The Environmental Protection Agency (EPA) is being accused by an environmental group (WildEarth Guardians’) in the United States of neglecting the public’s health by failing to decrease air pollution. The WildEarth Guardians’ accusations come from a 2005 investigation which found that all 50 states had not adopted clean air plans. A deadline was implemented to decide on a plan by 2007, but several states (including California, New Mexico and Oregon) still do not have plans.

The market failure here is the EPA’s inability to effectively respond to the pollution issue. A market failure is when a process or incentive allows the inefficient production and use of goods and services. In this instance, the market is failing to take into account society’s cost of this negative externality. A negative externality is when the production or consumption of a good has a negative/harmful effect on a third party. The graph to the left shows the negative externality of the production of cars. It can be seen that the marginal social costs are greater than the marginal private costs. The producer is externalizing their costs, or pushing them onto society. Pollution has no borders, and even people on the other side of the US are affected. Though the producer is aware of the impact polluting can have, the EPA is not enforcing its laws and as a result these manufactures and producers are able to legally get away with it.

“It’s been an issue that has kind of been cast aside. It’s not really important to the EPA,” said Jeremy Nichols, the WildEarth Guardian’s climate and energy program director. In 1990, amendments were added to the Clean Air Act that proposed a carbon market. This would be more effective than monitoring the emissions of each company/factory. Pollution permits would be auctioned off to industries. If a firm needs to go beyond the limit that their pollution permits allow, they would need to buy more. If firms do not use the entire allocated pollution quota then they can sell them off. This provides an incentive for firms to reduce their emissions so they can increase their profit by selling left over permits. An incentive is a means of urging people or industries to do more of a good thing and less of a bad thing.

To the left, a graph of the carbon market can be seen. The supply of permits is decided upon by the government. The more firms that want to pollute and buy permits, the higher the price. Advantages to this system are that the revenue from the sale of permits can be directed towards improving the environment or investing in more public goods such as national defense, fighting poverty and basic research. The pollution permit market is open to everyone. Groups or organizations who are adamant about reducing pollution can buy permits for themselves; this will decrease the available supply to major industries and will also drive up the price which may urge smaller firms to look for an alternative to polluting.

“We just want to see clean air. We just want to see this problem dealt with,” said Nichols. The EPA either needs to create a new division solely for monitoring the emissions of each factory or implement pollution permits. Monitoring would require a huge amount of work, effort, money and time. A carbon market is much more effective where the private market would fix the problem. The EPA also needs to consider penalties for those who pollute more than their allocated amount. These penalties would have to be harsh enough to dissuade firms from ignoring legislation.

Article: http://www.voanews.com/english/archive/2009-03/2009-03-08-voa11.cfm

In the Niger Delta, over 60 oil companies have been dumping waste from oil and gas extraction into the Niger Delta, which makes up 77% of Nigeria’s mangrove ecosystem. 1.5 million tons of waste has been dumped into the delta since the past 50 years. Niger’s National Oil Spills Detection and Response Agency has accused these firms for their crimes against the environment and people of the delta. The population of that area has suffered greatly from having no fresh drinking water because “they suspect most of the effluent must have gone into the water and the effect may be dangerous if they drink it.” As stated by the village head, Emmanuel Ebie.

The most probable reason that these 60 firms dumped their waste in the delta for the past 50 years is to reduce their cost of production. Externalizing is when a firm is pushing its costs off to a third party, so in this case, the oil companies are pushing the costs of taking care of the waste off onto society, which has disastrous effects on population and environment. This is called a negative externality (when externalities have bad effects on the third party). These would include: No drinking water, and the loss of agriculture and crops which makes up the area’s economy. By reducing their cost of production, firms are then able to increase their output of oil, and therefore are also able to increase their profit and eventually, their revenue. Production is expensive, so being able to reduce costs where ever they can is a benefit to the firm. This is a case of market failure. A market failure is when a market fails to allocate its resources in the most efficient way. A market failure occurs when either there is an underproduction of a merit good or the overproduction of a demerit good. In this case, with the oil production, too much is being produced thanks to the externalization, meaning that there is an overproduction of oil, which means that there is a market failure.

As can be seen on the graph, by externalizing, the Nigeria’s Oil companies are able to move from the Socially Optimal Point (P_SO, Q_SO) to the new equilibrium point (P_E, Q_E). By moving this point, the firms are now able to produce more at a lower price.

Externalities create welfare losses (welfare gained/lost from a good or service), therefore, Nigeria’s government will take action against the polluting oil companies.

One option would be to completely ban the externalization of waste. By dumping waste into such environments, the environment will be destroyed and reduce tourism. Once the oil of Nigeria has been depleted, and the tourism industry destroyed, Nigeria will have no more chance in economic growth. It will be hard to enforce a ban. The government needs to be in a good condition, and also, must be able to face the pressure of the oil companies because these firms are the sole form of revenue for the country, and are able to control Nigeria’s economy. If they ban externalization, firms might just leave Nigeria, and find another place to drill for oil, which leaves Nigeria on its own, with no source of national revenue.

Creating a per unit tax and/or a taxing the waste produced by the oil companies is another option. This will force firms to increase their costs of production and should eventually bring the Marginal Private Cost (MPC) curve back towards the Marginal Social Cost (MSC) curve, which would then mean that the social optimal point will be reached. But any taxes implemented will be pushed off onto the consumer. It is also hard to implement this tax. Its hard to control who pays this tax, because firms can export their waste. The tax has to be high enough to induce firms to internalize their costs, and calculating this amount will be difficult.

It can be seen that with a tax or a ban, the MPC will move towards the MSC, and reach the socially optimal quantity (Q_SO), eliminating the market failure and allowing the population of Niger to regain its welfare.

Therefore it is best to tax, due to lower risks for Nigeria’s economy.

This article addresses the fact Tuna fishing over the last couple of years has reached a point where it is being massively over produced. This is a prime example of a market failure. A market failure is just when a certain product is either over produced or under produced, which in this case it’s over produced. This situation with the tuna is referred to as tragedy of the commons. Tragedy of the commons is when private firms try and exploit common goods, which leads to an overproduction of the good. A common good is a good that is rival, which means that once one person uses it, it diminishes the value for others. Because fish is a common good that anybody can fish for, there is no regulation of the amount they are fished. This is the major problem, because without any limitations or regulations, what is to stop firms from trying to keep producing. Because companies are “profit maximizing machines,” they won’t stop unless they are made to stop. Not only is there that problem, but because the fishing is most likely happening in free waters, it becomes an international affair.

The graph above shows the current problem. This is what is currently happening, where the firms are paying less and society has to pay more for the loss of fish. This market failure is why this problem must be fixed. The major problem is the fact that it is near impossible to enforce regulations, because most fishing occurs in international water. So for example, if a boat from China is fishing in international waters off the coast of Japan, and the boat breaks Japan’s fishing limits, Japan can’t do anything about it, because it was international waters. Unless there is an international agreement, no limits can be set and enforced. That is why there is so much overfishing, without any solutions, boats and their companies will just keep trying to maximize profits by maximizing their catch. The article states that there is “an enormous amount of illegal fishing.” Because it’s in international waters though, there is nothing anybody can do. The United States blames European fishing companies for the decrease of the fish population. Europe has a great amount of ships in the waters, with France sailing the most, with 771 ships. Not only is the amount of ships in the water an important factor, but the place where the ships are fishing is effecting this fishing decline. Most companies are starting to fish near hatcheries, where the fish are born. This is because during birth season, there are more fish to be found there. Fishing here messes up the natural cycle of fish, and decreases the population drastically by not allowing fish to get old enough to reproduce.

One solution that governments try to take is setting a quota. A quota works by just reducing the amount of a good that a country may import. This will limit the amount of fish that a boat can catch, so it makes sense that the fish population would return to normal. So if there is a quota in place, why is over fishing a problem? The reason the fish population continues to decrease is because the quota is usually set too high in countries. Governments also want to maximize profits, so they set their quota high, therefore they can strengthen their economy. So right now the quota is pretty much useless if it won’t ever be reached. In my opinion, the best solution is to lower the quota. This way it would actually limit the fish intake. If countries won’t import anymore fish, then the boats won’t catch as many, because without buyers, the fish would be useless to the companies.

In this graph you can see, if the quota was set lower then it would force the Marginal Private Cost back, and thus reduce the negative externality. If they did set a new quota, a quota that is actually under the amount of fish produced, then it will limit the amount of fish that can be produced. This would help bring the natural cycle back to balance and the fish population would start to increase toward the normal amount again.

So in conclusion, I would say that to fix this problem, there needs to be an international agreement on a new quota that will actually limit the fish intake.

By Bjorn Borgers, Justus Poeschl and Bjorn Kvaale:

This article talks about the overfishing that is done in the ocean. “Small prey or forage fish” is being “overexploited”. This is due to the high demand of fish that people are consuming and the cheap costs to the firm. Another reason for the high demand of fishing is that some of the small species “are turned into oil”.

