Market Failure, Externalities, and Public Goods
Market failure,
externalities and
public goods.
Gwen Arnold
•
Strictly speaking, the eq’m is not
Pareto
efficient.
•
“NOT Pareto efficient”
“NOT KH efficient”
EPA (2010)
An
externality
results when the actions of an agent
(individual or firm) have an uncompensated effect on
the wellbeing of other agents.
•
Unintentional
•
Market participants (demanders and providers) do not
bear all of the costs or reap all of the rewards from the
transaction.
•
Typical examples
–
Positive externality (external benefit): beekeeper who places
bees in an area for honey
not paid for the pollination
services the bees provide for surrounding agricultural crops.
–
Negative externality (external cost): power plant which does
not pay for its emissions of green house gases or particulate
matter and chemicals which affect human health.
-K&O 2007
To model externalities we will decompose
social impacts into private and external.
Total social costs = total private costs + total external costs
TSC = TPC + TEC
Marginal case:
MSC = MPC + MEC
“private” costs or benefits:
“felt” by the decision maker
“external” costs or benefits:
not felt by the decision maker
Market equilibrium vs socially efficient outcome:
external costs (environmental damages)
Story: a pulp mill damaging a downwind
community with airborne emissions.
•
We will frequently think of the external
costs specifically as the value of
environmental “damage”.
C
l
a
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e
x
e
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c
i
s
e
.
I
d
e
n
t
i
f
y
:
•
predicted market rate of output (based
on
private incentives/payoffs
)
•
market equilibrium total amount of
external cost (env. damage)
•
socially efficient rate of output (based on
social payoffs
)
•
socially efficient total amount of
external cost (env. damage)
What does the shape of this
curve imply about damages?
Is the additional damage from
each additional unit of
production constant?
A
B
1.
rival
: one person’s
consumption of the good
diminishes the amount of the
good available for others to
consume
nonrival
: “does not
diminish”
Goods can be
classified using two
characteristics:
2.
excludable
: consumers are
selectively
allowed access to consume the
good; often involves existence and enforcement of property rights
nonexcludable
:
open to uncontrolled access by users
, often involves
absence of property rights or lack of enforcement
Continuum of private to public goods
Source: Fig. 5.2, Keohane and Olmstead (2007)
Rival
Nonrival
Excludable
Nonexcludable
Rival
Nonrival
Open Access Resources (OARs) are an
important source of externalities:
•
Typical examples:
fisheries, roadways,
air and water bodies
as waste sinks
•
Problematic canonical
example
–
The Tragedy of the
Commons (TOC)
,
Hardin, 1968
•
Grazing of cattle on a
pasture “open to all”
Property Rights & the TOC
•
Private property rights: exclusive authority to
use, profit from and distribute property.
•
Idea:
he who does not expect to reap will not
sow.
–
Thus, property rights
incentivize
investment.
(e.g. in investment in land, physical or human capital.)
•
In contrast, goods which are owned communally
are sometimes subject to the
TOC
, the tendency
of any resource that is
unowned
--and hence
nonexcludable
--to be
overused
and
undermaintained.
Cowen and Tabarrok 2010
Open access resources
Grazing story: the externality
•
Note: this is an OAR example if we assume that there are no
restrictions on use of the grassland (not the same as common property).
•
The externality:
–
Suppose many individuals or firms each draw upon some resource (e.g.
harvesting fish, grazing cows, etc) such that total utilization is at or beyond
the “carrying capacity”. (For this example, need the use to be a such a level
that additional use involves a cost to all users.)
–
I
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:
1.
The expanding individual receives the proceeds from increased utilization. (+)
2.
The return to each individual for utilizing each unit will subsequently be
diminished. ( - )
–
E
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.
One feature of an OAR problem is nonexcludability, i.e.
the lack of a (enforced)
property right
to the resource.
•
A rational sole owner sets use to maximize
profits (surplus). This w
ill also be the socially
efficient level of use. (Why?)
•
With open access, typically use of the resource
keeps increasing and the surplus is dissipated.
(diagram)
•
If the resource is environmental, then
increased use will likely result in a stressed
environment.
•
Connecting the framework of Hardin’s “The
tragedy of the commons” to our models for (1)
market equilibrium, (2) socially efficient outcome,
and (3) market failure/externality.
