Property Rights, Efficiency of Perfect Competition and Market Failures | AAEC 5308, Study notes of Agricultural engineering

Download Property Rights, Efficiency of Perfect Competition and Market Failures | AAEC 5308 and more Study notes Agricultural engineering in PDF only on Docsity! AAEC 5308/6308, Lecture 7 Page 1 Lecture 7 – Property Rights, Efficiency of Perfect Competition and Market Failures 1 Efficiency of Perfect Competition – how does an economy achieve Pareto-efficiency? 1.1 Central planner: a central planner could theoretically set prices ratios so that consumers and producers would maximize utility and profit according to those prices, and an efficient outcome would be achieved 1.1.1 The amount of economic data to be used to estimate these efficient price ratios is unimaginably large 1.1.2 Price ratios would have to change periodically, requiring an all new set of data and estimations 1.1.3 A centrally-planned economy is not likely to achieve Pareto-efficiency 1.2 Free market: Will perfect competition in a free-market economy produce a Pareto- efficient outcome? 1.2.1 Efficiency in exchange: MRS A , N I =MRS A, N II . 1.2.1.1 Utility maximizing consumers solves the following problem max A, N U  A , N  s.t. B=A PAN P N 1.2.1.2 First order conditions for a maximum give: ∂L ∂ A =MU A− PA=0 ∂L ∂ N =MU N− PN=0 which implies AAEC 5308/6308, Lecture 7 Page 2 MU A PA = MU N PN ⇒ MU A MU N = P A P N This is true for individual I and individual II 1.2.1.3 Recall that the ratio of marginal utilities is equal to the marginal rate of substitution, so if both consumers are faced with the same prices (which is guaranteed by perfect competition), we have MU A I MU N I = P A PN = MU A II MU N II or MRS A , N I =MRS A , N II 1.2.1.4 So perfect competition and utility maximization give efficiency of exchange 1.2.2 Efficiency in production: RTS K , L A =RTS K , L N 1.2.2.1 Cost-minimizing producers solve the following problem: max K , L K PKL P L s.t. F K , L=Y 1.2.2.2 First-order conditions for an optimum give the following: ∂L ∂K =PK−MP K=0 ∂L ∂ L =P L−MP L=0 which implies MP K P K = MPL PL ⇒ MPK MPL = PK PL This is true for producers of apples as well as producers of nuts AAEC 5308/6308, Lecture 7 Page 5 2.2.3 Enforceable: a system of institutions exist to enforce the property right 2.2.4 Transferable: any or all rights of ownership may be transferred to a willing buyer 2.3 What rights in American economic system are non-attenuated? There are examples of rights that are not clearly specified: rights to clean air and water 2.3.1 Flawed property rights lead to externalities – a form of market failure 3 How do property rights evolve in a society? (Demsetz, 1967) 3.1 Property rights arise when incentives are created to avoid externalities by internalizing benefits and costs 3.2 Consider the example of Montagne societies who inhabited what is modern-day Quebec 3.2.1 Prior to the fur trade (beaver) being brought to North America, no property right system for land existed among the various Montagne tribes 3.2.2 Beavers were hunted for food and for pelts, but in small amounts, so the (temporal) externalities associated with the hunting went unnoticed 3.2.3 With the fur trade the value of beaver pelts increased for the Native Americans, and scale of hunting increased; now the externalities of free hunting became much more apparent 3.2.4 The different tribes now had much more to gain by maintaining a viable beaver population which offset the costs of negotiating property rights among themselves 3.3 “Property rights develop to internalize externalities when the gains of internalization become larger than the cost of internalization” AAEC 5308/6308, Lecture 7 Page 6 4 Readings: Hanley, Shogren and White, 1997, Environmental Economics, pp. 22 – 46