Fish is a common resource. They are located in international waters and since we can’t exclude someone from fishing, it is not excludable. The good is rival because when someone catches on fish, it prevents another person from catching the same fish. Overfishing means that society is catching too many fish. This creates a negative externality of production because resources are being over-allocated in the fish market. The overproduction of fish is having a negative effect on a third party, which is in this case the food chain of the ocean and future generations. Therefore society would be better off with less of it. It is shown in the graph below

The market will produce at P₁Q₁, where the marginal private cost, which is the production cost to the company, is lower that the marginal social costs, the cost of production to society. We see that the firms are pushing the cost of the externality off onto society. Ideally, we should produce at P*Q*, where we would be in Pareto optimal. This means that we cannot make someone better off without making someone else worse off. Because we are not, we have a potential welfare loss. This represents the misallocation of resources because the marginal social benefits are lower than the marginal social cost.

However, it is going to be really hard to find a way to decrease the demand of fishing because of the tragedy of the commons which means that we cannot forbid any country to fish on international waters. Therefore “Oceana and Ocean Conservancy” are asking for catch limits that would protect existing fisheries.” These limits would decrease the supply. However, firms will have a higher marginal cost because they have a lower quantity. This would shift the marginal private cost and bring it closer to the marginal social cost, decreasing the dead weight loss if not eliminating it.

We can see that the dead weight loss has greatly decreased, and depending on the catch limit it could be completely decreased. However, this can cause problems. First of all, “Overfishing of prey species are going unregulated”. Implementing a catch limit has might not fix this. Since it is already done unregulated, firms will not feel affected and will keep fishing. To fix this problem, the government will have to make sure to check this, creating a huge cost to the government. Second of all, if firms do need pay attention to the catch limit, their total revenue is going to decrease, and smaller firms might be forced out of business, especially if they specialize in some type of fish. Lastly, implementing the catch limit will be hard to control as well because this fishing is done on international waters. This means that the ocean waters don’t belong to any of the countries, and it will be hard for all the countries to agree where to put borders, and say who should check what area since many countries rely on fishing as a primary source of income. Another reason this might not work is that countries whose major income comes from fishing will not accept these catch limits. They will just keep fishing, while other firms will decrease their quantity, giving them an unfair advantage compared to other firms.

For the government to solve this international problem they will need to work together with other governments. However, trust will play a big role since some countries might promise something but not implement it, like the USA and the Kyoto Protocol. Therefore the solution of implementing a catch limit suggested by “Oceana and Ocean Conservancy” might be ineffective, and therefore the best solution would be to work together and implementing different solutions such as a catch limit and making sure that every country checks the catch of the fishermen when they arrive back at the port.

Article Source:

Kay, Jane. “Overfishing imperils ocean life, study says.” San Fransisco Chronicle. 03 March 2009. 30 Apr 2009 <http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2009/03/03/BAGQ167VF6.DTL>.

Due to climate destabilization, companies worldwide are trying to reduce their carbon emissions. This article states that the Kyoto Protocol has not influenced countries enough so carbon emissions are still very high. The US is willing to reduce their emissions only if other countries are doing it too since otherwise they would be at a disadvantage. Due to this there should be international regulations followed by all, which states laws about carbon emissions.
Carbon emissions worldwide are not decreasing in a rate which would help our environment, and therefore countries have to agree new regulations. Currently the carbon emissions which are produced and consumed are a market failure. A market failure is when a market fails to be allocative efficient or is under/over allocating its resources. In this case the market failure is a negative externality of production. The term negative externality means that there is harmful effect on a third party due to consumption or production of a good or service. The third party in the case of carbon emissions could be the people who inhale toxic air or the animals which are affected by global warming. The Kyoto Protocol was supposed to make sure that pollution decreased, it is not working because America and Australia never agreed to the terms.

The graph shows that the MSC (the cost of society to produce the certain good) is above the MPC which means that there is a negative externality. The MPC is the cost that the company has to pay to produce the good. The best thing would be if the MPC=MSC, since then there would be no externalities. The welfare loss is created because the private firm is externalizing its cost on a third party, which is the society.
Barack Obama agreed to cut emissions if other countries are willing to do the same. However, China has said that they are already decreasing their emissions and they do not want to follow the lead of the USA. So, the US had the idea of taxing the goods that come from China, this would increase the price for the consumer but also make it more expensive for China. China responded by saying “Climate change and charging carbon taxed in imports…are two issues in two areas.” Perhaps if the US taxed Chinese goods and services the marginal private cost (MPC) would move closer to the social optimum place. This is because China isn’t willing to cut down their carbon emissions and if the US taxes them, there would be a higher cost for the goods and services.

The main conflict is that China thinks that US is only taxing their goods and services due to “protectionism”. This means that the US is protecting domestic industries from foreign industries. China said that US is putting on tax to find an excuse to make Americans buy their domestic goods and not China’s goods. Another problem with taxing goods and services is that it can be argued that taxing goods do not reduce emissions. Since taxing does bring along some problems it might not be the most sufficient and best idea.
The carbon emission problem is an international problem because it affects all countries. However, the biggest difficulty is to make all nations sign the solution and make them believe that if they reduce their carbon emissions it will benefit them. A solution would be to do negative advertisement. This means that there would be advertisement which would point out what happens if firms continue to release toxic fumes. The Kyoto Protocol did not work since the US and Australia never ended up getting the agreement confirmed, and therefore most countries did not meet the requirement set by the UN. A good solution for the future would be to make another protocol to reduce carbon emissions every 2 years and to set a limit of carbon emissions. However, this would also be a problem because people might sign the contract but no one knows if they would follow it through. Therefore, the UN should make sure that all countries are doing what they promised to do.

In 2001 the then president of the United States George Bush signed an executive order banning American stem cell research believing it was against human nature and would offend conservative supporters. On March 9th 2009; Barack Obama the new current president of the United States signed an executive order to end the restriction on federal funding for embryonic stem cell research. Obama believes the ban for the last eight years has caused a major setback in critical medical research.
Bush felt that stem cell research in America was against human nature and not beneficial. This led to people believing it was a negative externality. An externality is when a production or consumption of a good has an effect on a third party. This case is negative, a negative externality is something that has a harmful or bad effect on a third party. This is a demerit good, something that is going to cause problems to society. Societies want to get rid of demerit goods as they will be better off without them. Governments want to get rid of demerit goods therefore they set regulations such as illegalizing, taxing highly, and minimizing quantity. The third party here would be the private firms and the American people. Bush felt that if we invested in stem cell research it would be non-beneficial to us and firms investing. Bush believed that funds should go elsewhere. Below is a negative externality of production graph showing stem cell research from Bush’s view. Looking at the graph below you can see that the marginal social cost (MSC) which are the cost of society to produce a certain good, are great than our Marginal social benefits (MSB). Our marginal social benefits are the benefits that are caused by the product. When MSC is greater than MSB the product is over-allocative. Meaning there is too much of the product being produced to the point where it is no longer efficient and good for society.
Stem Cell Research under the power of Bush

Now eight years later Barack Obama has signed an executive order allowing scientists and doctors to restart research. Stem cell research according to Obama is an extremely important issue. Set up correctly and supplied with the right resources it can be extremely beneficial to society saving many lives in the future. Obama has taken the negative externality, originally perceived as something harmful and out of place to something that will benefit our society tremendously. Stem cell research would now become a positive externality. A positive externality is a good that will benefit our society and a third party. Even though the good is beneficial it is under allocated, therefore there’s not enough of the product. Obama wants stem cell research to be a merit good, unfortunately merit goods are undeveloped. Government power can attempt to increase merit goods, such as stem cell research. Private firms do not usually supply these goods because they are not profitable in the long-run. Therefore the government produces these goods using tax payers’ money or subsidizing a private firm to produce the good. Below is a graph showing a positive externality of production now that Barack Obama is president.

Positive Externality of Production of stem cell research now that Barak Obama is President.

The graph above shows that marginal private costs (MPC); the costs that the firm has to pay are greater than the marginal social cost (MSC); the costs of society to produce a certain good. This tells us that the good (stem cell research) is being under allocated and we have to start producing more to reach our socially optimal quantity (Q s.o) which is the quantity we are being efficient and benefiting our society and third party. The third party is the people of America and the government. Obama intends on doing this by using tax payers’ money to supply more resources to help the research increase and benefit not just America but the whole world. This is shown by shifting the MPC to the right bringing the curve down to a socially optimal price and quantity which is more beneficial. Overall Obama’s view of stem cell research is far more beneficial to us and our society than Bush’s negativity towards stem cell research. But is this really the best way? Can we continually use tax payers’ money to supply stem cell research till we find the outcome we want, or will we end up needing the money for something else that arises?

