CHAPTER 3: RIGHTS, RENTS, AND REMEDIES

I: Introduction

A. The last section provided a number of criteria for judging when environmental or
resource problems exist:

1. When resource allocations are inefficient

or

2. When resource allocations expect to leave future generations worse off

than current generations.

B. In this section, we will consider why these problems exist (i.e., why individual or
group interests diverge from societal interests.

1. Property rights play a key role in answering this questions.

a. Explains in many cases why the market and/or government

policies fail.

b. Provides a useful guide to setting environmental and natural

resource policies.

2. Imperfect Market Structures

a. Monopoly

b. Oligopoly (e.g., OPEC)

3. Divergence of Social and Private Discount Rates.

II: Property Rights

A. Introduction

1. DEFINITION: In economics property rights refers to the bundle of

entitlements defining owner's right, privileges, and limitations for the
use of resource.

2. Property rights can be vested with individuals, a group or the state.

3. The source of many environmental problems lies in there being ill-defined

property rights.

An example illustrates why this is the case:

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 EXAMPLE: Suppose there were no property rights with regards to
automobiles (as currently is the case with air). In fact, assume that it is
illegal to interfere in any way with a person's use of any automobile.

a. One would simply get into the nearest car , drive to the desired
location and abandon the car.

b. Initially this would work well enough. There are a lot of cars
around.

Question: What is going to happen in the long run?

c. Pretty soon, people would stop putting gas in the cars (or at most
enough to get them to the nearest gas station). Those cars with a
lot of gas would be taken by others.

d. The demand for gas cans would skyrocket.

e. Cars would not be repaired.

i. Why should I pay to fix up a car when someone else

could easily drive it away and I would never see it again?

ii. If you got into an accident, you could just get out and hop
into the nearest available alternative car.

f. No new cars would be bought

4. While this is a fanciful example, it illustrates many of the underlying

problems in resources and the environment.

B. An Efficient Property Rights Structure in a well-functioning economy.

1. Four characteristics:

a. DEFINITION: Universality requires that all resources are

privately owned and all entitlements completely specified.

Ownership is an essential precondition to trade, upon which our

economic system is based.

b. DEFINITION: Exclusivity requires that all benefits and costs

accrued as the result of owning and using the resources should
accrue to the owner, and only the owner, either directly or
indirectly by sale to others.

Automobile example illustrates why problems might arise when

exclusivity is not guaranteed.

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 Who would buy something if they could use it for free or only pay
part of the costs?

This characteristic is also a key to the pollution problem.

Typically, pollution costs are not exclusively borne by the
polluter.

c. DEFINITION: Transferability requires that all property rights

should be transferable from one owner to another in a voluntary
exchange.

i. This allows a resource to gravitate to its highest valued

use.

ii. The fundamental characteristic of trade is the property

rights rather than the physical transfer of things. When
you buy land, you purchase the right to use that land.
You do not carry the land away with you.

iii. This characteristic underlies some of the more recent

revisions to air pollution policy, enabling firms to trade
their rights to pollute the air.

d. DEFINITION: Enforceability requires that property rights

should be secure from seizure or encroachment by others.

i. An unenforced right is effectively no right at all.

ii. If not apprehended, it is cheaper to steal than to purchase

a good, so one would be better off to steal.

iii. Similarly, pollution is an inexpensive method of waste

disposal, if the polluter is assured that the rights of others
will not be enforce.

2. The owner of a resource with a well-defined property right structure has a

powerful incentive to use that resource efficiently, since a decline in the
value of the resource represents a personal loss.

a. Example: With property rights in place, one has an incentive to

keep their car in shape because of its resale value.

b. Similarly, farmers have an incentive to fertilize an irrigate their

land, as well as to rotate their crops, if that raises the productivity
(and hence value) of the land.

3. Consumer Surplus, Producer Surplus and the Efficient Solution

a. The property rights defined above facilitate the efficient exchange

of goods.

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 Define Graphically CS

Price

Consumer
Surplus
P0

MB

Q0 Quantity

Error! Switch argument not specified.