•
Quotes from TTOTC:
“In economic affairs,
The Wealth of Nations
(1776)
popularized the "invisible hand," the idea that an
individual who "intends only his own gain," is, as
it were, "led by an invisible hand to promote ...
the public interest".
Adam Smith … contributed to a dominant tendency
of thought that has ever since interfered with
positive action based on rational analysis,
namely, the tendency to assume that decisions
reached individually will, in fact, be the best
decisions for an entire society.
If this assumption is correct it justifies the
continuance of our present policy of laissez-faire
in reproduction.” (p. 1224)
Market
forces/
incentives
FTWE
[comment: yes but
only if certain
conditions are met
which preclude
market failure.]
Institutions and common property
Elinor Ostrom
•
Only woman to win the Nobel Memorial
Prize in Economic Sciences (2009). Not
an economist.
•
“…challenged the conventional wisdom
–
common property is poorly managed
and
–
should be completely privatized or
regulated by central authorities.”
•
Studied: user-managed fish stocks,
pastures, woods, lakes, and groundwater
basins
(
Source: Economic Sciences Prize Committee of the
Royal Swedish Academy of Sciences)
Institutions & common property: a critique
of conventional economic advice
•
When markets fail, economist advocate for
State intervention “without asking how
incentives are generated within State
bureaucracies to improve performance.”
–
The (mistaken) conventional
wisdom/accepted theory: “voluntary self-
organization to provide public goods or
manage common-pool resources is highly
unlikely”
Ostrom and Ostrom 2003
Do common-pool resources always result
in the TOC?
•
Results from a wide selection of field studies:
•
Common-pool resource users have developed a
variety of institutional structures for cooperation,
with
and without
the help of outsiders.
•
Also, there are many cases in which this
fails
to occur.
•
“Although
tragedies have undoubtedly occurred
, it is also
obvious that for thousands of years people have
–
self-organized to manage common-pool resources
, and
–
users often do devise
long-term, sustainable institutions
for
governing these resources” (Ostrom et al.
Science,
1999)
•
Central empirical and theoretical question: Why in some
instances and not others?
Ostrom and Ostrom 2003
“8 Keys to a Successful Commons”
(Ostrom, 2010)
1.
Define clear group
boundaries
.
{Common prop.
degree of excl.
}
2.
Match rules governing use of common goods to
local needs
and
conditions.
{Advantage of common prop mgt
customization.
}
3.
Ensure that those affected by the rules can
participate
in modifying
the rules.
4.
Make sure the rulemaking rights of community members are
respected
by outside authorities.
5.
Develop a system, carried out by community members, for
monitoring
members’ behavior.
6.
Use
graduated sanctions
for rule violators.
7.
Provide accessible, low-cost means for
dispute resolution
.
{Possiblerole for government
invest in institutions.
}
8.
Build
responsibility
for governing the common resource in nested
tiers
from the lowest level up to the entire interconnected system.
Source: Ostrom (Feb. 2010):
http://www.yesmagazine.org/issues/america-the-remix/8-keys-to-a-successful-commons
Pure public goods are
a common source of
external benefits
(and
hence of potential
market failure).
clean air
SHUTTERSTOCK
In cases of
external benefits
the market left to itself
will normally
undersupply
the good in question.
•
Why?
–
First: recall what we mean by
undersupply
•
Less than the
socially efficient
level
–
Because: an individual or firm
which bears the cost of supply will
enjoy only some fraction of the
total social benefit.
–
Individuals then have an incentive
to “
free ride
”
: contribute less than
their true WTP.
Private provision of a pure public good
Source: Keohane
and Olmstead (2007)
•
Who values
cleanliness more?
•
What level of
cleanliness would
each desire on their
own?
•
Who would we
predict to “free ride”
•
What is the
aggregate MWTP
(aka SMB here) for
the public good?
•
What is the socially
optimal level of
cleanliness?
Setting: housemates Alice and Bob
must individually decide on what
level of contribution to make to the
public good of household
cleanliness. MC is the same for
both. MB curves are given below.
Note that in this simple example,
“society” and “the public” is
comprised of just Alice and Bob.
M
C
Q
B
***MC curve detail: MC increasing because of increasing effort needed for
each additional unit (NOT due to increasing opportunity cost of time).
