6.1 Tragedy of the commons  (Page 3/20)

Unfortunately, many conditions can lead to market failure    such that the market outcome does not maximize social welfare. The extent to which net benefits fall short of their potential is called deadweight loss    . Deadweight loss can exist when not enough of a good is produced, or too much of a good is produced, or production is not done in the most cost-effective    (least expensive) way possible, where costs include environmental damages. Some types of market failures (and thus deadweight loss) are extremely common in environmental settings.

Externalities

In a market economy, people and companies make choices to balance the costs and benefits that accrue to them. That behavior can sometimes yield outcomes that maximize total social welfare even if individual agents are only seeking to maximize their own personal well-being, because self-interested trades lead the market to settle where aggregate marginal benefits equal aggregate marginal costs and thus total net benefits are maximized.

However, people and companies do not always bear the full costs and benefits associated with the actions they take. When this is true economists say there are externalities, and individual actions do not typically yield efficient outcomes.

A negative externality    is a cost associated with an action that is not borne by the person who chooses to take that action. For example, if a student cheats on an exam, that student might get a higher grade. However, if the class is graded on a curve, all the other students will get lower grades. And if the professor learns that cheating happened, she might take steps to prevent cheating on the next exam that make the testing environment more unpleasant for all the students (no calculators allowed, no bathroom breaks, id checks, etc.). Negative externalities are rampant in environmental settings:

• Companies that spill oil into the ocean do not bear the full costs of the resulting harm to the marine environment, which include everything from degraded commercial fisheries to reduced endangered sea turtle populations).
• Commuters generate emissions of air pollution, which lowers the ambient quality of the air in areas they pass through and causes health problems for other people.
• Developers who build houses in bucolic exurban settings cause habitat fragmentation and biodiversity loss, inflicting a cost on the public at large.

In situations where an action or good has a negative externality, the private marginal cost that shapes the behavior of an agent is lower than the marginal cost to society as a whole, which includes the private marginal cost and the external environmental marginal cost. The efficient outcome would be where the social marginal cost equals the social marginal benefit (labeled Q _efficient in Figure Inefficiency from Negative Externality ). Unfortunately, the free-market outcome (labeled Q _market in Figure Inefficiency from Negative Externality ) will tend to have more of the good or activity than is socially optimal because the agents are not paying attention to all the costs. Too much oil will be shipped, and with insufficient care; people will drive too many miles on their daily commutes; developers will build too many new homes in sensitive habitats. Thus, there is deadweight loss (the shaded triangle in the figure); the marginal social cost associated with units in excess of the social optimum is greater than the marginal benefit society gets from those units. Public policy that reduces the amount of the harmful good or activity could make society as a whole better off.