ECONOMIC MODELS OF ENVIRONMENT ISSUES

Neoclassical theory is applied to environmental issues to determine conditions necessary

for efficient allocation and cure inefficiency. This solely focuses on how resources can be allocated
efficiency it does provide solutions for other issues like income distribution or problems regarding
equity.

Figure 10.1 shows the optimal consumption of natural resources. In static efficiency we
are finding the efficient allocation of resource at one point of time only. This figure is similar to
supply and demand curve, the difference is that in this figure the supply curve will be considered
as the Marginal Cost, which is the cost incurred in producing one more extra unit of the resource.
Notice that in this figure, it is upward sloping, that is because for every one more unit that is
produced, the cost also increases. On the other hand, the demand curve will be considered as the
private benefit or marginal benefit, which is the benefit consumers get after consuming one more
unit. The reason that it is downward sloping is because of the law of diminishing marginal utility,
which states that for every one more unit consumed, the satisfaction consumer gets decreases.
To find the optimal market, it is necessary to discover where you can maximize the total
benefits of the society from the resource. This is equal to combined shaded are of consumer surplus
and producer surplus. There is a maximation if the marginal cost is equal to the marginal benefit,
in summary, the maximized total net benefits can be found on the equilibrium. In addition, in these
economic models we assume that there are no external factors affecting the cost and benefit.
 Figure 10.2 shows allocation of resources for more than one point of time. Resources are
being rationed over time to provide solution for the scarcity of resources, this will result to a
scarcity rent. This may be obtained when the marginal cost of the production is constant. In this
figure there is maximization on the present value of net benefits in relation with any possible ways
of allocating the resources. In this model, there is a presumption of scarcity and indifference of
consumer in consuming another unit today and obtaining them tomorrow. If the owner of the
resources is willing to offer only the 50 units todays, instead of 75 units, then the market price will
move to Ps and a scarcity rent will collected equivalent to the shade region of the figure. This
ability of owner creates the rationing effect that ensures efficient allocation of resource over time.

Proponents of neoclassical theory expresses that the inefficiency in allocation of resources

is a result from the imperfections in the property right system. As long as the resources are privately
owned and there are no market distortions, resources will be allocated efficiently.
A property right is the acknowledged right to use and benefit from a tangible or intangible
entity. A perfect property rights markets are characterized by the following conditions:
1. Universality – all resources must be privately owned
2. Exclusivity or Excludability – it must be possible to prevent others from benefiting
from the resources
3. Transferability – owner of resources has the ability to sell the resource whenever
desired
4. Enforceability – intended market distribution of the benefits from resources must be
enforceable
 Figure 10.3 is about the common property resources. A common property resources is
resources that is publicly owned and freely available to all. This kind of resources always often
leads to inefficiency of allocation, this is due to what we call the tragedy of commons.
Tragedy of commons is characterized as having a lack of private ownership which means
that there will be a lot of private producers who might act selfishly and will continue exploit
unsustainably the resources which will result to a depletion. This will then lead to a decrease in
the total net benefit.
Aside from this, there are some additional reasons why individuals making use of publicly
owned resources may make inefficient sue of them. For example, family farmers are generally the
most efficient cultivators of land but they might be reluctant in making land-augmenting
investments. Moreover, they may also have insufficient funds to hire additional labor or to
purchase complementary resources. If commonly owned resources will be sold then question as to
who would obtain the privatization will then arise. The answer is through a simple auction, but
this is an inconsistent solution.
Elinor Ostrom, a 2009 Nobel laureate in economics the designed principles for fair and
efficient management of common property resources.
 Public good is anything that provides benefit to everyone and the availability of which
is in no way diminished by its simultaneous enjoyment by others. It has a characteristic of non-
excludable, and non-rival, which means that everyone may use the resource no one can be
prevented from using it. On the other hand, a private good is the opposite. In addition to this is
public bad which is any product that decreases the well-being of others in non-exhaustive manner.
Considering the case of public bad in regional environmental degradation caused by
deforestation. Whether these trees are publicly owned or privately held, the continuous abuse will
lead to widespread regional degradation which will exclude no one in its effect. To simplify this
analysis, public bad problems will then be translated to public good framework. The conservation
and protection of environment will provide benefit to all, therefore, will become a public good.
 The difference between a public good and a purely private good is that aggregate demand
for the public resource is determined by summing individual demand curves vertically. In Figure
10.4a, rather than horizontally, like the case for private goods as illustrated in Figure 10.4b. The
difference results from the many individuals who may enjoy the same unit of a public good but
only one may benefit from a unit of a normal, private-consumption good. Through vertical
summation, we capture all benefits accruing to all individuals from each unit of a public good. The
marginal cost associated with the preservation of an additional tree is equal to the forestry
maintenance cost plus the opportunity cost of the tree, that is, the most valuable alternative use of
the tree. Figure 10.4 illustrates the problem of pricing public goods. In Figure 10.4a, the socially
optimal number of trees is Q*. It is determined by the intersection of the (vertically summed)
aggregate demand curve with the supply (MC) curve. At Q*, total net benefits to society from the
public good, PMD c, are maximized.
Free-rider problem occurs due to the characteristics of public goods. Individuals have the
incentive not to contribute anything at all with the provision of public goods and yet end up still
benefiting from these goods. If this is the case, many individuals may just choose to wait for the
others to contribute and free-ride off their contribution. If everybody acts this way the no private
firm would want to supply resources because they will not generate much profit. Therefore, it will
result to absolute 0 supply to the free market, which will lead to a missing market, a worst complete
market failure.
Due to the free-rider problem the limitation of public-good framework arises. Public-good
pricing mechanism has the problem of how to know which prices to charge. Government is capable
of reducing market inefficiencies but may not produce a perfect allocation of resources due to
insufficient resources of information. In addition to this, it is also possible to create quasi-public
goods. A quasi-public good is something that has both the provisions of both private and public
goods, therefore still creating profit. A few examples of these are road and beaches. They are a
public good which can be privately held.