Define Graphically PS

Price

MC

P0
Producer
Surplus

Q0 Quantity

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 b. Consumers and producers naturally move to the optimal point Q* .

c. Efficiency results not because individuals are pursuing efficiency.

Each is simply trying to maximize their surplus.

4. Long run producer surplus is known as scarcity rent.

a. Example: Very Fertile land will be put into production first, and
in the long run will receive a rent for its scarce quality attribute.

p p
MCgood MCpoor

qgood q qpoor q
p

MCpoor
Scarcity Rent

MCgood
D
qgood qpoor q

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 b. The marginal User's Cost is one form of scarcity rent.

Price
Scarcity
Rent

MEC+MUC

MEC

MB

Qd Qs Q

c. If there is no property right over the future resource, then both

rents dissipate, and there is no incentive to use the resource
efficiently in this period.Error! Switch argument not specified.

III: Improperly Defined Property Rights

A. Externalities

1. Introduction

a. DEFINITION: An externality exists whenever the welfare of

some agent, either a firm or a household, depends directly, not
only on his or her activities, but also on activities under the
control of some other agent as well.

i. Question: What Property Right characteristic does

this violate?

Exclusivity.

b. There are two types of externalities:

i. DEFINITION: An external economy exists when the

activities of one agent make another agent better off.

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 Question: What are some examples?

• Bee keeper/apple orchard

• ask questions in class

ii. DEFINITION: External diseconomies exist when the

activity of one agent makes another agent worse off.

Question: What are some examples?

• noise pollution

• air pollution

• steel mill polluting river with a fishery

downstream.

2. Consequences

Steel Mill example

Price MCs=MCprod + MCpoll.

MCproduction

P*

P0

MB

Q* Q0 Quantity

Conclusions:

a. The output is too large

b. Too much pollution is produced

c. The price of the product responsible for the pollution is too low

d. No incentives for less pollution exist.

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 e. Recycling and reuse of the polluting substances are discouraged
since their release into the environment is cheap.

Chip Game

B. Common Property Resources

1. DEFINITION: Common Property Resources are those that are not

exclusively controlled by one agent or source.

Access to these resources is not restricted and, therefore, the resource can
be exploited on a first-come, first-serve basis.

2. Examples:

a. Hot shower's

Question: Do you take into account the amount of water

available to other residents when you take a shower?

Question: Does this situation change in the setting of your

home (where there are fewer players)?

b. air

c. water

d. fisheries

e. wildlife

Books Bison Example

i. Historically, many animals, including the bison, have

been treated as a common property resource.

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 Price

MC=AC

MB AB

Q* Qm Quantity

ii. Question: What are the incentives for the

individual hunter?

Answer: To hunt to the level Qm.

OPTIONAL MATHEMATICAL DISCUSSION

Consider the situation of a new hunter entering the region, where currently Q0 buffalo are
hunted.

1. Let P(Q) denote the price received for buffaloes, given Q sold.

2. Revenues = QP(Q)

3. Revenues = P(Q1)Q1 - P(Q0)Q0

= P(Q1)[Q1 - Q0] + [P(Q1) - P(Q0)]Q0

The first term indicates the benefits to the new hunter, while the second term measures the
costs to the second hunter.

3. There are two characteristics of the common-property allocation:

a. In the presence of sufficient demand, common property resources

are overexploited.

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 b. The scarcity rent is dissipated; no one appropriates the rent so
that it is lost.

Unlimited access destroys the incentive to conserve.

C. Public Goods.

1. DEFINITION: A public good is a good whose consumption is

indivisible and non-excludable ( fully accessible to all).

2. DEFINITION: Consumption is said to be indivisible when on person's

consumption does not diminish the amount available to others.

3. Examples of public goods:

a. Clean air

b. Clean water

c. biological diversity

i. genetic diversity (i.e., diversity within species).

• different strains of wheat or barley

ii. ecological diversity (i.e., number of species).

• Approximately 20% of the species existing today

are expected to be lost in our lifetime.

• The destruction of tropical rain forests are a

major source of this problem .