Sixteen years of mounting scientific evidence are securing the idea that “specific forms of air pollution increase the risk of suffering a fatal heart attack, among other cardiovascular diseases.” If these particular toxins are present in the atmosphere, even at levels below the federal health standard, lifespan of the inhabitants near the source can be shortened by up to two years. One of 250 metropolitan cities, Salt Lake City has held long-term studies on the effects of the production of a factory which is thought to contribute to the majority of the city’s pollutant smog. When Salt Lake City’s steel-mill shut down for several months, the fatality rate of nearby neighborhoods “decreased by four to six percent. Once reopened, fatality rate increased to their previous levels.”
When a firm pushes costs onto a third party to minimize its costs and maximize its profits, it externalizes these costs. If these costs are harmful, for instance pollution of the environment, then the externalization becomes negative. Negative externalities of production are characterized by the over-allocation of the firm’s resources, and therefore are market failures. The steel-mill in Salt Lake City is a prime example of an externalizing firm. To avoid paying the costs of proper industrial waste disposal and newer clean machinery, the mill emits gasses and pollutants into the surrounding areas. As a result, the population and government ‘pay the price’ of the mill’s actions through medical bills for cardiovascular diseases and the cleanup of, for instance, the polluted water supply. The costs of the firm are the MPC and the society’s cost is the MSC.

The graph above shows the externalizing situation of the steel-mill in Salt Lake City. The marginal private costs are lower than the marginal social costs meaning that the society is paying for the majority of the externality whereas the firm is pushing the costs onto the public. Ideally, each market should perform at the socially optimal point, or where marginal social benefits equal the marginal social costs. This means that either the society or firm is paying more for the externality (therefore no externality exists). Although the costs at this point are higher and quantity produced is decreased, the benefits to society are higher. The negative externalizing situation is shown by the red lines. This is where the steel-mill is currently producing. The red area is dead weight loss (or welfare loss) which shows how extensively the social costs exceed the social benefits. This area is a visual representation of the extent of the externality which is taking place.
Solving a negative externality involves internalizing the costs so that they become private costs. This increases marginal private costs towards marginal social costs, in turn decreasing welfare loss and the externality. Essentially, fixing negative externalities of production ensures that the market produces nearer to the socially optimal point where no externality would exist. This is shown in the following diagram:

Above, marginal private cost has increased towards marginal social cost; nearing the socially optimal point. Note how welfare loss has decreased, signaling that the market failure severity has been minimized. This illustration applies, however, to only a few of the methods of solving a negative externality of producing involving pollution including per unit taxing. The market failure originates from over-allocation of resources. Per unit taxing can be set by the government onto the steel-mill to decrease this over-production by increasing the firm’s price to produce each unit. Due to the increase in production costs, the firm may have the incentive to find less costly methods of production.
Issues exist, however, that limit the effectiveness of the per unit taxing method. If a product has very inelastic demand, then the consumer will continue to consume the same amount as before the tax was imposed. Steel is a popular industrial product, so perhaps this could be a problematic factor.
For this reason, to internalize the steel-mill costs, it may not be wise to tax per unit. In order for the per unit tax to be effective on the mill, the elasticity of demand for the product must be less inelastic, meaning that demand will decrease quickly if price increases as the tax is set. The primary reason that the steel demand would become more elastic is the decreasing dependency of the population for steel. This is occurring slowly in the current economy as well; industries are always finding cleaner, more reliable and cheaper methods of production such as carbon-fiber structures and concrete-wood combinations.

China, whose economy heavily relies on exports, has been experiencing a decline in exports for six months now as of April. The value of China’s exports in April fell 22.6% in comparison to last year, a faster decline than in March’s exports (also in comparison to March of last year) during which China experienced a 17.1% drop.

Exports and imports are a factor of aggregate demand, and in our current situation of an economic crisis, people’s confidences along with many other factors contribute to an overall decrease in aggregate demand. However a senior retired government official points out that unlike the economic crisis in the 1930s, “the global economy is going to rebound quickly, at which point China will take a greater role in the world.” They rely heavily on government spending (another determinant of aggregate demand) on exporting industries in the form of favorable policies and tax rebates (which decrease the firm’s costs).

On the other hand, fixed asset investment (a long term asset that is not expected to be converted easily into cash) is doing comparably well as urban property prices begin to rise 0.4% in April compared to 0.2% in March. Fixed asset investment is another contributor to China’s growing economy because it is used to house the multitudes of Chinese civilians, as well as to provide factories for the production of cheap goods to be exported.

However a fall on both these major contributors of the Chinese economy lead to a decrease in the nation’s GDP growth from 13% in 2007 to 6.1% during this year, a clear characteristic of a recession. The decrease of net exports leads to a leftward shift of the aggregate demand curve below. This leads to not only a decrease in GDP, but also a decrease in price level, which in the long run may possibly lead to deflation.

Deflation for any economy is bad news as it can further lead to unemployment which in the graph above is characterized by the difference between full employment (Yfe) and the current point of output (Ye1). That is why the Chinese government steps in to attempt and make up for the lack of economic activity through spending, which brings me to the multiplier effect.

The spending multiplier is any increase in spending in the economy which gets increased by a multiple through further rounds of new spending, resulting in a higher GDP than the initial government spending. However this depends on the people’s tendency to consume with any change in income, also known as the marginal propensity to consume (calculated by: change in consumption/change in income). If the Chinese have considerable confidence in the economy and a high marginal propensity, then the multiplier effect will be all the more effective. On the graph below, the multiplier effect is more than double the initial government spending (GS), so final aggregate demand (AD1) is successfully increased.

As we are dealing with exports, the government cannot directly control other country’s consumption of Chinese products, what they can do is increase investment to stimulate firm activity by decreasing business taxes, so that the firm’s expected return on capital is greater. And finally, by passing monetary policies the Chinese government can decrease interest rates, and the expected rate of return will increase and encourage investment.

New stem cell research policy
Former president of the United States, George W. Bush, banned stem cell research during his administration and therefore no public resources were allocated towards this good. President Obama now wants to overturn Bush’s policy to increase public funding for stem cell research.

According to Obama, stem cell research is a merit good, a good which is beneficial to society. Merit goods are under- provided by the free market and therefore under- consumed. The government, in this case President Obama, wants to supply more of the good because it bears external benefits to society. With the increase of stem cell research, more ways of healing diseases could be made possible to the extent that human lives can be saved by replacing damaged tissue. Stem cell research creates positive externalities of consumption, external benefits to a third party, the whole society, not involved in the market transaction. Positive externalities of consumption are caused by an under-allocation of resources towards goods that have spillover benefits when they are consumed. If more of the good would be produced and therefore consumed, there would be a greater benefit to society, because society as a whole would become healthier. When resources are under-allocated, the government, exception George W. Bush, usually intervenes to increase the supply of the merit good. Graph 1 shows the stem cell research without government intervention.

In the graph MSB, the marginal social benefit, is greater than the marginal private benefit (MPB). Society as a whole benefits more from stem cell research than the producers. If new ways of healing diseases are discovered society gets healthier and therefore has a greater benefit than an individual. The marginal social cost (MSC) equals the marginal private cost (MPC), because the cost for society is the same as for the producers. Stem cell research is provided at Q_P, and so the optimal quantity for society, Q_So, is not reached. A market failure, an over or under- allocation of resources, occurs, because of the under- allocation of resources towards funding stem cell research. Potential welfare gain, occurring due to the under- allocation of resources, could be gained by the society if the market failure is corrected (black area). This graph fits to former President Bush’s policy which “barred the National Institutes of Health from funding research on embryonic stem cells”. Stem cell research was banned and therefore under- provided by the free market.

President Obama, in opposition to Bush, wants to increase stem cell research. “An expansion of stem-cell research could boost medical progress toward eradicating the debilitating diseases.” Obama sees stem cell research as a benefit to society. To increase stem cell research the government needs to subsidize the research to the point where it has the greatest benefit to society. This is shown in graph 2.

The subsidy lowers the marginal private cost (MPC), shifting it to the right. The quantity produced increased to Q_So, the social optimal level, and the market failure is corrected. The resources in this market are now allocated efficiently, shown by point A, which is now at the same quantity as the social optimal quantity B. Because more stem cell research can be provided, the benefit of the producer increases.

But to what extend should stem cell research be subsidized? President Obama’s move is “a slap in the face to Americans who believe in the dignity of all human life”. There are many ethical issues surrounding the research. “Many conservatives object to the destruction of human embryos because they contend that it ends a human life.” A lot of Americans are against stem cell research and agreed with Bush’s policy that banned stem cell research. Many people also do not see stem cell research as a merit good that benefits society. Especially religious people oppose Obama’s policy because they see stem cell research as the killing of human lives. This issue was debated among politicians, but science was faster: “Breakthroughs announced in recent years confirm the full potential of stem cell research can be realized without the destruction of living human embryos”. If stem cell research can develop into the direction that no ‘human life’, viewed by religious people, is ended, the ethical issues should decrease close to zero, because then there are only the positive externalities for society left and no arguments against the further increase of stem cell research.