R
e
c
a
l
l
:
a
g
g
r
e
g
a
t
e
M
W
T
P
f
o
r
a
r
i
v
a
l
g
o
o
d
•
Aggregate MWTP for a rival good:
–
Heuristic: “sum demand curves HORIZONTALLY for a private good”
–
for any given dollar value (p) sum up the quantity demanded (q) across all
individuals:
q
Agg
(p) = q
A
(p) + q
B
(p) + q
C
(p)
q
Agg
(15) = q
A
(15) + q
B
(15) + q
C
(15) = 4+0+3 = 7
C
l
a
s
s
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m
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x
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c
i
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e
:
C
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u
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d
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a
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d
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d
a
t
p
=
8
.
?
(private good/OAR)
A
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W
T
P
f
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a
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o
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r
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g
o
o
d
•
Example: Lake pollution. Currently pollution
concentration is at 5 ppm.
•
Identify (graphically
and
in the table)
–
Aggregate demand for water quality (vertical
sum in graph):
AMWTP(q) = MWTP
A
(q) + MWTP
B
(q) +
MWTP
C
(q)
•
N
o
t
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i
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d
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u
a
l
“Agg. MWTP” or “Agg. demand”, D
(
pure public
/club)
Efficient provision of a nonrival good
E
x
e
r
c
i
s
e
:
–
What is the socially efficient level of
pollution?
–
What level of contaminant would be
reached if only Homeowner A paid for
cleanup? Hint: superimpose MC curve
on Homeowner A’s figure.
–
Would B or C voluntarily contribute to further
cleanup?
–
Connect this to the idea of “free-riding”
Aggreg. WTP
MC
The “Tragedy” as collection action problem. First, a diversion: “Adam Smith was wrong.”
http://www.smbc-
comics.com/comics/20100605.gif
Game theory
Saturday Morning
Breakfast Cereal
by Zach Weinersmith
Game theory &
international environmental agreements (IEAs)
Game theory:
the study of multi-agent decision problems where the payoffs to
actions depend on the actions of others.
A simplified story of the transboundary/international pollution problem:
•
Two countries, A & B, contribute to emissions of a transboundary pollutant.
–
Currently, neither A nor B is addressing the pollution issue but both are
considering doing so
•
Discrete strategies: each country will choose either to contribute or shirk (not
contribute)
•
Non-cooperative game theory: A & B will not negotiate but rather simply choose
(irreversibly) a strategy.
•
Each behaves individually rationally
•
Information is complete: payoffs are fixed and common knowledge
•
Static, one-shot game: the actions of A & B are selected once, simultaneously, and
are permanent.
•
Any “agreement” to take action must be self-enforcing—there is no higher authority
to impose constraints.
Finus, M. (2001)
The cost/benefit structure
Assumptions:
•
Costs:
•
effective action: 4 total
•
If one country takes effective action (“contributes”) its
costs are 4.
•
If both “contribute” then
each
faces a cost of 2.
•
no action: zero cost
•
Benefits
•
effective action: 3 each
•
Both countries receive benefits of 3
regardless
of
whether the effective action is due to the efforts of one or
both countries
•
no effective action by either: 0 each
**This example based on Keohane and Olmstead (2007, p. 79)
Contribute
Contr.
Shirk
Shirk
Country B
Country A
T
h
e
p
a
y
o
f
f
m
a
t
r
i
x
:
f
o
r
e
a
c
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p
o
s
s
i
b
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o
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c
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,
t
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a
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c
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t
r
y
a
r
e
g
i
v
e
b
y
:
(
N
B
A
,
N
B
B
)
Assumptions:
•
Costs:
•
effective action: 4 total
•
If one country takes
effective action
(“contributes”) its costs
are 4.
•
If both “contribute” then
each
faces a cost of 2.
•
no action: zero cost
•
Benefits
•
effective action: 3 each
•
Both countries receive
benefits of 3
regardless
of whether the effective
action is due to the
efforts of one or both
countries
•
no effective action by either:
0 each
Note: payoffs to A depend on
the choice of B and vice versa.
Nash equilibrium
Solution process: check whether each possible outcome satisfies the
NE condition:
1.
For each player and for each strategy, determine the other player’s best
response (and underline that payoff)
•
Consider B’s best response:
If A contr.
should B shirk or contr.?
If A shirks
should B shirk or contr.?
•
Consider A’s best response:
If B contr.
should A shirk or contr.?
If B shirks
should A shirk or contr.?
Contribute
Contr.
Shirk
Shirk
Country B
Country A
2.
