Environmental Decisionmaking
Problem Set 4
1: (6 pts). Use a fairly large graph for this problem, so that you have room to do some analysis. Draw a hypotheical supply and demand curve for the market in MEKY (methyl-ethyl-killyou). Mark on your graph the amount of MEKY that will be produced at equilibrium in this market. Now, assume that the production of MEKY involves the emissions of toxic gasses into the high atmosphere, and that the companies involved are able to emit these gasses without penalty. Draw the "total cost" curve (i.e. production costs plus social costs) on your graph. If the government wanted to add a cap on the production of MEKY, what would be the amount of MEKY that should be produced? Show that value on your graph. Finally, assume that the government isn't quite sure exactly what the social cost function is (though you can see it on your graph), and so they have to estimate the level where they should cap emissions. Can you indicate on your graph at roughly what level the cap would be so onerous as to be worse than not doing anything?
In the above figure, the pre-regulatory quantity is where the market supply curve meets the demand curve. The optimal level for a cap would be at the point marked Q*, because that is where the total cost curve intersects the demand curve: the economically efficient level where deadweight loss is 0 ("deadweight loss" is the econ term for loss relative to the market optimum).
Q- is the point below which the regulations would be worse than an entirely unregulated market, because that is the point where the deadweight loss from regulations is equal to the deadweight loss from the lack of regulations. How can we see this? Notice that the actual deadweight loss from the non-regulated market is the triangle below total cost and above market demand, between the point Q* and the simple market equilibrium where supply and demand cross. That triangle is not drawn on the figure, so you should try to locate it yourself. Now, this is the amount that society loses by having this market around. The amount that it gains is represented by the triangle above total cost and below market demand. The true value of the market to society is the amount gained minus the amount lost. That is the big triangle on the left minus the little triangle that you just drew in your minds. Let's say that we regulate just a little--not quite reducing the level to Q*, but still reducing it a little. That will be a benefit, because it reduces the deadweight loss without reducing the benefits. I can make things better all the way down to Q*. But what if I regulate too much, meaning that I reduce below Q*? Well, in the beginning it will be worse than Q*, but still better than doing nothing because I have eliminated the deadweight loss on the right of Q*, and only moderately interfered with the market to the left of Q*. However, if I regulate so much as to get to the left of Q-, then I will be cutting the market so much that the cost is worse than the deadweight loss before the regulation.
2: (4 pts) Some people argue that the reason we have problems with externalities is that ownership rights are not fully defined in many cases. In fact, they suggest that we could solve any environmental problem caused by externalities simply by assigning ownership rights for all goods (including things like air, water, and so on). Ignoring for the minute the fact that this might be technically impossible, and forgetting that the owners will be greedy bastards who will focus on short term gains, explain the idea behind this argument.
The easiest case is the "Tragedy of the Commons" situation, where assigning ownership rights simply keeps people from using up a resource because if they don't, someone else will. Most people got this idea. But that is only one very specific example of an externality, and the question asks about "any" environmental problems, so I'd like you to go beyond this.
If someone values something, then they are willing to pay for it. If they are not willing to pay for it, then they must not value it very much. If everything has been assigned ownership rights, then we will not have to deal with the tragedy of the commons, because there will be no commons. For example, if someone owned fairy shrimp, then they could ask people to pay to protect them from extinction. If nobody was willing to pay, then they must not be very valuable. Hence, the owner may be willing to give up his right to the shrimp if a farmer is willing to pay more to farm the land then others are willing to pay to protect it. However, that's OK, because in that case farming was worth more than protecting the shrimp. Another example might be air. Let's say various firms had rights to the air, and you had to pay them to use it--either to pollute the air or to breathe it. Well, in that case the firms would have a very strong incentive to make sure that people don't pollute their air, because people would pay less for polluted air (those people would buy their air from someone else). On the other hand, if a little bit of pollution was not a big deal, but a company could pay a lot to be allowed to produce it, then maybe some firms would allow a little pollution, but not a lot. Eventually, the market would work out the right amount of pollution, and people would be able to pay what they think clean air is worth. This may sound terrible, but right now some people can't even pay to get clean air, so maybe they would prefer this type of situation.
Of course, these are both intentionally silly ideas. Nobody really intends to give ownership rights for things like air or fairy shrimp. However, economists think that this would at least get rid of all externalities, and under those conditions the market should work to provide the greatest social utility. Many people do argue that things like parks, water resources, and other things that we currently think of as public should be privatized, because then someone will have an incentive to protect them.
3: (4 pts) Under what types of conditions might it be economically "rational" to use up a renewable resource, even if it means you will never get to use that resource again.
If the resource grows or reproduces more slowly than the market interest rate, then it would make economic sense to harvest to extinction and then let the extra money grow elsewhere. There's no sense in waiting around for redwoods to grow back if it will take hundreds of years before you can harvest them again. Better to cut the redwoods, put the money in the bank, and plant Douglas Fir or Eucalyptus, because at least those things will bring a profit in your lifetime.
4: (4 pts) Is society the sum of individual wants as economists assume? In other words, can we determine net social good by summing up everyone's value for individual subjective well-being (or consumer surplus)? Discuss in an interesting way (for example, if it isn't, then what else is there?).
Here I want you to consider the question of what is social good. Is society better off if we all have the things we want? Are there situations where our desires might be bad for society? What would "bad for society" mean in this case if we're each individually better off? Considering the distribution question, assume that the consumer surplus in providing a rich person a yacht for $650,000 is a million dollars, because she would have been willing to pay $1,650,000 for it. At the same time, the consumer surplus of providing 100,000 starving people with free food is only $500,000, because they would only have been able to pay $5 each for the food (maybe that's all they have). Is social welfare higher if we provide the rich person with the cheap yacht? But if not, what is a better measure of social welfare?
5: (2 pts) Why do economists think it's OK to ignore distribution when looking at social welfare?
Essentially, economists think the thing to do is not to figure out how to redistribute the pie, but to figure out how to make the biggest pie possible. If we focus on that, then politicians can always come in later and redistribute the pie so that everyone is better off than they were before. Hence, economists concern themselves with efficiency, and leave the distribution of wealth to the politicians. At least, that's the official claim.