Title of the Extract: Carbon market crashes with a whisper, not a bang

Commentary Number: #2

Source of the Extract: Guardian Unlimited - http://www.scenta.co.uk/nature/news/cit/1744022/a-collapsing-carbon-market-makes-megapollution-cheap.htm

Date of the Extract: 23/02/09

Word Count: 746

Date of Commentary: 27/03/09

Section of the Syllabus: Unit 2.4 - Market Failure

Candidate Number:

Candidate Name: Ultan Whelan

Economic Recessions Cause Pollution

The carbon market was created to reduce environmental pollution. As a control measure, governments limit the number of pollution permits to polluting companies, usually via auctions. Consequently the number of available permits decreases and prices rise. Now, due to the recent economic recession, pollution has become a favourable and cheap option for firms.

The carbon market was created to eliminate the negative externality (a non-beneficial impact on a third party) of pollution by distributing a limited amount of pollution permits to polluting firms. To eliminate the negative externality, the Marginal Private Costs (MPC) (the cost to private industries of producing one more unit) have to equal the Marginal Social Costs (MSC) (the cost to society of producing one more unit) and thus become socially optimal, see figure 1. Otherwise, it’s deemed a Market Failure, which occurs when there’s an over or under-allocation of resources towards a particular product. The Market Failure also occurs when a negative externality exists, i.e., when the MPC is less than the MSC. In the diagram below, the desired quantity and Costs & Benefits to society are at point (QsubE, CBsubE). Unfortunately, the quantity is excessive, and therefore Costs & Benefits to society are too low at point (Q, CB). Hence welfare loss occurs. The perfect inelastic supply of pollution permits was designed to increase Marginal Private Costs. This market encourages firms to reduce their pollution output as they can sell excess permits to other companies. They’re further encouraged to use non-polluting resources as the supply of permits is tapered over the years. Demand represents the capability and incentive for firms to purchase permits, see figure 2 below. In 2008, the quantity and price is at point (Q, P). Ultimately, e.g. 2009, these values increase to point (Qsub1, Psub1). The problem with the carbon market is that demand reflects the price. Normally this is beneficial, motivating companies to pollute less as the price of permits escalates, but, in a recession, the demand for pollution permits decrease and the excess of pollution permits means the price also decreases. “A tonne of carbon has dropped to 8 Euros, down from……31 Euros and far below the 30 Euros to 45 Euros range at which renewables can compete with fossil fuels.” When the price decreases, two incentives to firms are removed: to trade pollution permits and to utilize more environmentally friendly resources. See figure 3, where the Demand curve has shifted left to DemandsubR after the recession. Thus the equilibrium changes from point (Qsub1, 31) to point (Qsub1, 8). Price decreases can influence companies to “dump plans for the wind turbine” or conclude they “can’t afford not to burn coal.” See figure 4, where MPC + Permits decrease to MPCsubR + Permits after the recession. Although the welfare loss has now increased, the Marginal Private Costs after the creation of the Carbon Market and emergence of the Economic Recession (MPCsubR + Permits) are still greater than the original Marginal Private Costs (MPCsubOriginal). See Figure 4, where the Welfare Loss has increased after moving from point (Q, CB) on the MPC + Permits curve, to point (QsubR, CBsubR) on the MPCsubR + Permits curve. One solution could be to decrease the quantity of available pollution permits, resulting in both increased prices and Marginal Private Costs, thus reducing the negative externality. However, “no government will be brave enough to do that”. Alternatively, the EU could reduce the glut of permits by preventing importation, e.g., from Russia.

The current system forces a choice between the economy and the environment. As demonstrated, pollution increases during economic recessions. Since the carbon market only works in growing economies, it’s more favourable to restore the economy. With economic growth, the demand for permits will increase, leading to a price increase and the restoration of the pollution permit market. Although high amounts of pollution will be produced short-term, in the long-term pollution is certainly reduced.

Article

Due to lack of proper disposal facilities, radioactive nuclear waste is piling up at hospitals and research institutions around the USA. The waste may be considered to be consumed by the hospitals and research institutions, as it is a product of things such as medical equipment they are using, and it is being kept by them. Since this waste may harm people, it can be considered a negative externality of consumption – i.e. the waste creates negative effects such as genetic mutation, disease or even death for third parties like patients, students etc. A potential negative externality is the use of these in order to make dirty bombs.

This situation can be explained in economic terms as a market failure, which is the under or over allocation of resources towards the production of a particular product. One way of looking at this would be that waste is being overproduced due to overconsumption of goods which produce such waste, leading to negative externalities. Another way to look at the situation would be that waste disposal facilities are being underproduced, which is leading to positive externalities of production. Whatever the case, the existence of negative externalities is one of the causes for market failure.

The first situation is graphed below.

First Situation

The Marginal Social Cost curve gives the cost to society of producing goods which result in nuclear waste. It also represents the supply of the goods in question. The Marginal Private Benefit curve gives the actual amount of these goods being consumed by the hospitals and research laboratories, while the Marginal Social Benefit curve gives the amount of goods consumed at a socially feasible level. This level occurs when social welfare, the total of producer and consumer surplus is maximized.

The socially optimum point is represented at A in the graph. The actual equilibrium of the market is represented at E. As the socially optimum level is not achieved, there is a welfare loss represented by AEX. Further, the negative externality is represented between the Marginal Private and Social Benefit curves.

In essence, the costs of the radioactive wastes are being “pushed on” to third parties, i.e. the institutions in question are externalizing their costs in order to maximize profits.

The second situation is graphed below.

Second Situation

Here Marginal Private Cost represents the cost to producers for supplying waste facilities. This is more than the socially optimum price for producing the facilities, represented by the Marginal Social Cost. The actual equilibrium is at E, while the socially optimum point is at A. Therefore, the facilities are underproduced, which lead to positive externalities – positive effects on third parties such as preventing diseases, genetic mutations etc. The potential welfare gain due to this is represented by AEX.

This market failure can be fixed through government intervention.

One of the basic solutions would be to make it mandatory through legislation for every state to have facilities to dispose of nuclear wastes, and prevent states from passing laws that disable such facilities, which was the case in the article. Penalties could also be set up for states that fail to establish such facilities. This would not cause the institutions to externalize their costs, as their waste would be taken care of. However, this solution may cause the creation of externalities for other third parties, which would defeat the purpose of having specific disposal facilities. Therefore, such a solution would have to be carefully contemplated.

Waste Disposal Facilities Solution

The measures would move the equilibrium quantity closer to the socially optimum quantity.

Another way would be to tax the production of goods which result in nuclear waste. Such a move would cause the Marginal Cost Curve to move upwards which would shift the equilibrium quantity closer to the socially desirable quantity. This is illustrated below.

Taxing Solution

Here, due to tax the equilibrium quantity has become Q₁, which is closer to the socially optimum quantity of Q^* than the previous quantity of Q.

It must be kept in mind that the tax will reduce the consumption of the goods. This may be undesirable, as the reduction of consumption of certain goods like medical equipment will be counterproductive. Due to this reason, banning such goods is also not very feasible. However, it is also possible that these goods such as capsules may be overconsumed, due to doctors overprescribing them.

This situation is very ambiguous, and it is hard to get a clear solution due to the complexities involved. Another possibility to solve this would be to invest in alternate technologies – but even that has opportunity costs of changing spending patterns.

As the number of pollinators decline each year, certain organizations have recently demanded funding for further research into this; specifically in the area of bees, as they play a vital role in the pollination of vital crops.

The causes of this steady decline in bee population are not certain, but there are some estimates according to the January report from the British Beekeeper’s Association, ‘New diseases and pests could be part of the problem, as could habitat loss, the inappropriate use of chemicals in farming, and poor weather conditions.’ If we focus on the effects of these chemicals used in farming, specifically on the toxic fertilizer industry, not only does nature suffer through no fault of its own, but society will also suffer in the form of higher food costs and potential food shortages. These negative externalities from the production of whatever product this farming is producing can be illustrated on a graph. The curve labeled MSC represents the marginal social costs which are greater than the marginal private costs or the costs of the farming industry since they are externalizing their costs to the outer bee world, which in turn affects us. The marginal social benefits represent the amount of output society demands, which decreases as more output is produced.

A number of charities, including the department for environment, food and rural affairs and the BBSRC are each planning on funding $2.9 million to the top British world-class researchers, in hopes of discovering the true causes of the decline of this phenomenon, and take the right steps to correct this problem. Another form of incentive is the $4.1 million awarded by the U.S. Department of Agriculture to whichever scientist can discover the true cause in this decline. However, this is merely identifying the problem, but how do we go about solving it?

Different causes are suggested throughout the article which can be corrected, but I will continue with the problem of chemicals released in farming. If this were to be the cause of decline in the bee population, the government should feel forced to intervene seeing as these pollynators control a vast portion of our food industry. Although it isn’t mentioned in the article, there are special fertilizers which are water soluble and therefore not as damaging to the environment. What can be achieved by subsidizing these fertilizers, is lower the costs to the producers of this good which will decrease the price of them and encourage farmers to buy these instead.

