Lesson 7: Property Rights: Is the Environment Different?

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Key Terms

Property rights Transaction costs Negative externalities
Positive externalities Tragedy of the Commons Coase Theorem
Marginal benefits & costs    

National Content Standards Addressed

Standard 1: Scarcity

Productive resources are limited. Therefore people cannot have all the goods and services they want; as a result, they must choose some things and give up others.

  • Like individuals, governments and societies experience scarcity because human wants exceed what can be made from all available resources.
  • Choices involve trading off the expected value of one opportunity against the expected value of its best alternative.
  • The choices people make have both present and future consequences.
  • The evaluation of choices and opportunity costs is subjective; such evaluations differ across individuals and societies.

Standard 2: Marginal Decision Making

Effective decision making requires comparing the additional costs of alternatives with the additional benefits. Most choices involve doing a little more or a little less of something: few choices are “all or nothing” decisions.

  • Few choices are all-or-nothing decisions; they usually involve getting a little more or one thing by giving up a little of something else.
  • To determine the best level of consumption of a product, people must compare the additional benefits with the additional costs of consuming a little more or a little less.
  • Marginal benefit is the change in total benefit resulting from an action. Marginal cost is the change in total cost resulting from an action.
  • As long as the marginal benefit of an activity exceeds the marginal cost, people are better off doing more of it; when the marginal cost exceeds the marginal benefit, they are better off doing less of it.
  • To determine the optimal level of a public policy program, voters and government officials must compare the marginal benefits and marginal costs of providing a little more or a little less of the program’s services.

Standard 10: Institutions

Institutions evolve in market economies to help individuals and groups accomplish their goals. Banks, labor unions, corporation, legal systems, and not-for-profit organizations are examples of important institutions. A different kind of institution, clearly defined and well enforced property rights, is essential to a market economy.

  • Property rights, contract enforcement, standards for weights and measures, and liability rules affect incentives for people to produce and exchange goods and services.

Standard 16: Role of Government

There is an economic role for government in a market economy whenever the benefits of a government policy outweigh its costs. Governments often provide for national defense, address environmental concerns, define and protect property rights, and attempt to make markets more competitive. Most government policies also redistribute income.

  • Markets do not allocate resources effectively if (1) property rights are not clearly defined or enforced, (2) externalities (spillover effects) affecting large numbers of people are associated with the production or consumption of a product, or (3) markets are not competitive.
  • An important role for government in the economy is to define, establish, and enforce property rights. A property right to a good or service includes the right to exclude others from using the good or service and the right to transfer the ownership or use of the resources to others.
  • Property rights provide incentives for the owners of resources to weigh the value of present uses against the value of conserving the resources for future use.
  • Externalities exist when some of the costs and benefits associated with production and consumption fall onto someone other than the producers or consumers of the product.

Key Ideas

1. Review:

ERP-2: Choices impose costs; people receive benefits and incur costs when they make decisions. The cost of a choice is the value of the next-best alternative foregone, measurable in time or money or some alternative activity given up.

ERP-3: People respond to incentives in predictable ways. Choices are influenced by incentives, the rewards that encourage and the punishments that discourage actions. When incentives change, people’s choices change in predictable ways.

ERP-5: Understanding based on knowledge and evidence imparts value to opinions. Opinions matter and are of equal value at the ballot box. But on matters of rational deliberation the value of an opinion is determined by the knowledge and evidence on which it is based. Statements of opinion should initiate the quest for economic understanding, not end it.

  • “The environment” or “environmental quality” is an economic good:
    • The amount we have is affected by limited resources, so it is scarce.
    • Decisions about “environmental quality” have opportunity costs.
    • People’s choices about environmental quality respond to incentives in predictable ways.
    • The incentives that influence people’s choices about “environmental quality” are shaped by environmental laws and regulations (i.e., the rules of the game).
  • However, “the environment” or “environmental quality” may also have characteristics that make it different from many other goods.
    • For example, decisions about resource use for environmental quality may be made by people who do not bear the costs. This is source of many conflicts over environmental quality.
      • This may occur because the state of nature is such that it would cost to define and enforce ownership of the resources involved.
      • It may also occur because providing a given level of environmental quality would reallocate wealth among individuals, and government chooses not to make the correction.

2. Property rights are the formal and informal rules governing the ownership, use, and transfer of goods, services, and resources.

