334
©2014 Pearson Education, Inc.
Chapter 17
Property Rights, Externalities, Rivalries, and Exclusion
Chapter Outline
17.1 Externalities
Application: Spam: A Negative Externality
17.2 The Inefficiency of Competition with Externalities
Supply-and-Demand Analysis
Cost–Benefit Analysis
17.3 Regulating Externalities
Emission Standard
Application: Reducing Pulp and Paper Mill Pollution
Emissions Fee
Solved Problem 17.1
Application: Why Tax Drivers
Benefits Versus Costs from Controlling Pollution
Application: Protecting Babies
Emissions Fees Versus Standards Under Uncertainty
17.4 Market Structure and Externalities
Monopoly and Externalities
Monopoly Versus Competitive Welfare with Externalities
Solved Problem 17.2
Taxing Externalities in Noncompetitive Markets
17.5 Allocating Property Rights to Reduce Externalities
Coase Theorem
No Property Rights
Property Right to Be Free of Pollution
Property Right to Pollute
Summary
Problems with the Coase Approach
Application: Buying a Town
Markets for Pollution
Application: U.S. Cap and Trade Programs
Chapter 17 Property Rights, Externalities, Rivalry, and Exclusion 335
©2014 Pearson Education, Inc.
17.6 Rivalry and Exclusion
Open–Access Common Property
Application: For Whom the Bridge Tolls
Club Goods
Public Goods
Free Riding
Application: Radiohead’s Public Goods Experiment
Optimal Provision of a Public Good
Solved Problem 17.3
Reducing Free Riding
Valuing Public Goods
Application: What’s Their Beef?
Teaching Tips
Students are often eager to discuss topics related to this chapter. Consumers are constantly confronted with
environmental claims made by firms, public interest groups, and the government, but they do not have much
information about how to react. If you like, you can cover portions of this chapter in the form of an introduction
to Chapter 7 (Costs). While introducing cost in Chapter 7, you will need to note that social costs are excluded
because the simple minimization model includes only private costs. You might take an extra 15 minutes at
that time to talk about the existence of externalities, the problem of the commons, and the way the
inclusion of these costs would affect the measurement of cost. You can also introduce the Coase theorem
at the intuitive level. Because of the recent trend in firms being “green,” many students have a fairly simplistic
view of negative externalities. It is an important point that although competitive markets do produce excessive
pollution, the optimal level of pollution is not zero.
It is also important for students to understand the international perspective as it relates to production
externalities. Pollution standards vary greatly in different countries, which can create a competitive
disadvantage for firms in environmentally conscious countries. If two firms from separate countries
compete in the same world market, and have otherwise equal costs, the firm that faces the pollution
tax is at a competitive disadvantage. This can be shown by simply comparing the pretax and posttax
solutions in Figure 17.3 in the text. One of the reasons that NAFTA was so controversial was the claim
that Mexico had a built-in cost advantage due to less stringent pollution standards.
When discussing the Coase theorem, you might ask the class whether they have rules in their dorms
regarding property rights. For example, at most schools, property rights regarding noise pollution are
determined by time of day. Between the hours of midnight and 8 A.M., individuals have the right to quiet.
At all other times, individuals have the right to make noise. Although bribes for the right to either have
noise or quiet are probably rare, without such rules, noisy and quiet individuals have no basis on which to
negotiate a solution.
The problems of the commons and the markets for public goods are intuitive and do not take much time to
cover. The lobster fishery application on the Web site makes the point well. If you discuss this example, you
may find the table on the next page from Wilson (1977) useful in summarizing the effects of controlled
access.
336 Perloff • Microeconomics: Theory and Applications with Calculus, Third Edition
©2014 Pearson Education, Inc.
Table 17.1
Private Versus Common Property in Maine Lobster Fishers
Private Ownership
Common
Weight per trap haul (kgm)
0.54
0.32
Number of lobster per trap haul
0.98
0.61
Weight per lobster (kgm)
0.55
0.53
Length of lobster (mm)
89.98
87.89
Avg. gross income of fishers ($)
22,929*
16,449
*Income of fishers in privately controlled areas was adjusted to remove the effect of higher prices
in seasons in which their output remained high (while it fell off in the commons).
Source: Wilson, James A., “A Test of the Tragedy of the Commons,” in Hardin, Barret, and
John Baden, eds., Managing the Commons. San Francisco: W.H. Freeman, 1977, 96–111,
especially Table 12.1.
This will also be a good point at which to discuss the problems of the 2010 BP oil spill. While information
is not fully available at the time of writing of this manual, this issue involves problems of negative
externalities, information, and common goods.
Additional Applications
Firms Aren’t Green
Some firms claim they are environmentally aware. They may endorse the Valdez–CERES Principles,
which require that a company “sell products that minimize adverse environmental impacts,” or the
Business Charter for Sustainable Development, which calls for firms “to modify their operations to
prevent serious or irreversible environmental degradation.” Are these firms just “talking green,” or are
they willing to raise production costs to improve environmental quality?
To answer this question, Lave and Matthews (1996) surveyed 54 large American companies that had
expressed environmental concerns, such as by publishing an environmental report. They posed the
following hypothetical situation:
A material used in one of your company’s products is found to harm the environment. Another, nontoxic
material is available that yields the same product quality but costs more than the original input.
Would the company switch to the nontoxic input?