The article is about the rejection of a motion to tax chocolate bars. A doctor in Glasgow claimed that chocolate should be taxed like soft drugs and also compares it to fast food because it causes obesity and type two diabetes. The doctor says “There is lots of negative publicity about other fast food and junk food but chocolate is sneaking under the radar.” This is a market failure because, here, chocolate is considered as a demerit good and therefore the doctor wants the government to intervene with a tax which makes the product more expensive and less demanded. A demerit good is over produced and therefore over consumed in a free market. It is viewed as being negative for the society which is why the doctor wants to reduce its consumption. Consuming too much chocolate causes a negative externality of consumption because private benefits of consuming chocolate are higher than society’s. The private cost is low because they are externalized and pushed onto society. Society then has to deal with health care costs and special treatments when people become obese or diabetic.

The graph shows the negative externality of consumption; marginal private benefit is higher for society. The cost for society is enlarged because the point of production is at Quantity 1 instead of at the socially optimal point (Quantity*). Consumers are consuming where marginal private benefit equals marginal social cost at Price1. This shows that there is an over consumption of the product, which causes welfare loss to society. With chocolate bars, the over consumption costs are pushed onto society because the government has to use tax money to provide health care and other special needs for people who become diabetic or obese.

Because the socially optimal point is where marginal social cost (MSC) equals marginal social benefit (MSB), the tax put on chocolate bars would make the marginal social cost curve shift leftwards, decreasing their supply from Quantity1 at Price 1 to Quantity* at Price2. The over consumption and market failure has been fixed because supply has decreased and made more expensive , in theory, causing demand decrease.

Taxing chocolate is not a good solution because, like cigarettes and alcohol, demand for chocolate bars may be considered inelastic which means that even though the price has increased demand has not because the private value of the product is more than the price. The article mentions this is why the government rejected the tax: “Introducing regressive taxes on the foods that consumers love would result only in lighter wallets, not smaller waists…”. However even though chocolate may be inelastic, whilst before there was welfare loss, after the tax there is a potential welfare gain because of under-consumption. The quantity with the tax has shifted from Quantity1 to Quantity2 past the socially optimal point which means that the tax would also create an externality (market failure) as now the costs are mostly on the consumer. Furthermore, the people who eat chocolate bars in low quantities also have to pay the tax although they consume it moderate quantities. They are being penalized for somebody elses benefit; the tax also causes an externality of consumption to a third party therefore taxing is not a benefiting solution.

What the government could do to fix the problem of obesity is to educate people about the consequences of eating too much chocolate by creating negative advertising to decrease demand. This will bring the MPB down closer to the socially optimum point. Quantity, price and costs have from Quantity2 to Quantity1 at Price1 which means that the costs to society are being internalized so that society doesn’t have to bare all of them. This method could work efficiently except it takes a long time for the effect of the negative advertising would set in and there are to make it are high.

 Espresso’s Cost almost twice as much in Zurich as they do in Lugano!

In an article in the “Wirtschaft” section of the “Tages Anzeiger” it is quite clearly shown on a graph how much the price varies throughout the country for a cup of coffee. What is causing the price variation is unclear. This news is no surprise to the people of Zurich who in places have to pay 5.30 FR. for an espresso. 

The trend is that the German Swiss kantons charge much more for this luxury good then the Italian and French speaking kantons. The price variations within the kantons themselves are also shown in the surveys, and in four of the kantons there is a lack of competition evident, according to the article, due to the variation between the lowest and highest prices being less than 15%.

Johanna Bartholdi, the president of the Swiss cafe’s confederation (yes I know, I can’t believe it exists either) offered one explanation. She thought it was possible that the espresso’s being on average 1.10 francs cheaper in Geneva then Zurich could be due to the seriously higher rent in Zurich and this may be an indication of wealth in the area. This would indicate that the incomes of the inhabitants of Zurich would be able to afford a more expensive cup due to it being a smaller percentage of their income. Their demand would be more inelastic for this reason then the inhabitants of other cities. As the cafe’s increase the price, the inelasticity results in a slight decrease in demand, yet a higher percent increase in price, then percent drop in demand, resulting in an increase of revenue.

The cost of the beans is the same for all in Switzerland, and a Cafe owner in Basel boasted being able to walk away with 93% profit per bag of beans he buys. He sells the espresso’s at 4 francs a cup, and buys the bag of coffee for anything up to 30Fr (depending on quality) and makes 130 espresso’s per bag. He has to pay other costs too, yet labor does not vary throughout the country at all, so the cafe’s are not increasing the price due to risen costs.

Bartholdi offers a better explanation. She claims that there is evidence to show that cafe’s determine their price by observing the prices of other cafe’s selling in the market and adjust theirs to a few Rappen beneath or above it. It has nothing to do with costs, and together the cafe’s keep the prices artificially high. This also means that they have judged that if they begin a price war, they would not gain enough customers to make it worth their while, and therefore keep the prices static. The inelasticity also reinforces this need to maintain the high prices. The cafe owners also defend their high prices, claiming that they struggle to cover costs as it is, especially because they find it difficult to squeeze a profit on the food they produce. It is the espresso’s and other drinks which bring in the profits for the firm and keep it operating.

Can you draw any other ideas as to why they the espresso’s are so expensive?

Does the Italian Swiss lifestyle have any impact on the price?

Is the variation in kantons to do with too much competition, too little or collusion?

What role does non price product differentiation have to play in those situations?

Benji Rosen

Not everyone earns benefits from entertainment festivals. The BBC news article reports the concerns of citizen living close to the upcoming “Beach Break Live”. The neighbors complain about the noise, litter and traffic they are exposed to during this event.
A negative externality of consumption occurs anytime when an individual or a group, that plays no part in a market transaction is negatively affected by bearing some of the cost of this process. In the case of this music festival neighbors bear external costs created by the music festival. A third party is harmed by the consumption of this product which defines a negative externality of consumption.“Nineteen hours out of 24 does not give you much peace.”, a neighbor, who is worried about the extent that the loud music is being played at, complains.
Negative externalities are a common example of market failure caused by an over or under allocation of resources. Private utility is reduced by the negative benefits suffered by a third party. The significance forthcoming problem can be analyzed in the following graph:

The Market For Music Festivals

Due to the resulting pollution, traffic and noise of the music festival the benefit society obtains (marginal social benefit) is smaller than the benefit acquired by the producers and also visitors of this music festival (marginal private benefit). This creates spillover costs which are externalized costs that the firm is not covering. The over allocation of resources towards this product is the difference of the quantity available (Qe) at Bp and the optimum quantity (Qo) at Bs of this product. This creates a dead weight loss, an area representing the total welfare loss society is bearing through this market transaction: The potential welfare gain if circumstances might change.

“The only way the event will be welcomed back is if we manage it properly.”, the managers of the Cornwall music festivals announce. “We agree to (music) levels that are acceptable and the council can log in to the system and see what sounds are coming off the site.” That this government control will not limit the negative externalities created and therefore will not diminish the dead weight loss indicates that a better solution is required. A possible solution that would eliminate spillover costs and dead weight loss would be giving compensations to people living close to “Beach Break Live”. This method would internalize spillover costs to the concert producer. Additionally neighbors start earning benefits from the festival. Its affects can be examined from a graph:

Possible New Market For “Music Festivals”

Due to the compensation the festival makers have to pay Marginal Private Cost is increased to a level at which it is at Qo. The new cost P is now covering all the costs. Additionally people will benefit from receiving the compensation. This will shift MSB to MPB and eliminate the dead wealth loss. There market failure is diminished.

But how high should the compensation be? It is very difficult to measure the extent of the over allocation and pay the right compensation. An under allocation of resources would remain and also a welfare loss, if too less would be compensated. But if too much money would be given to neighbors the concluding spillover costs could result in the opposite. Neighbors will benefit more than festival visitors and owners which would create a positive externality of consumption. To avert the danger of another market failure the compensations therefore have to be measured carefully.
Since the cost of producers is higher with compensation it could lead to a rising festival price which due to the law of demand might decrease the number of visitors of “Cornwall Festival”. If more music festival managers were compelled by the governments to pay compensations to neighbors, they would think twice about the planning of a festival. This could lead to a decrease in supply of music festivals, which would resolve an over allocation of music festivals.
As a conclusion giving compensations to neighbors is a way of resolving market failure by resolving the over allocation of resources. By diminishing the welfare loss the utility of society is increased.

Ski helmets should become mandatory after Natasha Richardson dies in ski accident

The article explains that the recent death of a renowned celebrity at a Canadian ski resort could make wearing helmets in ski resorts compulsory.

Skiing with a helmet on is an action with positive externalities of consumption. A positive externality of consumption occurs when the consumption of a certain good has a spill over or external benefits on a third party or society as a whole. Figure 1 illustrates such a situation.

When society benefits from the consumption of a good, it experiences greater benefits than the individual consumer does. Therefore, the marginal social benefit is higher than marginal private benefit. As a result, the quantity supplied (Q_e) is less than the socially optimal level of output (Q_so), meaning the good is a merit good which is underprovided by the free market. There is also a dead weight lost for this reason. In a free market, Q_so will not be reached because private firms will produce at Q_e to maximize their benefits. Due to a misallocation of resources toward the good, the market has failed.