The pair of strategies {s
*
A
,
s
*
B
} is a
NE if each players’ strategy is a best
response to the other’s (i.e. if both
payoffs are underlined).
Is the predicted outcome
Pareto inferior
(i.e. can one agent be made better off
without making any other agent worse off)?
Prediction of the equilibrium
•
Any “agreement” to take action must be self-enforcing
•
Each player’s predicted strategy must be that player’s
best response to the anticipated strategy of the other
player.
C: contribute
S: shirk
•
The strategy of player
i,
given by
s
i
, is chosen from the
set {C,S}•
The strategies {s
*
A
,
s
*
B
} are a “Nash equilibrium” (NE) if,
for each player,
s
*
i
is player
i
‘s best response to the
strategy specified for the other player.
(There is no incentive to
deviate.)
Gibbons (1992)
Prisoner’s Dilemma in Action: Golden Balls - £100,000 Split Or Steal? 3/14/08
Model extensions:
•
To capture the wide variety of IEAs
requires model extensions:
–
N>2 countries
–
Coordination
–
Dynamic/repeated games (finite, infinite)
–
Continuous strategy space
–
Negotiation models
–
Coalition models
See Finus (2001)
Optional additional slides
In Memoriam: whitehouse.gov/energy/climate-change
https://web.archive.org/web/20170119044801/https://www.whitehouse.gov/energy/climate-change
Common property is not open access
Property held by a group or in common may be
governed by formal or informal institutions
•
From explicit rules to informal social norms
(Ostrom et al.
Science,
1999)
single owner
no owner
OPEN ACCESS
INDIVIDUAL PROPERTY
COMMON/GROUP
PROPERTY
Example: common/group vs. government property (mgmt)
Ostrom et al.
Science,
1999, pp. 280
Institutions & common property
•
Ostrom findings: resource users can create
sytems of governance to manage a shared
resource by generating explicit rules about
•
what people can use
•
what their responsibilities are
•
how they will be punished if they break the rules
•
Key departure from the idea of the TOC:
–
When resource users interact repeatedly over time
“clever punishments for wrongdoing (are) feasible”.
•
Credible threats
enable cooperation.
The Economist
(2009)
Institutions and common property
•
“Any single, comprehensive set of formal laws intended
to govern a large expanse of territory containing diverse
ecological niches is bound to fail in many of the areas
where it is applied.”
(p. 10)
shorthand
no panacea
•
Policy recommendation: as opposed to imposing uniform
management rules from above, focus on building the
capacity of resource users to self-organize.
–
Courts (efficient, fair and honest), effective property rights, and
infrastructure (e.g. highways).
–
Develop policy that works in concert with the ways in which local
collective efforts evolve and operate.
Ostrom and Ostrom 2003
Ostrom v. Hardin
•
F
r
a
n
:
S
o
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•
E
l
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:
Y
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.
P
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“
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.
•
E
l
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:
N
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p
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a
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!
W
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a
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p
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.
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w
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a
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:
p
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Korten and Ostrom (2010)
Smoking image: www.faqs.org/nutrition/A-Ap/Antioxidants.html
Smokestack: www.films.com/id/8737/Market_Failure_External...
Market failure occurs when the equilibrium is not Pareto efficient, often due to externalities where the actions of individuals or firms impact others without compensation. Positive externalities like bee pollination and negative externalities such as air pollution from power plants are examples. By modeling externalities, we can differentiate private and external costs to achieve socially efficient outcomes. Additionally, goods can be classified based on characteristics like rivalry and excludability, influencing access and consumption.
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Presentation Transcript
Market failure, externalities and public goods. Gwen Arnold
Strictly speaking, the eqm is not Pareto efficient. NOT Pareto efficient NOT KH efficient EPA (2010)
An externality results when the actions of an agent (individual or firm) have an uncompensated effect on the wellbeing of other agents. Unintentional Market participants (demanders and providers) do not bear all of the costs or reap all of the rewards from the transaction. -K&O 2007 Typical examples Positive externality (external benefit): beekeeper who places bees in an area for honey not paid for the pollination services the bees provide for surrounding agricultural crops. Negative externality (external cost): power plant which does not pay for its emissions of green house gases or particulate matter and chemicals which affect human health.
