Econ 200 Externalities _Contd_ by yurtgc548


									  Coase Theorem
Review of Regulation

     ECON 100
     Mar 9, 2009
         Negative Externalities
           & Property Rights
• “Common” Property Problem
  – No one “owns” the air/water; therefore no one
    benefits from managing (pricing) its usage
• One solution is to assign the property right
  to one party and allow them to trade its
  use in the marketplace
  – Coase Theorem
        Problem of the Commons
• An example from Fisheries
   – No one “owns” the fishery; therefore no one benefits
     from “economically” optimally managing its usage
   – Rivalry in consumption; but non-excludable resource
• Solution is to assign/auction the property rights
  to catch “x” fish to one or more party (parities)
  and allow them to trade the permit in the
   – Coase Theorem solution
          Coase’s Theorem
• If property rights exist and transaction
  (bargaining) and information costs are low
  – Then parties will be able to bargain among
    themselves (without government intervention)
    to obtain an efficient outcome
An Example of the Coase Theorem
• Marketplace
  – Firm upstream from a farmer
    • Firm produce a good valued by consumer but
      dumps pollutants into the river as a byproduct
    • Cost of using the river to the firm is $0
  – Farmer
    • Downstream from the firm
    • Uses water to irrigate his agricultural products
    • Pollution affects/degrades his product
  Assigning the Property Rights
• If assigned to the firm
  – Farmer is willing to “bribe” the firm to reduce
     • Willing to pay firm to reduce gallons discharged up
       to marginal value of crop damage due to pollution
     • Firm: willing to accept payments that are >= marg
       costs of treatment/reduction
    Assigning Property Rights
• Assigned to the Farmer
  – Firm is willing to pay farmer up to the marginal
    value of “avoided” treatment costs
  – Farmer is willing to accept payments >=
    marginal cost of crop damage
• Either way: socially efficient (marginal
  value = marginal cost) solution
  – However, there are different income effect
     • Concluding which is best => normative statement
  Criticism of Coase’s Theorem
• If more than 1 farmer
  – Transaction costs of getting all affected parties
    together may be too great to get to optimal solution if
    rights assigned to firm
     • Demsetz (1964): “when transaction costs are too high; status
       quo may be optimal”
         – Leffler: “if it exists, it’s optimal. But, why?”
         – Use of the government to lower transaction costs
• Strategic behavior
  – Last individual may “hold” out (lower bribe/higher
    payment) as key to agreement
  – Fire protection example
     Tradable permits proposed to
          slow deforestation
•   Environmental groups are pushing for the use of market mechanisms to address one
    of the world's largest sources of greenhouse gas emissions: deforestation.

•   Similar to carbon trading, the CR plan would award tradable "credits" to countries that
    voluntarily reduce their deforestation rates below historical baseline levels
     –   countries could then sell the credits to other nations that are unable to meet their emissions
         reduction goals.
•   To ensure the validity of countries' claims, compensation would be given only after a
    specific period of time and after sufficient satellite and on-the-ground observation.

•   According to Environmental Defense and its partner groups, the clearing and burning
    of tropical forests is responsible for as much as 25 percent of human-created GHG
     –   South America's Amazon Forest alone holds some 60 gigatons of carbon
           •   more carbon than all countries release from cars, power plants, and other human-related activities in a
     –   current rates of destruction, forest losses in Brazil and Indonesia alone will negate nearly 80
         percent of the emissions reductions achieved under the Kyoto Protocol by 2012.
•   Slowing deforestation has the additional benefit of preserving biodiversity in
    threatened tropical forests, the groups note.
      Application to Fisheries
• Fishing Industry
  – ITQs: Individual Transferable Quotas
     • Boats bid for the right/license to catch pre-
       determined amount of fish
        – Then can either use the license to catch fish;
        – or resell license to another boat
  – Boat owners will be willing to sell license if the
    price offered > profits from catch
     • Licenses will go to highest valued/most efficient
• Other approaches
  – Quotas
    • Total catch for the fishery
    • Quota for each boat
  – Maximum Sustainable Yield (Biologists)
     Regulatory Effectiveness
• What are the goals?
  – Allocative Efficiency
     • Marginal Value (benefits) to consumers = Marginal costs
       (including opportunity costs) of the resources used to
       produce the goods
  – Productive Efficiency
     • Firms produce at minimum costs
  – Technological Innovation
• Other considerations
  – Administrative Costs
  – Dynamics
     Regulatory Effectiveness
• Regulatory prohibitions
  – Prohibiting Anti-competitive behavior
     • Sherman Anti-trust Act, Clayton Act
     • Designed to prevent “monopoly-like” behavior
        – Should improve all 3 goals
     • But:
        – Lag behind what’s actually occurring in the marketplace
        – Depends on getting caught and convicted
        – Long judicial process
     Regulatory Effectiveness
• Standards
  – Prohibit emissions/pollution beyond a “threshold”
     • Can be designed to get to “optimal” level of pollution
  – But:
     •   Don’t change prices/costs in the marketplace
     •   Don’t provide incentives for tech innovation
     •   Don’t allocate quotas in a least cost manner
     •   Not dynamic
     •   High administrative costs (2x taxes admin costs)
    Regulatory Effectiveness
• Incentive Mechanisms
  – Price caps, taxes and tradable permits
  – Taxes
    • Correct market signal -> raises costs -> raises
       – Productive/allocative efficient; provides incentive for tech
         innovation (adopt least cost technology)
    • Administratively less costly than standards
    • Easier to adjust for dynamic/market changes than
     Regulatory Effectiveness
• Price Caps
  – Provide “correct” price signal
     • Adjust for inflation and incentive to innovate from
       use of average industry productivity
     • Allocative/productive efficient
  – Administrative costs less than rate-of-return
     • No incentive to “goldplate” costs (AJ Effect)
     • Fewer rate reviews/hearings
           Final Comments
• Remember the goals
  – Economic efficiency
  – Low Administrative Costs
  – Flexibility to adjust
• Competitively neutral
• Simplicity
  – Sappington’s myths of deregulation
     Regulatory Effectiveness
• Tradable Permits
  – Fisheries, pollution
     • License to catch “x” fish or emit “x” pollutants
  – Can be designed to attain “optimal” level of
    pollution/fish catch
  – Market Value of permit (resalable) ensures marginal
    benefit (keeping permit) = opportunity cost
     • Allocative/productive efficiency
     • Incentive to adopt cost-savings technology
  – May be better at adjusting to changes in the
    marketplace than taxes > standards

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