An individual’s usage of a helmet while skiing has spill-over benefits to society; The main reason is because he or she is less likely to have a severe injury.

“Safety first: Ski helmets have been known to save the lives of skiers on many occasions.”

For instance, if a skier is protected by a helmet, it lowers the burden on snow patrols. Or, if fewer skiers need hospital care, the doctors would not have an unmanageable number of patients. and other patients who are sick will not have to pay the cost of longer waits. Moreover, hospital service is ultimately funded by tax payers in many countries. Fewer injuries could make taxes lower. Consequently, MSB is greater than MPB and the output of helmets is lower than the socially optimal level. Therefore, the market has failed.

The death of Natasha Richardson, a renowned actress, has emphasized the importance of wearing a helmet while skiing. Therefore, the demand for helmets has increased.

“From talking to retailers and also seeing people out on the slopes we know that more and more people are wearing helmets.”

However there are also some methods which the government should use in order to increase helmet usage so that society has higher benefits.

One method is a subsidy. If helmet-making firms are subsidized, the helmet supply would increase and thus shift the supply curve downward bringing the price lower and the quantity supplied higher. In order to reach the exact socially optimal output, the subsidy would have to be the amount of the externality. This concept is illustrated in figure 2.

The new supply, S_s, would beget a lower price, P_s and the socially optimal output would be reached, making more helmets available and affordable for society. If price were to drop drastically, the government could make helmet usage compulsory, which is what many individuals and institutions are requesting.

“Governors in Quebec received a request by the province’s A&E doctors to make helmets mandatory…”

The flaw of such methods however, is that they would be costly and governments may refuse to concentrate their spending on helmets. Besides, the subsidy would require tax money and thus would take away some of society’s utility. Also, in the case of a compulsion for helmet usage, skiers may resist by claiming that their freedom of choice is being infringed by the government.

Other methods are to use positive advertisement to convince people of the importance of helmets, or to subsidize ski resorts so that they make tickets cheaper for people wearing helmets, hence creating the incentive to wear helmets for cheaper tickets. Both these methods involve influencing the demand for helmets. The two methods would bring about a decrease in demand or MPB so that the socially optimal output can be achieved. This is illustrated in figure 3.

MPB would shift up to MPB₂ so that Q_so is achieved. The problem with such measures is once again government reluctance to pay for advertising and subsidizing ski resorts.

Due to overfishing in European seas nearly 80% of the world’s fish species are on the verge of extinction, and if nothing is done to mitigate the overfishing the consequences will be dire - not only to the marine ecosystem but also to the large percentage of people who depend on fish as their source of protein. The European Union now has to step in and set stricter fishing quotas and ban poor fishing conduct – before it’s too late.

The EU clearly believes that overfishing is a negative externality of production, i.e. that the production of a good or service has a negative impact on a third party. Fish in international waters are an example of a common resource; a resource that is rivalrous (one person’s use diminishes another’s) but non-excludable (a person cannot be excluded from using the good). Therefore, fishermen act in their own self-interest to fish as much as possible, to hinder other fishermen from taking fish that could have been theirs. This is known as the tragedy of commons; fishing through self-interest may ultimately lead to the destruction of the shared and limited fish, as only a few fishermen will have the benefit whereas the costs will be spread on everyone.

Currently, fishermen “remove many more fish from the sea than are replaced through natural reproduction”, meaning that the marginal private cost (the cost to the fishermen from catching another fish) is less than the marginal social cost (the cost to society from catching another fish). The fishermen are externalizing their costs by dumping bad quality fish back into the ocean and trawling the seas with huge nets. To society this is disastrous: “the economic costs of overfishing reach up to €40 billion per year”.

The socially optimum point is at quantity Q_O, but since there is an over-allocation of resources towards fishing, in essence an overproduction of fish, the fishermen produce at the greater quantity Q_A, creating a market failure. At Q_A the Marginal Social Cost (Point C) is greater than the Marginal Private Cost (Point D). The production is at a point where the cost to society is far greater than the cost to the fishermen, and due to the overproduction of fish society is worse off than if the quantity supplied had been lower.

The EU stated that “fishing quotas will be set “on the basis of scientific recommendations.”” and that “it will “very soon” ban throwing caught fish overboard back into the sea”.

These steps would be put in place to increase the marginal private costs of the fishermen, which in turn will reduce the negative externalities. With restrictions and bans fishermen would have to spend money to meet the standards set by the government, and thus increase their costs. The quantity is reduced from Q_A to Q_B, and the welfare loss is therefore simultaneously lowered, as the market is moving closer to the socially optimum quantity. The government is making sure that the fishermen simply cannot internalize their costs.

Although restrictions, i.e. fishing quotas, have benefits such as assuring that a certain percentage of the fish remains, the restrictions also have drawbacks. In some cases the cost to scientifically measure the optimum quota requirements may be much higher than the costs to society that overfishing has. In such a case it would be better for the government to use another method, such as privatizing or nationalizing greater areas of the ocean. Although this might create disputes among nations the fish would become excludable, meaning that governments or private firms could have control of how many fishermen were allowed to fish in their waters.

Bans are also an option. “If [fishermen] weren’t permitted to throw back the low-quality catch, there would be less incentive to randomly trawl the water and more incentive to develop targeted fishing techniques”. The fishermen’s costs would increase, as the percentage of good-quality fish brought back to shore would decrease. Bans could however have severe effects on the economy, and since bans will be implemented only gradually they may not have time to solve the problem before it’s too late.

http://www.spiegel.de/international/germany/0,1518,614133,00.html

This blog is not based on an article, but some data has been used from:

Reuters - Global carbon price unlikely for 10-15 years: analysts

Part of Barak Obama’s plans, are to create an emissions cap and trade scheme in the US. An emission trading scheme is an administrative approach used to control pollution by providing economic incentives for companies to reduce their emissions. Normally this is started by a government, which sets a cap, a maximum amount of emissions they wish to allow. Companies are then issued emission permits, based on their emissions in the past years. If the company decreases their emissions, they can sell the permissions and make money. In theory, this should reduce emissions cheaply, by creating an incentive to produce at the lowest possible emissions level.

I believe that a cap and trade market for carbon emissions, solely in the US, will not solve the global problem, since companies would only open new factories in other countries, to evade this cost that would be added by internalizing the negative externalities they put on society. If other countries also create carbon markets, where the carbon price will be different, there might still be some that move to evade the higher costs.

I believe that one way to fix this problem would be to eventually have a global Emissions Trading Scheme, with a global cap on emissions, which would be found out by the joining of the caps of all countries. This would create a global incentive to minimize emissions, and could make coal and other harmful wastes become less competitive as fuels.

Because the expectations are that prices of carbon permits will be less in the US than in Europe, the US will first have to increase the price of the permits before markets can be linked globally, to avoid a one way flow of carbon permits from the US to Europe. “Price expectations under a U.S. scheme are fundamentally different to what you expect for the EU. European prices will likely be higher, so if the schemes were linked by 2015, [it] would mean a one-way flow of [carbon permits] from the U.S. to Europe.” said Sikorski.

My suggestion for this is that the US government will have to begin buying back carbon permits, to keep the price high and possibly reach a similar price to the European price. Obama plans to auction carbon permits initially, to generate $646 billion in revenues between 2013 and 2020. Possibly, some of this money could be used to slowly buy back permits and keep the price up. Another way to keep the price of these permits up would be to create incentives for firms to retire their permits when they do not need them anymore, possibly by giving tax cuts.

The Reuters article doubts a global scheme will be achieved before 2025, and the main goal to be achieved now is change legislations in countries to make such a scheme available. The sooner the global emissions trading scheme is put in place, the sooner we will begin saving our world, with measurable changes of polluting emissions.

Article

The Obama administration is proposing an increase in the federal tax on cigarettes from 39 cents per pack to $ 1.01 per pack. In doing so, it hopes to decrease the number of smokers in the United States, and prevent people from starting smoking.

The US government is implementing this tax because it believes cigarettes to be a demerit good; that is, a good whose consumption is considered socially undesirable or unhealthy. The consumption of a demerit good such as cigarettes has an adverse affect on the consumer, and therefore the government wants to limit the consumption of this good. Danny McGoldrick says “this tax could prevent 905,000 deaths and save the US more than $ 44 billion in the long run.”

The government does not just want to decrease the smoking rate to benefit smokers; another reason for this is that smoking produces negative externalities of consumption - a negative effect on a third party caused by the consumption of a good or service. In the case of smoking, the marginal social benefit (the benefit derived by society from the consumption of another cigarette) is much lower than the marginal private benefit (the benefit derived by the consumer from smoking another cigarette). This is because the smoker is pushing off “costs” onto a third party by causing second-hand smoking and by increasing public healthcare costs. This is shown on the graph below;

For simplicity, we assume that the MSC is equal to the MPC; the marginal social benefit is lower than the marginal private benefit since second-hand smoking and similar effects decrease the benefit to society of consuming another cigarette compared to that of the smoker. The socially optimal point, where MSB is equal to MSC, is at the quantity Q_s. The consumer, weighing the costs and benefits, will consume cigarettes at the point where MPB is equal to MPC, that is, at the quantity Q_p (greater than Q_s). At this higher quantity, MSC (cost to society) is greater than MSB (benefit to society); as a result, there is a welfare loss, shown on the graph. Because of this, there is an overallocation of resources toward cigarettes (since we are past the socially optimal point where the value society places on a good is equal to the benefit derived from it).