To model externalities we will decompose social impacts into private and external. Total social costs = total private costs + total external costs TSC = TPC + TEC Marginal case: MSC = MPC + MEC social private costs or benefits: felt by the decision maker private external external costs or benefits: not felt by the decision maker
Market equilibrium vs socially efficient outcome: external costs (environmental damages) Story: a pulp mill damaging a downwind community with airborne emissions. What does the shape of this curve imply about damages? Is the additional damage from each additional unit of production constant? We will frequently think of the external costs specifically as the value of environmental damage . B Classroom exercise. Identify: A predicted market rate of output (based on private incentives/payoffs) market equilibrium total amount of external cost (env. damage) socially efficient rate of output (based on social payoffs) socially efficient total amount of external cost (env. damage)
Rival Nonrival Goods can be classified using two characteristics: Open access resources Pure public goods Non- excludable Club goods Private goods Excludable 1. rival: one person s consumption of the good diminishes the amount of the good available for others to consume nonrival: does not diminish 2. excludable: consumers are selectively allowed access to consume the good; often involves existence and enforcement of property rights nonexcludable: open to uncontrolled access by users, often involves absence of property rights or lack of enforcement
Continuum of private to public goods Rival Nonrival Nonexcludable Excludable Rival Nonrival Source: Fig. 5.2, Keohane and Olmstead (2007)
Open Access Resources (OARs) are an important source of externalities: Typical examples: fisheries, roadways, air and water bodies as waste sinks Rival Nonrival Open access resources Pure public goods Non- excludable Club goods Private goods Excludable Problematic canonical example The Tragedy of the Commons (TOC), Hardin, 1968 Grazing of cattle on a pasture open to all
Property Rights & the TOC Private property rights: exclusive authority to use, profit from and distribute property. Idea: he who does not expect to reap will not sow. Thus, property rights incentivize investment. (e.g. in investment in land, physical or human capital.) In contrast, goods which are owned communally are sometimes subject to the TOC, the tendency of any resource that is unowned--and hence nonexcludable--to be overused and undermaintained. Cowen and Tabarrok 2010
Open access resources Grazing story: the externality Note: this is an OAR example if we assume that there are no restrictions on use of the grassland (not the same as common property). The externality: Suppose many individuals or firms each draw upon some resource (e.g. harvesting fish, grazing cows, etc) such that total utilization is at or beyond the carrying capacity . (For this example, need the use to be a such a level that additional use involves a cost to all users.) If one individual increases their level of utilization (e.g. grazes an additional cow) there are two effects: 1. The expanding individual receives the proceeds from increased utilization. (+) 2. The return to each individual for utilizing each unit will subsequently be diminished. ( - ) Each individual feels (internalizes) the diminished return (per unit of the resource) to herself, but the diminished return imposed on all others is considered external it is ignored.
One feature of an OAR problem is nonexcludability, i.e. the lack of a (enforced) property right to the resource. A rational sole owner sets use to maximize profits (surplus). This will also be the socially efficient level of use. (Why?) With open access, typically use of the resource keeps increasing and the surplus is dissipated. (diagram) If the resource is environmental, then increased use will likely result in a stressed environment.
Connecting the framework of Hardin s The tragedy of the commons to our models for (1) market equilibrium, (2) socially efficient outcome, and (3) market failure/externality. Market forces/ incentives Quotes from TTOTC: In economic affairs, The Wealth of Nations (1776) popularized the "invisible hand," the idea that an individual who "intends only his own gain," is, as it were, "led by an invisible hand to promote ... the public interest". FTWE Adam Smith contributed to a dominant tendency of thought that has ever since interfered with positive action based on rational analysis, namely, the tendency to assume that decisions reached individually will, in fact, be the best decisions for an entire society. [comment: yes but only if certain conditions are met which preclude market failure.] If this assumption is correct it justifies the continuance of our present policy of laissez-faire in reproduction. (p. 1224)
Institutions and common property Elinor Ostrom Only woman to win the Nobel Memorial Prize in Economic Sciences (2009). Not an economist. challenged the conventional wisdom common property is poorly managed and should be completely privatized or regulated by central authorities. Studied: user-managed fish stocks, pastures, woods, lakes, and groundwater basins (Source: Economic Sciences Prize Committee of the Royal Swedish Academy of Sciences)
Institutions & common property: a critique of conventional economic advice When markets fail, economist advocate for State intervention without asking how incentives are generated within State bureaucracies to improve performance. The (mistaken) conventional wisdom/accepted theory: voluntary self- organization to provide public goods or manage common-pool resources is highly unlikely Ostrom and Ostrom 2003
Do common-pool resources always result in the TOC? Results from a wide selection of field studies: Common-pool resource users have developed a variety of institutional structures for cooperation, with and without the help of outsiders. Also, there are many cases in which this fails to occur. Although tragedies have undoubtedly occurred, it is also obvious that for thousands of years people have self-organized to manage common-pool resources, and users often do devise long-term, sustainable institutions for governing these resources (Ostrom et al. Science, 1999) Ostrom and Ostrom 2003 Central empirical and theoretical question: Why in some instances and not others?
