to q^m?

Answer 11

The problem with producing those units is that although the benefits do exceed the FIRMS’S private production costs, they don’t exceed the total costs when you take into account XC = the cost of the negative externality.

Question 12

Why is the output level produced in a market economy (aka q^m) unfortunate?

Answer 12

Because every unit of output produced in excess of output level q^soc is a unit for which the total costs exceed the benefits.

Question 13

Is the common reaction to negative externalities - to outlaw them! - ever socially optimal?

Answer 13

No.

Look at the socially optimal output level q^soc below. This quantity is a positive number - i.e. producing steel is socially optimal even though some pollution is going to be produced along the way.

ex. cars create pollution, how do we stop this? ban ALL cars? But what about ambulances and fire engines, should we ban them too?

Not at all, because although these vehicles do emit some pollution, the costs imposed on society by the pollution are more than compensated for by their social benefits - the lifesaving activites in which the vehicles are engaged.

The same reasoning applies for the pollution being produced by the steel factory at output level q^soc.

Question 14

Is the goal to eliminate negative externalities?

Answer 14

No, the goal is to ensure that when ALL costs and ALL benefits are weighed, the benefits from the units of output that are produced outweigh the costs of producing them - including the costs of the negative externalities.

Question 15

What are the three ways of dealing with negative externalities?

Answer 15

1) Pass laws banning or restricting activites that generate negative externalities i.e. most cities now forbid you to dispose of your rubbish by burning it.
2) Pass laws that directly target the neg ext itself (rather than the underlying activity that leads to the ext) i.e. still mills are now required to insert scrubbers to remove the pollution before it goes on to the atmosphere
3) Impose costs like taxes on people or firms generating neg ext’s i.e. a pollution surcharge on SUV’s i.e. pollution tax

Question 16

Why do economists like pollution taxes the most?

Answer 16

Remember: XC is the external cost of the steel mill’s pollution on others.

If the gov impose a tax of XC pounds on every unit of steel produced by the firm, the tax raises the firm’s cost curve up vertically from PRIVATE MC to SOCIAL MC.

So when s and d curves interact, the socially optimal output level q^soc is produced.

Question 17

What is the issue with policies in which firms are ordered to install scrubbers to reduce pollution?

Answer 17

You need to hire inspectors to monitor factories constantly to make sure factories aren’t cheating.

This is a much more costly system than simply imposing a tax on the mill’s easily measured steel output and then letting s and d set the socially optimal output level.

Question 18

What is one issue with setting the XC tax?

Answer 18

Working out exactly how large the tax XC needs to be to work as an effective deterrent is difficult.

Question 19

In our positive externality (bee keeper) example, is the beekeeper paid by the farmer?

Answer 19

No. The farmers don’t pay her for the benefits that her bees bring them - they just fly in and out of their fields and theres no way of keeping track of them - so the result is: she is going to raise fewer hives of bees (underproduction) than she would if the farmers were paying her for the benefits that her bees bring them.

Question 20

Graphically depict how the beekeeper underproduces honey (which has a positive externality).

Answer 20

Her supply curve = MC curve

private demand = customers demand for honey

where the s curve and the private d curve intersect gives the market equilibrium for honey, q^m.

Question 21

What does the market equilibrium quantity of honey q^m not take into account?

Answer 21

This output level does not take into account the benefits that bees bring to farmers. Imagine these benefits have a monetary value of XB = external benefits. Then the total social demand for her honey is given by the SOCIAL DEMAND curve, which is the PRIVATE DEMAND curve + XB pounds to account for the benefits that go to the farmers as well as the customers.

Question 22

Where is the socially optimal output level of honey?

Answer 22

At q^soc. Where the SOCIAL DEMAND curve crosses her SUPPLY CURVE because, for each unit of output up to and including q^soc, the total social benefit is at least as great as her cost of production.

Question 23

Is the market equilibrium quantity of honey q^m more or less than the socially optimal output level, q^soc?

Answer 23

q^m is less than q^soc

In other words, because the market mechanism has no way of taking into account the positive externality, Sally produces less honey than is socially optimal.

Question 24

What is the most common way to encourage higher production of goods that generate positive externalities?

Answer 24

Using a subsidy.

i.e. the gov may pay sally say 20p per kilo of honey to encourage her to keep more hives. The result = more bees pollinating more flowers, leading to higher output levels for farmers.

in fact, govs may even tax farmers to get the money to subsidise dally’s honey = makes the programme pay for itself.

Question 25

What is another ex. of govs subsidizing positive externalities.

Answer 25

Govs often subsidise the planting of trees in and around cities. They must do so because many of the benefits of trees - shade, cooling, cleaner air, less soil errosion etc - are positive externalities that markets don’t take into account. Without the subsidy, fewer trees would be planted than is socially optimal.

Question 26

What is the tragedy of the commons?

Answer 26

Economists refer to the important economic problem that results from poorly defined property rights, which don’t take account of negative externalities, as the TRAGEDY OF THE COMMONS.