Nearly half, 25, of the firms responded to the survey. Almost all firms were willing to switch if doing so
would raise product cost by 0.01 percent; if, for example, switching raised a manufacturer’s costs by $2
on a $20,000 car.
The willingness to switch fell off quickly, however, as the cost increased. Two–thirds claimed they would
substitute if costs rose 0.1 percent; one-third if costs increased 1 percent; 8 percent (2 of the 25 firms)
would substitute if costs rose 5 percent; and none of the companies would switch if the cost increased by
more. Thus even among firms that profess to be green, few would be willing to take actions to protect the
environment if the actions raised their costs and lowered their profits by more than 1 percent.
1. How would firm behavior change if consumers preferred “green” products over nongreen substitutes?
2. Should the government require firms to place environmental impact stickers on product labels?
Chapter 17 Property Rights, Externalities, Rivalry, and Exclusion 337
©2014 Pearson Education, Inc.
Energy Saving1
“The United States Senate should reject ‘energy rationing’ amendments that would harm the U.S. economy,”
the United States Chamber of Commerce said.
In a letter sent to the U.S. Senate Tuesday morning, the Chamber announced its opposition the McCain-
Lieberman and Bingaman amendments to the Energy Policy Act of 2005 (S. 10). Those amendments
would establish mandatory cap–and-trade programs for greenhouse gas emissions.
“Such amendments will limit the sources of energy the nation can use, impose millions of dollars in
new costs on businesses, and will cripple the economy,” wrote Bruce Josten, the Chamber’s executive
vice president.
“Rather than engaging in the costly energy rationing scheme embodied in the McCain-Lieberman or
Bingaman amendments, the Senate should let American technological ingenuity work as it has for decades
improving environmental quality.”
The Climate Stewardship Act, first introduced in the U.S. Senate in 2003 by John McCain (R-Ariz.) and
Joe Lieberman (D-Conn.), was reintroduced in both chambers of Congress in February 2005.
The Chamber said it supports an alternative amendment expected to be introduced by Senators Chuck Hagel
(R–Neb.) and Mark Pryor (D-Ark.), which would provide incentives (direct loans, loan guarantees, etc.)
for reducing greenhouse gas emissions and also address international as well as national sources of
emissions.
The goal, the chamber said, is to reduce greenhouse gas emissions without devastating the U.S. economy.
1. Using theory of externality, explain why the market alone is not enough to solve the greenhouse gas
problem.
2. What is the fundamental difference between the energy rationing proposal and the one by Hagel and
Pryor? (Hint: What is the difference in terms of incidence?)
Discussion Questions
1. What is the likely effect of a pollution tax on the mix of goods and services sold in the economy?
2. The EPA states that a nationwide ban on smoking in public places could save $39 to $72 billion per
year and as many as 12,900 premature deaths annually. Discuss the pros and cons of such a policy.
3. Give an example of a positive externality that creates a problem for society. Would a market develop
to eliminate the problem? Why or why not?
4. Serious, contagious illnesses spread throughout the population. Should vaccines be mandatory? What
are the externalities to consider?
5. Is there too little or too much commercial fishing? Why? What regulations might reduce the problem?
6. List as many public goods as you can, and discuss why exclusion is impossible.
7. What should the government do if it does not have enough information to regulate pollution properly?
1Susan Jones, “U.S. Business Lobby Rejects ‘Energy Rationing’,” CNSNews.com, June 21, 2005.
338 Perloff • Microeconomics: Theory and Applications with Calculus, Third Edition
©2014 Pearson Education, Inc.
8. What positive and negative externalities are created by airports? What would be the consequence of
shifting away from air travel toward greater use of rail travel?
Additional Questions and Problems
1. Why would someone buy a home in a development that reduces individual freedom through the
establishment of restrictive covenants such as no above–ground pools, restrictions on paint schemes,
and limitations on allowable fence types?
2. Show, using a graph, that the more elastic the demand curve, the greater the social cost of ignoring a
negative production externality.
3. Comment on the following: “All pollution should be eliminated.”
4. Market supply in a competitive industry is p = Q. Demand is p = 100 − Q. Production creates pollution
with a social cost of $1 per unit of output. In response to environmentalists, the government creates a
tax of $2 per unit. Is overall welfare improved or reduced by the tax?
5. In Problem 4, would social welfare in the industry be larger or smaller if it were monopolized and the
tax were dropped? Explain.
6. Explain how the Coase theorem would apply to a factory polluting a stream and a spring water
producer located downstream.
7. Many lakes in the Adirondack State Park in New York are carefully managed. At some lakes, fines
are levied for introducing nonintended fish into the lake. Why would such a rule exist?
8. White Mountain National Forest in New Hampshire is currently experimenting with use permits,
whereby a person must pay for a parking sticker for the right to park his or her car at any of the
trailheads for any length of time. Area residents, as well as many other park users, are furious.
Others support the fees. Discuss these fees as they relate to the problem of the commons.
9. Choose a law designed to curb a negative externality related to driving. Explain the externality the
law is designed to reduce, and discuss its effectiveness.
10. Explain why a lot of countries subsidize education. Try to relate this to the concept of externality.
11. The market demand curve of public goods is the vertical sum of private demand curves. What would
the market demand curve of a public goods look like if the number of private demand curves gets
sufficiently large? What is the economic implication?