8 Keys to a Successful Commons (Ostrom, 2010) 1. 2. Define clear group boundaries. {Common prop. degree of excl.} Match rules governing use of common goods to local needs and conditions. {Advantage of common prop mgt customization.} Ensure that those affected by the rules can participate in modifying the rules. Make sure the rulemaking rights of community members are respected by outside authorities. Develop a system, carried out by community members, for monitoring members behavior. Use graduated sanctions for rule violators. Provide accessible, low-cost means for dispute resolution. {Possible role for government invest in institutions.} Build responsibility for governing the common resource in nested tiers from the lowest level up to the entire interconnected system. 3. 4. 5. 6. 7. 8. Source: Ostrom (Feb. 2010): http://www.yesmagazine.org/issues/america-the-remix/8-keys-to-a-successful-commons
Rival Nonrival Nonexcludable Excludable Rival Nonrival Source: Fig. 5.2, Keohane and Olmstead (2007)
Rival Nonrival Pure public goods are a common source of external benefits (and hence of potential market failure). Open access resources Pure public goods Non- excludable Club goods Private goods Excludable clean air SHUTTERSTOCK
In cases of external benefits the market left to itself will normally undersupply the good in question. Why? First: recall what we mean by undersupply Less than the socially efficient level Rival Nonrival Open access resources Pure public goods Non- excludable Because: an individual or firm which bears the cost of supply will enjoy only some fraction of the total social benefit. Club goods Private goods Excludable Individuals then have an incentive to free ride : contribute less than their true WTP.
Private provision of a pure public good Setting: housemates Alice and Bob must individually decide on what level of contribution to make to the public good of household cleanliness. MC is the same for both. MB curves are given below. Note that in this simple example, society and the public is comprised of just Alice and Bob. Who values cleanliness more? What level of cleanliness would each desire on their own? Who would we predict to free ride MC What is the aggregate MWTP (aka SMB here) for the public good? What is the socially optimal level of cleanliness? QB ***MC curve detail: MC increasing because of increasing effort needed for each additional unit (NOT due to increasing opportunity cost of time). Source: Keohane and Olmstead (2007)
(private good/OAR) Recall: aggregate MWTP for a rival good ? Aggregate MWTP for a rival good: Heuristic: sum demand curves HORIZONTALLY for a private good for any given dollar value (p) sum up the quantity demanded (q) across all individuals: qAgg(p) = qA(p) + qB(p) + qC(p) Classroom exercise: Calculate aggregate quantity demanded at p = 8. qAgg(15) = qA(15) + qB(15) + qC(15) = 4+0+3 = 7
Aggregate WTP for a nonrival good (pure public/club) Example: Lake pollution. Currently pollution concentration is at 5 ppm. Identify (graphically and in the table) Aggregate demand for water quality (vertical sum in graph): AMWTP(q) = MWTPA(q) + MWTPB(q) + MWTPC(q) Note this is different than for a rival good since for a non-rival good we are valuing the same unit across each individual Agg. MWTP or Agg. demand , D
Efficient provision of a nonrival good MC Exercise: What is the socially efficient level of pollution? What level of contaminant would be reached if only Homeowner A paid for cleanup? Hint: superimpose MC curve on Homeowner A s figure. Would B or C voluntarily contribute to further cleanup? Connect this to the idea of free-riding Aggreg. WTP
The Tragedy as collection action problem. First, a diversion: Adam Smith was wrong.