In order to increase the welfare to society, the government will try to decrease the quantity consumed of cigarettes by taxing it. They are proposing an increase (62 cents) in the per-unit tax; a per-unit tax will force consumers to think at the margin, considering the new, higher price of each pack. Ideally, the tax would increase the MPC, so that, at the new equilibrium, the consumer buys cigarettes up to the socially optimal quantity.

As can be seen on the graph, the tax will increase the cost to the consumer, whose quantity demanded will thus decrease to the quantity Q_s, which is the socially optimal quantity. Therefore, we have reached a point of maximum welfare in society.

This method of dealing with smoking and its externalities brings with it several benefits; it is comparatively simple to implement, and will bring in additional revenue for the government. It will also succeed in decreasing the amount of smoking in society. At the same time, it has significant drawbacks; it does nothing to deal with the underlying negative externalities of consumption. Although we have reached the socially optimal quantity, externalities are still occurring; smoking will still affect non-smokers and healthcare costs will remain higher. It is difficult to pinpoint the optimal value for the tax increase, so 62 cents may not be the optimal increase.

I am not sure how effective this tax will be. Demand for cigarettes will tend to be inelastic (an increase in price will lead to a proportionately smaller decrease in quantity demanded) since cigarettes are addictive. Therefore, even if we substantially increase the price of each cigarette pack, the demand for cigarettes will not decrease drastically. At the same time, the demand for cigarettes is the number of consumers willing and able to buy cigarettes at a certain price. Especially considering we are currently in an economic crisis, it is possible this tax will have the desired effect simply because many consumers will no longer be able to afford cigarettes.

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Economics Commentary Karol Remin

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According to this article, more Liberian restaurant owners in Liberia are dropping rice for pasta. As the price of rice is increasing rapidly, due to the worsening food crisis in the world, the demand for it becomes more elastic which is due to two main determinants in the case of Liberia: the substitutes available and the percentage of the consumers’ income. In economics, when a good is said to have an elastic demand we mean that: the consumer is very responsive to a change in price of the certain good. Pasta is the substitute as it can be consumed in place of rice in some of rice’s possible uses. Pasta and rice have a positive relationship, meaning that as price of rice goes up, the demand for pasta goes up and vice versa. As pasta is less expensive than rice, it takes up less of the consumers’ income. Therefore, in Liberia, demand for rice becomes elastic for the consumer once substitutes are introduced.

The demand curve above is almost horizontal which signifies that as the price rises, demand decreases significantly. It is not perfectly horizontal as there are still people in Liberia who buy rice. Viola Nelson sells rice although the resource is very expensive.

Graph A also shows the change in price of rice. From the graph it can be seen that the price has almost doubled (from P1 to P2). As prices went up, the quantity demanded decreased significantly from q1 to q2.

Pasta

The price for rice has risen steeply during the last year causing rice demand in Liberia to go down. The current price for rice in Liberia is ~$34/50kg while pasta costs about $12/50kg. Augustus Geepo, a Liberian food vendor states that he could sell about 40x 50kg of rice a day last year, while this year he is lucky if he sells 10x 50kg a day. He also states that due to the rice crisis and the prices, the demand for pasta went up. Therefore, a rational move would be to increase the supply of pasta which would allow him to sell pasta at a lower price causing his total revenue to increase.

A rational restaurant owner in Liberia would switch to rice’s substitute good, pasta. By doing so, the owner could decrease his marginal cost, which in economic terms is defined as the derivative of total production costs with respect to the level of output, It would decrease their total costs, allowing him to increase supply and sell at a lower price, meaning that the demand for his good would increase and he could therefore also increase his total revenue.

Moreover, it can be seen from this graph that: By increasing the supply of rice (from s1 to s2) they’re able to sell at a lower price (P1 to P2) while being efficient. This would attract more customers and the quantity demanded for the product would go up (from D1 to D2).

An example of an entrepreneur in the market for Liberian style restaurant owners is Emmanuel Biddle. He switched from selling rice to selling pasta boosting his quantity demanded up. In comparison, Ms Nelson still sells rice in her restaurant at a higher price ($2 compared to Mr. Biddles $1).

Analysis

As the rice prices continue to rise, in future, demand for pasta is going to continue increasing. When pasta producers start to realize that demand increases, they will want to produce more of their good as well to maximize their revenue. This will result in pasta being sold in greater quantities at a lower price and might therefore have an impact on the whole wheat market. A consumer in Switzerland for example, is not going to stop buying and ordering rice at a restaurant due to a 10% price increase, whereas consumers in Liberia consider substitutes right away as it takes up a great portion of their income. The price of rice is also very unstable, meaning that there is a constant fluctuation in price. Lastly, wheat and rice producers will want to switch from producing and supplying rice to supplying more pasta as there is more profit to be made. Moreover, it can be said that the slightest increase in price is going to affect low income countries such as Liberia more than high income countries.

FT.com / In depth - Daewoo to cultivate Madagascar land for free

Daewoo predict not having to pay anything for the farming of maize and palm oil in Madagascar. The farmland the size of Belgium is under “free” cultivation by Daewoo after they agreed to sign a memorandum with the Madagascan government. Food exports are “Said to be a weapon in this world” claims Hong Jong-Wan, a manager at Daewoo, the car firm.

The 99 year leasing of 1.3m hectares to help produce more oils and foodstuffs for Korea, I suspect, will have a notable impact on the economy, even though the market for Oil is not monopolized. Such a big potential supply for such a large company, lowered production costs not included, could really mean that this valuable resource will earn Daewoo a foreseeable future, even considering the growing concerns about the world’s economy. The good thing is that the oil market is incredibly inelastic.

The demand for oil is too high for people just to not buy it if its prices are raised. It has become more of a necessity in the modern world for all the cookers and the ever expanding middle class. Human being could live without oil, but it would be a major step backwards for most countries. It was very lucky that the firm has been offered this opportunity, because it is not a common one.

On the other hand, this deal will also become profitable for the Madagascan authorities as well. Although it might seem like a bad move giving free cultivation rights to the Korean business, the Madagascans have actually thought this one through. By allowing them to harvest the maize and palm oil on their land, they are opening up nice new job opportunities for the unemployed citizens in the country. In the long run, when employment is up, so is the productivity of a nation. The economic growth for each country will be appreciated in times such as these, when the prices of oil have been rising due to dwindling supply. Also the food element that comes out of it will give the Koreans the upper hand.
Increasing the “Food security” of Korea with the large amounts of corn that will be shipped there is something the country will look forward to feeling the benefits of. Korea says it will export very little of the said corn. Supposedly the quantity demanded for corn in Korea would help achieve a higher equilibrium price if the quantity supplied were to increase.

The growing Korean population would aid in the increase of demand for basic foodstuffs. Obviously, in the case of food and of oils, the increase in supply means a fall in price and therefore to increased demand for both goods respectively. A large increase in demand for one good will lead to a notable decrease in demand for substitute products, whether the good is inferior or not. People will be more inclined to buying corn as opposed to wheat products now that corn is cheaper.

Fallen price generally equals increase in demand for the product.
Interestingly, if the situation has been read well, we will see a really positive outcome come from government intervention in the economy. Both economies are profiting from the deal, and even though neither market is directly under a command economy, the help of the Madagascan government is prevalent. This exception to the general rule that involvement with the government will have negative returns makes this article exceptionally interesting. The fact that they did not implement a price floor or ceiling probably helps, since that would increase the dead weight loss and decrease the consumer and producer surpluses, which undeniably is not a good thing.

Demand for food and oil will always be high but regardless, expanding worldwide markets is important in the way of necessary goods. Keeping in mind that this plan works best with a developing country and a developed one, the world economies would benefit from more deals like these. Hopefully the full potential of this great idea will be actualized and both economies will feel the effects soon.

Demand for the products of the chemical company BASF is falling. The demand has fallen sharply in the automotive, construction and textile industries due to the economic slowdown. BASF has decided to cut down output by temporarily halting or slowing down production in 180 plants and also to decrease output from 20% to 25%.

