More about "Free" Resources
The second problem when resources are "free" is that the wrong mix of goods and services will be produced. In terms of efficiency, the marginal rate of transformation will not equal the marginal rate of substitution. This is a common result when decision-makers do not take into account some by-product of their actions that burdens or benefits others. A polluter, for example, considers air or water free. For him, dumping pollutants into the air or water is a cheap way to dispose of wastes. Yet, his actions do involve costs because he affects the alternatives that others face. The polluter may make others forego clean water. One could say that the polluter imposes some costs of production on others, although this use of the word "cost" differs from the normal meaning of cost. Those who bear this cost are not involved in the choice, and in its pure meaning cost is an alternative foregone in a choice.
It is easy to show that when a decision-maker ignores some costs of his decision, his decision may be economically inefficient. The graph below assumes that the market can be represented by supply and demand curves. The demand curve represents the marginal benefit to consumers (and to firms because they are price takers). The supply curve represents the marginal cost to sellers, and because producing the product requires resources that could be used elsewhere, it also represents a cost to buyers. But the production of the product also generates an unwanted by-product that sellers ignore. The marginal cost from the point of view of society as a whole includes this by-product and is thus higher than it seems to the firm. The economically efficient amount to produce in this illustration is q0, but the forces of the market will tend to result in the production of q1.
If negative externalities cause too much of a product to be produced, positive externalities should cause too little to be produced. When a person improves his house, his neighbors benefit. Because the decision-maker will not generally consider these spillover advantages to others, less than the efficient amount of the activity will take place. In terms of a supply-and-demand diagram, the marginal benefit curve as perceived by the decision-maker will be to the left of the marginal benefit curve of society as a whole, and thus too little of the activity will take place.
When scarce resources are perceived as "free", there will be potential value that a market will not capture. Is it possible for a society to capture this value, and if so, how?
A common "solution" to this problem has been to assume it away. This solution is especially common in plans for utopias, and writers in the Marxian tradition frequently illustrate it. In some of these arguments, pollution exists because capitalistic man is greedy, but when the new socialist man comes into existence, the problem will cease. Solution by assumption has at times crept into mainstream economic thinking as well.
A more practical solution is to increase private ownership in the system of property rights.1 This is an ironic solution in a way, because many environmentalists and ecologists have argued that the existence of externalities proves that a market system is seriously flawed and should be scrapped for an alternative, generally with greater state ownership and control. Economic analysis, however, shows that externalities exist when property rights are incomplete. Reducing the role of private property would make the externality problem worse. When no one owns the air or water, there is no incentive to avoid an overuse of the resource.
In a classic example of the problem of the commons, buffalo were hunted almost to extinction in the 19th century. If an individual hunter limited his kills, he was unlikely to benefit from his restraint. Someone else would probably kill a buffalo that he did not kill. Yet, from the point of view of buffalo hunters as a group, the optimal strategy would have been to limit killing so that the industry could maintain itself indefinitely.
In contrast with the buffalo, the number of cattle in the American West increased during the 19th century. The key difference between the different fates of buffalo and cattle was not that buffalo hunters were greedy and cattle raisers were not. It was that cattle were privately owned and buffalo were "free." Private-property rights force people to take into account all costs and benefits of their actions. A cattleman's decision to kill or not kill his cattle did not affect other cattlemen in the way that a buffalo hunter's decision to kill or not kill buffalo affected other buffalo hunters. When a resource is owned by all, when it is "free," there is a strong tendency for individuals to misuse that resource.
The existence of private property rights allows the law to deal with externality problems. A person who is harmed by someone's actions can ask the courts to decide about compensation. The court's decision will depend on whether or not he has a right to some good or service. Courts have established property rights for clean air, clean water, scenic views, sunshine, and quiet. If a person is not due compensation, then he does not have the property rights but the other party may have them. In this case he can pay the party harming him to stop the offending activity.
Victims of pollution seldom band together and sue the polluter, nor do they band together and pay him not to pollute. The difficulty with legal action is that there are serious problems (and thus large costs) in contracting and organizing large groups for legal action. One of these problems is the free-rider problem. Ronald Coase pointed out that pollution problems would not exist if there were no difficulties and expenses in making contracts between polluter and victim. The implication of Coase's work is that externalities should not be a serious small-group problem because if only a very few people are involved they can usually organize and seek legal remedies. On the other hand, the costs of organizing and negotiating when large groups are involved make non-governmental solutions very difficult.
Coase shows that private-property rights are not always a feasible way to solve the externality problem of "free" resources. Another solution is for the government to act as if it were the owner of these resources. The government does this when it regulates the number of ducks that hunters can kill. It says in effect that the government owns the ducks, and people cannot kill them without the permission of the government.
Government can charge for the use of its resources. It could, for example, charge polluters for the use of clean water and air. This charge would make polluters take into account the side effects of their activities (or in the jargon of economists, they would internalize the externalities), and would move the marginal cost curve in the graph upward. There is some user fee (pollution tax) that would make the decision-makers' marginal cost curves coincide with the marginal-cost-to-society curve, and thus correct the efficiency problem.
Government policy dealing with pollution and negative externalities has largely been one of regulation. Most economists believe that this is a less-desirable (efficient) method of dealing with the problem than a policy of a pollution tax.
Finally, there may not be a good solution to the problem of "free" resources for two reasons. First, the cost of a solution may be greater than the benefits of the solution. Most economists believe that there is some "optimal level" of pollution. Many productive processes produce waste products. These waste products, when considered damaging to people, are pollution. To remove them or to transform them into a form that no one considers damaging requires resources, and the use of those resources means that fewer other products can be produced. Thus the reduction of pollution involves the weighing of costs and benefits as does virtually all other activity that economists discuss. The optimal level of pollution becomes that level at which the marginal benefit of any more reduction just equals the marginal cost of any more reduction. If removing pollution that causes $1.00 worth of harm costs $10.00, it is economically inefficient to remove it. It is extremely unlikely that the optimal (economic efficient) level will ever be zero.
Second, there may be externality problems within the government just as there can be externality problems in the market. When there are externality problems in the market, we can call on the government as an outside agent to solve them. But if these problems exist in the government, there is no one to turn to. For example, suppose that the citizens of a country are split into fifty special interest groups, and each group gets special benefits from the government. To pay for those benefits, the government must tax the citizens. The citizens end up paying a dollar in taxes to get eighty cents of special benefits. (Bureaucracy eats up the other 20%.) Though all would be better off getting rid of all special benefits, no one group will want to give up its special benefits, and the costs of organizing the fifty different groups to come up with an agreement may be very large. There may be no solution to this problem of the commons.
1Every society has a system of property rights. Property rights are the social rules, that may or may not be legally enforced, that tell people where they can be and what they are allowed to do with locations and physical objects. Economics stresses that some systems of property rights lead to more economically efficient results than others.
Copyright Robert Schenk