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Environmental Economics: Market Failures Essay

1182 words - 5 pages

“Most environmental and natural resource problems arise because of market failure, therefore solving these problems could be easily achieved through the appropriate extension of markets.” Critically evaluate this statement with reference to specific examples of pollution, natural resources and environmental public goods.

The market represents a decentralized exchange mechanism that allows society to allocate resources efficiently. (National Oceanic and Atmospheric Administration, 2011)

An example of a perfect market for the supply and demand for oysters is shown in Figure 1. Assuming that the full cost is captured, the equilibrium point b will result in a pareto optimal outcome, efficiently allocating resource and maximizing economic benefits to society. (National Oceanic and Atmospheric Administration, 2011)

Markets fail when they are unable to protect the environment from which their resources come from. The full social costs of exploiting a natural resource is not captured, resulting in an inefficient resource use. There are three factors contributing to market failures. The first factor of market failure is that the market is not purely competitive. Secondly, the resource is a common property or an open access resource and lastly, when externalities are present.

A monopoly ensues when the market for a resource is not purely competitive. In contrast, when there is pure competition, firms can purchase as many units of the resources as required at the market price. However, in the case of a monopoly, firms pay more to acquire the resources. As shown in Figure 2, the equilibrium price is raised higher as the controlling firm wants to maximize its profits.

Figure 2. In the presence of a monopoly, the controlling firm will tend to shift its MC from e to f so as to maximize their profits.
This imperfect competition causes the reduction of economic welfare for other firms other than the one controlling the market and hence, leading to a market failure.

Natural resources can be managed as common property or open access resources. Common resources are owned by everyone and are not excludable. For offshore oil, which is a common property resource, a state government can control it by leasing exploration and development rights. This will ensure that this common resource will not be overexploited. For example, in the United States, companies bid for the rights to explore for offshore oil in a particular area. This means that efficient property rights are established, and also limits the number of companies to the same exploration area. (T.Prato, 1998)

For open access resources, no one owns the resource and hence, cannot exclude others from using it. Air pollution is an example of overexploitation of an open access resource. Every nation will continue to produce massive amount of harmful air emissions so long as their economic growth objectives are met. Free riding tends to...

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