Lesson Six: Externalities, Property Rights and Pollution

 

Externalities, Property Rights and Pollution

Key Terms:

• Externalities
• Property rights
• Transaction costs
• Cost/benefit analysis
• Tragedy of the commons

National Content Standards Addressed:

Standard 1 - 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.

Standard 2 - 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.

Standard 16 - 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.

Lesson Objectives (5)

1. Externalities, also know as spillovers or neighborhood effects, are any costs or benefits of production and exchange that are not taken into account by those who create the costs or benefits.
   • Examples of positive externalities include the benefits to passersby of a beautiful garden on a busy street, or the safer neighborhood for others that results from some residents hiring private security patrols.
   • Examples of negative externalities include an unmowed lawn in a suburban neighborhood, or automobile exhaust, or second-hand cigarette smoke.

2. Cooperation becomes more difficult and markets operate less efficiently when externalities exist, because individuals have no incentive to take into account the consequences of their actions for other people.

3. Externalities, both positive and negative, persist in situations where property rights are poorly defined or are unsecured.
   • Define property rights and give examples.
   • Sometimes, property rights remain undefined because the costs of defining them are prohibitive.
   • The existence of clearly defined and well-secured property rights creates incentives for owners to consider the value of conserving resources for future use.
   • The "Tragedy of the commons" refers to the lack of incentive to husband resources (like fish in a public lake) that are owned by everyone, and thus by no one (until they are caught).
   • Defining property rights more satisfactorily enables market processes to encourage productive cooperation instead of waste and conflict, as is demonstrated by the case of the African elephant or the use of pollution tax credits to reduce sulfur-dioxide emissions.

4. Government efforts to protect the environment or to eliminate pollution are most effective when they concentrate on establishing clear rights to property and freedom to exchange.
5. In considering nature, conservation, and the environment, marginal analysis is necessary to clearly evaluate alternative courses of action.
   • Define (or review) "marginal" and give examples.
   • Marginal analysis compares the anticipated additional benefit of a course of action to the anticipated additional cost (in terms of alternative benefits forgone).

Teaching and Discussion Ideas:

As a way of providing a concrete example, some professors like to create an externality during their lectures. Examples might include dropping trash or garbage as they talk, having someone make disruptive noise in the hall or the back of the room, or arranging to have a cellular telephone or beeper ring in the middle of the lecture.

Sample Interactive Discussion Problems:

Pose problems requiring students to compare situations where a tragedy of the commons exists to situations in which property rights are clearly defined and well-secured.

1. Consider the typical high school cafeteria. Why are most of the tables dirty and surrounded by trash, while the senior section is relatively clean?
2. Why is there graffiti on the walls of the school bathrooms, but not on the walls of your bathroom at home?
3. Why do you suppose that there are many people moving freely around the park, there is little visible trash, and the bathrooms are clean at Disney World, while at Yellowstone National Park, roads are congested and trash barrels often overflow?

Sample Small Group Discussion Problems:

Pose a problem requiring students to use the concept of property rights.

4. Cows and buffaloes provide similar benefits to humans. Why did the buffalo nearly become extinct while the cattle population was never endangered and continued to grow?
   • Why have buffalo populations recovered while other animal species remain endangered?
5. Present students with a brief description of the elephant situation in Africa, contrasting the growing population in some countries where elephant hunting licenses are sold, with the continued decline in countries where elephants are "protected" in large national parks and game preserves. Ask students to use property rights to analyze the mystery and to identify the operative incentives in each system.
6. Suppose that the Nature Conservancy, a nonprofit conservation organization, has just received a $100 million gift from the estate of a wealthy philanthropist. Recently, the Conservancy has been concerned about a piece of land near the Mississippi delta in Louisiana. Besides being beautiful, it is breeding habitat for endangered waterfowl. Unfortunately, the current owner has offered the land for sale and several oil companies are interested. The Conservancy and EPA are worried that drilling will destroy the fragile wetlands.
   • Formulate a plan:
     • What is the best course for the Nature Conservancy to take?
     • How can it best spend its money to advance its goal of conservation?
     • If the Conservancy decides to buy the land, are there any circumstances in which it should allow the extraction of oil and natural gas?

7. Suppose that the owner of a large parcel of land in California makes a deal to sell his land to a resort developer for several million dollars. The EPA blocks the deal by telling the developer that since an endangered species of kangaroo rat nests on the land, he may not build a resort hotel.
   • What has happened to the property rights of the people involved in this case?
   • Do you think this action by the EPA qualifies as a "takings?" (The Bill of Rights specifies that private property shall not be taken for public use without just compensation.) Defend your answer.

Definitions

Cost/benefit analysis - A comparison of the costs and benefits of a choice in an effort to select alternatives that maximize the difference between benefits and costs.

Externalities - The cost and/or benefits that are not internalized by the processes of production and exchange, and which therefore spill over onto third parties. Externalities may be positive or negative. (Also known as spillovers or neighborhood effects.)

Property rights - The conditions of ownership, including the rights and restrictions regarding use, ownership, and sale.

Tragedy of the commons - Describes the phenomenon of overuse of resources held in common (i.e. by the "public" or by government) that occurs because the failure to adequately define property rights means that no one has an incentive to conserve or maintain the resource and all have an incentive to use the resource before others do.

Transaction costs - The resources (like time and energy) that are used in making an exchange. An example of a transaction cost is time spent shopping or the time and energy necessary to negotiate a contract.

 

Copyright © 1999 Foundation for Teaching Economics
Permission granted to copy for classroom use.