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Chapter 6

Markets and Efficiency

Ch6: positive question; how markets function in the case of natural resourcesCh7: normative question; public policy

SECTION III General Natural Resource Issues

1. Market Demand and Supply

• Demand curve– downward slope illustrates diminishing marginal

willingness to pay– It reflects consumers’ incomes, tastes, and other

economic factors

• Supply curve– upward slope reflects increasing marginal production

costs– Its exact shape is related to input prices,

technologies, etc.

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2. Markets and Static Social Efficiency

• If a market equilibrium means social efficiency,

– then market demand curve = MSB curve: there are no sources of social value that are not registered by market participants themselves

– and market supply curve = MSC curve: there are no sources of cost to members of society that are not registered in those private cost/supply curves

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• Consider a collection of paper mills located on a river– They produce paper: marginal supply curve is

marginal private costs (MPC) curve– Paper mills emit residuals into the river which lead to

damages suffered by downstream communities: downstream external costs (EC)

– Marginal social costs (MSC) = MPC + EC– Socially efficient quantity and price are q* and p*;

competitive market outcome is qm and pm (qm > q* , market quantity is too high; pm < p*, market price is too low) 4

(a) External Costsa negative production externality

Page 91: Figure 6-3

5

p

q of paper

D = MPB = MSB

42

S =MPC

MSC = MPC + MEC

10

160

pm = 22

128

p* = 26

0q* qm

External Costsa negative production externality

Consumption externalities Production externalities

(c)Positive

(d)Negative

(b) Positive

(a) Negative

The benefits to the rest of society of people being vaccinated before traveling abroad

Noise pollution from using car stereos

The benefits to the environment that arise from the planting of woodland by a forestry company

Wastes being dumped into a river by a company

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7

$

q

MPB = MSB

MPC

MSC = MPC + MEC

0 q*qm

b

a

(b) External Costsa positive production externality

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($ millions)

MSC

MPB

MSB=MPB+MEB

0 qm = 200 q* = 210

pm = 170

p* = 175

q

K

L

(c) External Benefitsa positive consumption externality

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$

q

MPB

MSC

MSB = MPB + MEB0 q* qm

(d) External Benefitsa negative consumption externality

• The resource that is open to unrestricted use by anyone who might wish to utilize it: ocean fishery, hunting, public parks…

• “The Tragedy of the Commons” (Garrett Hardin, Science, Vol. 162, 1968, pp. 1243-1248): Open-access externality that leads to overuse of the resource is the diminution in the quality of the pasture as more and more animals are out on it

• Page 95, Table 6-2, public beach: the fifth visitor reduces the value of the beach to the four already there, from $20 to $18 for each one

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Open-Access Resource

• Public beach example: efficient visitation level is 4 visitors; benefits – costs = $80 – $48 = $32

• $32 is a return attributable to the resource itself (the beach); this is the resource rent produced by the beach

• If visitation level had risen to 8 people, then benefits – costs = $96 – $96 = $0; open access had led to the dissipation or disappearance of all natural resource rent

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Open Access and the Dissipation of Resource Rent