Demand is a schedule or curve that shows the quantities of a product that consumers are willing and able to purchase at corresponding prices during a specified period of time. Demand has fallen because of income and special circumstances, two of the determinants of demand. Due to the economic slowdown, firms don’t earn as much revenue because the consumer’s income has fallen. The consumers of BASF are other firms, who have also suffered from the economic slowdown, so overall firms have less revenue.
Since demand has fallen, the firm has had to reduce quantity supplied. “BASF is temporarily shutting down about 80 plants and will reduce production at another 100 plants”. Furthermore, one can also look at price elasticity of supply, the responsiveness of producers to a change in price of a specific product. The main determinant of price elasticity of supply is time; this is what will affect how much output BASF will reduce. The amount of time over which PES is measured will affect its value. In the immediate time period or the fixed plant period (directly after), BASF cannot decrease supply greatly because there is not enough time to close down factories or decrease labour. BASF can, however, decrease the intensity of labour, in order to slightly decrease supply. BASF can cut hours or grant “involuntary” holidays. This is exactly what BASF plans to do. Mr. Rees, the company spokesman, stated that many workers would face “involuntary vacations during the year-end holiday period”. This is because PES is very inelastic during this period. In the short run, BASF should decrease some of its factors of production by closing down factories and reducing labour, but BASF still won’t be able to sell its capital. During this period PES is more elastic than in the immediate time period, but will still be inelastic, as shown in graph 1. BASF will be able to shut down factories. In the long run, if demand stays low, BASF should reduce all the factors of production. PES will be very elastic, as shown in graph 2.

If demand stays low, BASF will have to adjust accordingly in order to minimize costs.
If demand is this low in a year, then BASF should close down factories, sell capital and reduce their labour force. Firms look to maximize profit by reducing costs and increasing revenue. By closing down factories, selling capital and reducing its workforce BASF would be cutting the costs of rent, interest and wages. “BASF’s earning will fall below 2007 levels”. It is obvious that BASF will lose money because of the significant fall in demand, but it is up to them to maximize the profits according to the situation. Graph 3 shows that before the fall in demand in the chemical market, BASF was earning profits, but after the fall, it had to reduce output in order to reduce cost and be able to prevent loses and end up in a breaking even situation. Even though the chemical market is not a purely competitive market, it is still fairly competitive and therefore this graph is still valid.

If demand keeps falling until the point where BASF cannot survive by itself, it may need a subsidy. If the government were to subsidize BASF, it should increase supply, shown by a shift to the right. Since supply would increase, price should theoretically decrease and this would therefore cause an increase in quantity demanded. This would benefit BASF since the government would help it to reduce costs, but on the other hand, it would have a negative effect on consumers. The money used to subsidize BASF would essentially come from taxes, and this would be a misallocation of resources since it would result in a dead weight loss. The government should also ask itself if it should subsidize an inefficient company. That would lead companies to believe that whenever they had problems the government would help them out.

A recent study of the real estate market in Zurich has shown that the rents for the busy street Bahnhofstrasse are the 12th highest in the world. The main concern of the stores’ owners is that rents are going up each year by almost 23%.

Demand is a schedule that shows the various amounts of a product that a consumer is willing or able to purchase. The law of demand states that, ceteris paribus, as the price rises, the quantity demanded decreases. In the article, the size of the market is one of the most relevant determinants of demand that changes the curve of demand; the more firms in the market the more of a product they will demand.
The Bahnhofstrasse in Zurich, being one of the most elite and prestigious streets in Europe, has one of the highest rents of all cities, with an average rent of SFr 61,400 per month. Because more and more firms wish to acquire retail space on the Bahnhofstrasse, the demand has gone up dramatically. On the other hand, supply is a schedule or curve showing how much a product producers will produce at each of possible prices during a specific time. The law of supply states that, ceteris paribus, there is a direct relationship between the price and the quantity of output supplied. As the price rises, the quantity supplied increases as well. In the article, the supply doesn’t change, meaning that it doesn’t decrease since buildings are not destroyed but that new buildings are not being built either. Because the retail space is highly demanded, and that many firms and companies are willing to pay a certain rent, there is much competition for any space available. Competition increases the prices of the good or product, or in this case rent, justifying the dramatic increases in rents on the Bahnhofstrasse.
As shown in Graph 1, the demand curve has shifted up, while the supply curve has not moved. Demand has increased, and has shifted the equilibrium price up. In the short-run, the supply curve is perfectly inelastic, meaning that the supply doesn’t change at all. One of the reasons for the shift of the demand curve could be that preferences, particularly advertising, have driven companies to invest more in the location, therefore increasing the demand for the location.
“The city centre location of the country’s main shopping streets adds enormously to their popularity. That in turn spurs demand for businesses to set up in those areas.”
The shift in demand can be justified by looking at how popular the location is, easily accessible and great for advertising. The location of the Bahnhofstrasse in Zurich and in Europe is prestigious, and generates more revenues and advertising than someplace else. Elasticity is a measure of the responsiveness of consumers or producers to a change in price of a good, the price of a related good, or income. If a good, in this case real estate, is inelastic, it means that consumers, or firms that are looking for retail space, will not be very responsive to a change in rent. The demand for commercial retail space on the Bahnhofstrasse is relatively inelastic, and the supply for retail space is perfectly inelastic.
“Studies have estimated that roughly 25 per cent of all overnight stays in Switzerland in 2007 were business travelers, who tend to shop.”
The real estate in Zurich, especially retail space on the Bahnhofstrasse, has become inelastic mainly because of its location and easy access, and because there are not many substitutes for such ‘prestige’. In the short run, supply for retail space on the Bahnhofstrasse is perfectly inelastic, since people cannot “just build more buildings” or “create more space on the street”.

As shown in graph 2, in the long run, the supply will increase since more buildings can gradually be built, and therefore make it more elastic. Apartment buildings could also be turned into retail space, therefore benefiting new companies that wish to do business on the Bahnhofstrasse. This would make the supply less inelastic and probably more affordable for smaller firms. If more apartment buildings are turned into retail space, then the demand will still be the same, however the prices for rent will be considerably less. Even though the location of a business is very important, the Bahnhofstrasse should not be the only location where shopping is ‘present’. Other parts of Zurich could become as good location-wise and more affordable for smaller companies. This would keep the city busy all over, and create a homogeneous city, with stores all around. It would certainly keep the city alive and more social.

UAW: GM to cut production

The article talks about GM’s plans of reducing its production in order to cope with the difficulties in a time when demand and prices for automobiles are low.

The US is currently in recession which accounts for lower incomes. GM automobiles are normal goods meaning people buy less of them as their income decreases and vis versa. Therefore, Americans’ lower incomes lead to a decrease in demand for GM automobiles, as illustrated in F1. In this situation the free market reduces the price to P_e2 to maintain equilibrium, a state where quantity demanded equals the quantity supplied.

In response to the lower prices of automobiles, GM, as rational producers must reduce their quantity supplied and their production costs as they are profit maximizers who must make sure that revenue stays relatively greater than costs.

“GM has announced thousands of factory layoffs so far this year and is cutting its salaried staff in order to pare expenses and conserve cash.”

Another interesting observation to make about GM is how much production it reduces in reaction to this price change. This can be explained by the economic concept of price elasticity of supply, (PES) which is defined as the measure of the responsiveness of producers to a change in price. When PES is inelastic, the price change creates a relatively small change in quantity supplied and when PES is elastic, the price change accounts for a relatively large change in price. The graph on the left and the graph on the right illustrate an elastic supply and an inelastic supply respectively.

Both situations depict a similar price change; however, the left graph has a significantly greater change in quantity supplied than the right graph.

The main factor which determines PES is time. For instance at the very moment the price change occurs the producer or firm does not have much time to cut its production because the size of plants is fixed which means PES will be highly inelastic. In the short run period, PES is slightly more elastic because the firm has some time to gradually start reducing quantity supplied by using its existing plants more or less intensely. And finally, in the long run period, the firm can make greater changes in the quantity supplied by closing or opening factories, making the PES very elastic.

Due to a series of causes and effects during the economic recession, the prices of automobiles have gone down and GM was prudent when they decided to decrease output in order to save costs and maximize profits.

“Dave Green, president of a United Auto Workers local in Lordstown, Ohio, said workers were told that the normal holiday shutdown will be extended until Jan. 20^th.”

“Green said that after Jan. 20, the Lordstown complex will keep operating around the clock, but assembly line speed will be reduced from the current 62 vehicles per hour to 46.5 vehicles.”

Reducing working days for workers, and slowing down the production of factories are appropriate ways of cutting production in the short run. Furthermore, one can also observe how they are in the process of closing down 10 factories and reducing labor by laying off 1,100 of their workers. These are sound ways of reacting to lower prices in the long run when the size of plants is variable. David Green also said, “It’s all driven by the market, so it’s really out of our hands.” In this he implies that GM itself cannot govern the prices for automobiles, for the market decides those figures. This again is a valid assertion because as long as the demand stays low, all GM is capable of doing is adapting to the lower prices of the current market for automobiles by cutting its costs in order to maintain profits. This is exactly what GM is doing according to the article and it should continue to do so until the market becomes more forgiving. The article further states that GM requested a government bailout or subsidy. A subsidy is a determinant which increases supply. Subsidizing for GM would be a poor allocation of US resources because GM would produce more cars which is exactly what GM should not be doing because as long as there is a recession and Americans’ incomes are low, demand of cars will remain low; therefore, producing more cars is futile. In other words, GM should avoid all measures which increases their costs: i.e. their production.