Markets and Market Failure

1
Markets and Market Failure

• A preview

2
A Story

• Wolves
• Good for naturealready more growth in
  Yellowstone from suppression of herbivores.
• Bad for ranchers
• How to increase wolf numbers?
• Create a market in wolf damage
• Ranchers are paid happy
• Environmentalists get wolves and have to
  payhappy

3
Pareto Improvement

• When at least one party to a deal is made better
  off and no parties are made worse off the deal is
  said to be Pareto improving.
• Examples of market trades that are pareto
  improving
• Examples of market trades that are NOT pareto
  improving

4
What Goes Wrong With Markets

• Reasons for
• No ownership
• Externalities
• Public Goods
• Insufficient weight on future
• Government Failure

5
Ownership

• If you dont own it you cant sell it.
• Water rights are hard to trade (once not legal)
• Government seizure of property
• Open access (anyone can fish)
• Lack of enforcementcant use land as collateral
  in some places because government wont/cant
  enforce contract.

6
Externality Defined

• An Externality is an effect (of a transaction)
  that is borne by someone(s) other than the buyer
  or the seller.

7
Externalities

• Power causes pollution
• Buyer of power doesnt suffer from the pollution
  (it is in the four corners and the wind blows
  from the west)
• Buyer and seller happy.
• Third party (external to the trade) not happy
• Not pareto improving

8
Wolves

• I keep wolves on my park.
• Wolves eat neighbors sheep.
• Thats externalI didnt pay for the sheep.
• Good guys set up a fund to pay for the sheep.
• Not externality any morenow a market
  transaction. We buy sheep for wolf food.
• Story told better in text.

9
Public Goods

• Goods are not diminished by use are public goods.
• The Moon. (Looking at it)
• Does not have to be excludable
• Sports on pay tv is public good and excludable
• Moon is not excludable.

10

• Public goods tend to be underprovided.
• Consider two people, both willing to pay 4 for
  one unit and 3 per unit for two units.
• Good costs 4 to make
• First person pays 4 and buys one unit.
• Both now have one unit.
• Neither will buy a second unit cause it costs 4
  and they will only pay 3.
• Suppose they work together?

11
Future

• Some say that we weight future generations too
  little in our decisions.
• Look at the Hetch Hetchy story in the text.
• Was it that the people in 1900 didnt care about
  we 2000ers or was it that the people who did it
  didnt care about anyones appreciation of the
  natural environment.
• Dont know.

12
More Relevant

• Stern Report
• http//www.hm-treasury.gov.uk/independent_reviews/
  stern_review_economics_climate_change/sternreview_
  index.cfm
• How bad is global warming?
• Happens in the future
• At 1 discount rate, one should take expensive
  action now to avoid further climate change. Nick
  Stern takes this view
• At a 4 discount rate, why worry? Others take
  this point of view.

13
Government Failure

• Pays off special interests who help get them
  elected (or keep them in power by other means) at
  the expense of others.
• US ag policy includes both payments to farm
  states and the food stamp program.
• Often environmentally destructive, as in dams,
  prestige projects like airbus, and so on.