4. Under-provision of public goods: the Public Television example

a. Let

10 − 2q 0 ≤q ≤5
MBa = 
 0 q>5

10 − q 0 ≤q ≤10
MBb = 
 0 q > 10

and

MC = 8

b. Graphically, we have

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 Price
20

MBs=MBa+MBb
15

10
MC

Pb
5
MBb

Pa
MBa
0
Q
0 1 2 4 5 10

c. Question: What would individual a do?

Set MBa = MC

10 - 2q = 8

q=1

d. Question: What would individual “b” do?

Set MBb = MC

10 - q = 8

q=2

But, since individual a has already purchased 1 unit, individual b

will free-ride and we end up with 2 units total of public television.

e. Social optimality requires that Mbs = MC, but

20 − 3q 0 ≤q ≤5

MB s = MBa + MBb =  10 − q 5 < q ≤10
 0 q > 10


Set MBs = MC

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 ⇒

20 - 3q = 8

q=4

f. Vertical summation of individual demand curves gives the market

demand curve.

g. There is a free rider problem.

h. Efficiency would require charging different people different

prices.

i. But there would be no incentive for the individual to

reveal their true market demand curve.

ii. Hard to implement.

IV: Other Problems

A. Imperfect Market Structures

B. Divergent Private and Social Discount Rates

1. discount rate = risk free cost of capital + risk premium

2. risk premium may be different for private and social decisions

C. Government Failure

1. Special interest groups ("rent seeking")

2. Political institutions, by interfering with the market, can create

inefficiencies through improper incentives.

3. Education on political issues is a public good subject to free riding.

V: Possible Remedies for Externalities

A. Negotiation - using, for example, bribes

1. This approach works well when there are few players

2. Example: Stereo Owner and the Noise Externality

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 Price of
Loudness

MBs.o.
MCn
B

A
P*

Qn. Q* Qs.o. Quantity of

Loudness

3
a. The stereo owner sets volume at Qs.o., which is inefficient.

b. Neighbor can offer to pay the bribe P* per unit to bring loudness
to Q*. Both gains.

c. Two things worth noting:

i. The bribe simply internalizes the externality decision for

the stereo owner.

ii. The problem starts with the stereo owner essentially

owning the property rights of noise or quite.

d. Question: Would the problem change if the neighbor owned

the rights to quiet?

i. Start with Qn and bribe to Q*.

e. This solution will not work well if there are many individuals.

Question: What would happen if there were two stereo

owners?

B. Courts

1. The court system can respond to environmental conflicts by imposing

either property rules or liability rules.

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 2. DEFINITION: Property rules specify the initial allocation of the
entitlement.

a. In the noise example the entitlements are the right to peace and
quite and the right to play the stereo loudly.

b. DEFINITION: According to the Coase Theorem, as long as

negotiation costs are negligible and affected consumers can
negotiate freely with each other, the courts can allocate the
entitlement to either party and an efficient allocation will result.

c. These rules provide the basis for negotiation, but not the solution
itself. Negotiation is still required.

3. DEFINITION: Liability rules award monetary damages after the fact to

the injured party.

a. In the stereo example, the court may award the neighbor his/her
total costs resulting from the stereo playing. (IN GRAPH AREA:
QnBQs.o.).

b. This award does not change the past, but creates incentives for
the future.

Question: Assuming the stereo owner expects to be hit with

the same type of damages in the future, how high will he/she
turn up his/her stereo?

Answer: Q* .

c. Question: What are some potential limitations of this

approach?

i. Transactions costs

ii. Difficulty of obtaining cost estimates

• Notice that this problem does not exist for the

negotiation solution, if it is feasible.

C. Legislative and Executive Regulation

1. Example: No one can play their stereo above a specified level (X

decibels).

Question: What are the potential problems here?

a. Regulatory costs

b. Establishing the proper level may be difficult.

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VI: The Role of Government

Question: Does the existence of market inefficiencies imply that government should
intervene to correct the problem?

A. No. The costs of government intervention may exceed the possible benefits.

B. Pollution in the old west example.

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