  • Property rights may be private, common, or collective.
    • Private property ownership allows the owner to exclude others from the use of the resource.
      • Private property creates incentives for conservation and improvement of resources. A stable, dependable enforcement mechanism is essential for these incentives to work.
  • Common property is characterized by the inability to exclude users.
    • Common property arrangements – shared ownership arrangements where “everyone” owns the property together – create incentives for overuse, a phenomenon known as “the tragedy of the commons.”
    • Common property can be an effective alternative to private ownership of large-scale resources, if access to the resource can be kept closed to outsiders.
  • Collective property is similar to common property in that ownership is shared, but it differs in that decision-making is through government and political processes and in that individuals cannot avoid “ownership” without departing from the political jurisdiction.
    • Collective property arrangements can be either public or private.
      • A country club swimming pool is an example of a private collective.
      • A city-owned swimming pool is an example of a public collective.
  • Because users cannot be excluded, collective ownership creates incentives that lead to the tragedy of the commons.
  • If effective exclusion is feasible, common and collective ownership arrangements can avoid the tragedy of the commons.
    • Community run fisheries in the coastal waters off New England and Newfoundland, for example, have effectively solved the problem of depleted fish stocks that resulted from over-fishing in common waters.
  • Collective ownership (and sometimes common ownership) also creates incentives for political allocation of benefits and “rent-seeking” behavior.

3. Governments play a key role in the definition and enforcement of property rights and, therefore, the effectiveness with which nations address social concerns like environmental quality, poverty, etc.

  • Clearly defined and well-secured property rights add value to goods and services, and facilitate wealth-creating trade.
  • Differences in the legal “rules of the game” that define and secure property rights vary the incentives for wealth-producing trade.
  • Analyzing historical and contemporary examples of different property rights schemes illustrates the value of looking at environmental issues as problems of incentives rather than blaming them on “bad people doing bad things”.

4. Conflicts over regulatory and eminent domain “takings” arise when property rights are not secure.

  • Example of regulatory takings: restrictions on landholders’ use of their property that result from enforcement of endangered species legislation.
  • Example of eminent domain takings: decision by a government that a private piece of property would be better put in a “public” use. Government may force the owner of the property to sell at a “fair” market price, whether or not the owner wishes to sell.

5. Externalities occur when property rights are not defined or are not effectively enforceable.

  • “Negative externalities” exist when the costs of producing a good spill over onto (are borne by) people other than those who decide how much or whether to produce that good.
    • Negative externalities result in more being produced than would be if the producers and consumers of the good bore all the costs.
  • “Positive externalities” exist when the benefits of a good or service spill over onto people other than those who decide how much or whether to produce that good.
    • Positive externalities result in less being produced – scenic views, for example – than would result if those who bore the costs could capture all the benefits.
  • When property rights are not well-defined, enforceable, and transferable, cooperation becomes more costly and markets operate less effectively to allocate resources to their most highly-valued uses.
  • The Coase Theorem provides insight into how the definition of property rights can facilitate “willing seller – willing buyer” exchanges that enhance environmental quality.
    • When property rights are well-defined, enforceable at low cost and transferable, property rights to resources will be traded in the market until they reach their highest-valued use—that is the use that maximizes net benefits, taking into account all of the costs and benefits of their use.

6. Some environmental problems arise because of a failure to account for differences in present and future values.

  • People place a premium on goods available now over goods not available until the future. (a premium reflected in a positive interest rate)
  • Sensible environmental policies take this premium into account, insisting that more than a dollar’s worth of benefits be received in the future before a dollar’s worth of costs are incurred today.

7. Marginal analysis helps us to determine the optimal level of pollution—that is the level that yields the highest net benefit from our scarce resources.

  • At the margin, the optimal level of pollution is higher than 0%, and the optimal level of environmental quality is less than 100%.
  • Activities like pollution abatement or environmental preservation should continue only up to the point where marginal benefit equals marginal cost.

Ideas To Take Away From This Lesson

  • The “tragedy of the commons” arises when property rights are not well defined or not enforced.
  • Well defined property rights increase the market value of products and services.
  • Many environmental problems arise because property rights are not clearly-defined or secure, and prices cannot effectively signal the (marginal) costs to the marketplace. These conditions may create a role for government action.
  • When property rights are well-defined and cheaply enforceable and transferable, resources can be allocated privately by market participants in ways that maximize their net values and thus yield the highest wealth to society.