Question 27

Describe the tragedy of the commons using an example.

Answer 27

Imagine one farming town where most of the land is PRIVATELY owned. However the twon has one large field of COMMON LAND - where anyone can graze their cattle.

Question 28

In our farming town ex. how much cattle is grazed on PRIVATE land?

Answer 28

In a private field, the owner has an incentive to limit the no. of cattle that he puts out to graze. Thats because if he puts too many cows in the field, they eat all the grass and ruin the field for future grazers.

So he only puts a few cows out to graze which reduces his short-run profits (because he restricts the current no. of cows) but maximises his long term profits (because the field stays in good shape and he can keep grazing well into the future).

Question 29

In our farming town ex. how much cattle is grazed on COMMON land?

Answer 29

Because the field is commonly owned, you don’t have to pay for the right to graze cattle there. So everyone is going to want to do so because the personal cost is zero.

But because everyone is thinking the same thing, the field is soon overrun with cattle and ruined as they eat all the grass = turns into a mess.

So although putting a cow out to graze on a common field incurs no personal cost, a social cost IS incurred. Each additional cow causes damage to the field - damage that reduces the future productivity of the field.

Question 30

What causes the difference in what happens to the common/private land?

Answer 30

The difference is due to the different property rights governing the 2 types of land.

For privately owned fields - farmers have an incentive to weigh the costs as well as the benefits of putting out more cattle to graze.

Whereas with the commonly owned land - nobody has a personal incentive to preserve its future usability.

Question 31

What is the most important thing to take away from the tragedy of the commons?

Answer 31

That in the absence of any other regimes or management system, individual incentive to overexploit the common resource tends to form a runaway destruction of the resource.

Question 32

What is the tragedy of the ANTIcommons?

Answer 32

This is a variant of the tragedy of the commons that looks at the case of goods that are socially underexploited due to the existence of private property rights.

ex. think of the case of the DVD of a TV series that can’t be produced because the property rights to the music in the series are too expensive to license.

Question 33

What is the key thing to take away from the tragedy of the ANTIcommons?

Answer 33

The key thing to take away is that economists aren’t keen on property rights just because they are property rights; they like them because property rights work when you do a CBA of the situation.

in our DVD ex economists would like to test the degree of harm done by the overly strong property rights and recommend modifying them to mitigate the costs. The principal behind the way we look at the problem, though, remains the same.

Question 34

Why do poor property rights cause animal extinctions?

Answer 34

Many enviro issues are caused by the tragedy of the commons situation in which nobody owns the property rights to a given resource. Notbaly, most animal extinctions are caused by the absence of property rights.

ex. tuna in the ocean. By international treaty, nobody owns the ocean - hence nobody owns the tune swimming in the ocean.

Question 35

How do you acquire a property right for the tuna in the ocean?

Answer 35

If you catch it and pull it on your boat you then have a property right over it and can sell the fish for money. That is, the only way to benefit economically from a tuna is to kill it.

The result = tuna/many fish species are over-fished, leading to near extinction as each boat has the same incentive to harvest as many fish ASAP before anyone else does.

Question 36

Why does nobody have an incentive to hold back in the fishing of tuna?

Answer 36

because of the way the property rights are set up, no single boat can prevent the calamity from happening.

If one boat decides to hold back and take fewer fish with the hope that by doing so the species will be saved, someone else just comes in and catches the fish that were spared. The species become distinct anyway.

Question 37

What do economists do to prevent a tragedy of the commons situation?

Answer 37

Their first instinct is to change the property rights system governing the resource in question. Instead of COMMONLY hel property rights in which each person has an incentive to take as much of the resource as possible before anyone else does, economists suggest PRIVATE ownership so an incentive exists to preserve the resource.

Question 38

What is one solution to the over-fishing issue?

Answer 38

To give fishers PRIVATE property rights to an entire fishing ground.

That gives the new owners the proper incentive to manage the stock on a sustainable basis.

Furthermore, because only one person has the right to fish there, a mad rush no longer exists between competing fishers.

Question 39

What is one solution for fish species that migrate freely between different area?

Answer 39

Biologists first determine the max. number of fish that can be sustainably harvested each year. The gov then auctions off fishing permits for exactly that amount of fish.

Question 40

What is advantageous about the ‘fishing permit’ method?

Answer 40

The method prevents the tragedy of the commons by creating a new sort of property right - the fishing permit.

The method also has a nice benefit of creating a self-sufficient governement programme.

The money raised from auctioning off the permits can be used to hire game wardens to prevent unlicensed fishing, as well as for conservation and wildlife mgmt programmes.

Question 41

Give an ex. of a technique used for carbon emmissions similar to the fishing permit.

Answer 41

In EU and USA a ‘property right’ to a certain amount of emmissions is granted by the gov, and firms that are more efficient are allowed to sell the surplus emmisions that they don’t need to less efficient firms.

In this way, emmisions are not only capped, but also firms are given good incentives to deal with the problem.