Game theory Saturday Morning Breakfast Cereal by Zach Weinersmith http://www.smbc- comics.com/comics/20100605.gif
Game theory & international environmental agreements (IEAs) Game theory: the study of multi-agent decision problems where the payoffs to actions depend on the actions of others. A simplified story of the transboundary/international pollution problem: Two countries, A & B, contribute to emissions of a transboundary pollutant. Currently, neither A nor B is addressing the pollution issue but both are considering doing so Discrete strategies: each country will choose either to contribute or shirk (not contribute) Non-cooperative game theory: A & B will not negotiate but rather simply choose (irreversibly) a strategy. Each behaves individually rationally Information is complete: payoffs are fixed and common knowledge Static, one-shot game: the actions of A & B are selected once, simultaneously, and are permanent. Any agreement to take action must be self-enforcing there is no higher authority to impose constraints. Finus, M. (2001)
The cost/benefit structure Assumptions: Costs: effective action: 4 total If one country takes effective action ( contributes ) its costs are 4. If both contribute then each faces a cost of 2. no action: zero cost Benefits effective action: 3 each Both countries receive benefits of 3 regardless of whether the effective action is due to the efforts of one or both countries no effective action by either: 0 each **This example based on Keohane and Olmstead (2007, p. 79)
Assumptions: Costs: effective action: 4 total If one country takes effective action ( contributes ) its costs are 4. If both contribute then each faces a cost of 2. no action: zero cost The payoff matrix: for each possible outcome, the net benefits to each country are give by: (NBA, NBB) Country B Contribute Shirk Benefits effective action: 3 each Both countries receive benefits of 3 regardless of whether the effective action is due to the efforts of one or both countries no effective action by either: 0 each (1,1) (-1,3) Contr. Country A Shirk (3,-1) (0,0) Note: payoffs to A depend on the choice of B and vice versa.
Nash equilibrium Solution process: check whether each possible outcome satisfies the NE condition: 1. For each player and for each strategy, determine the other player s best response (and underline that payoff) Consider B s best response: If A contr. should B shirk or contr.? If A shirks should B shirk or contr.? Consider A s best response: If B contr. should A shirk or contr.? If B shirks should A shirk or contr.? Country B Contribute Shirk Contr. (1,1) (-1,3) Country A 2. The pair of strategies {s*A, s*B} is a NE if each players strategy is a best response to the other s (i.e. if both payoffs are underlined). Shirk (3,-1) (0,0) Is the predicted outcome Pareto inferior (i.e. can one agent be made better off without making any other agent worse off)?
Prediction of the equilibrium Any agreement to take action must be self-enforcing Each player s predicted strategy must be that player s best response to the anticipated strategy of the other player. C: contribute S: shirk The strategy of player i, given by si, is chosen from the set {C,S} The strategies {s*A, s*B} are a Nash equilibrium (NE) if, for each player, s*i is player i s best response to the strategy specified for the other player. (There is no incentive to deviate.) Gibbons (1992)
Prisoners Dilemma in Action: Golden Balls - 100,000 Split Or Steal? 3/14/08
Model extensions: To capture the wide variety of IEAs requires model extensions: N>2 countries Coordination Dynamic/repeated games (finite, infinite) Continuous strategy space Negotiation models Coalition models See Finus (2001)
In Memoriam: whitehouse.gov/energy/climate-change https://web.archive.org/web/20170119044801/https://www.whitehouse.gov/energy/climate-change
Common property is not open access (Ostrom et al. Science, 1999) COMMON/GROUP PROPERTY OPEN ACCESS INDIVIDUAL PROPERTY no owner single owner Property held by a group or in common may be governed by formal or informal institutions From explicit rules to informal social norms
Example: common/group vs. government property (mgmt) Ostrom et al. Science, 1999, pp. 280
Institutions & common property Ostrom findings: resource users can create sytems of governance to manage a shared resource by generating explicit rules about what people can use what their responsibilities are how they will be punished if they break the rules Key departure from the idea of the TOC: When resource users interact repeatedly over time clever punishments for wrongdoing (are) feasible . Credible threats enable cooperation. The Economist (2009)
Institutions and common property Any single, comprehensive set of formal laws intended to govern a large expanse of territory containing diverse ecological niches is bound to fail in many of the areas where it is applied. (p. 10) shorthand no panacea Policy recommendation: as opposed to imposing uniform management rules from above, focus on building the capacity of resource users to self-organize. Courts (efficient, fair and honest), effective property rights, and infrastructure (e.g. highways). Develop policy that works in concert with the ways in which local collective efforts evolve and operate. Ostrom and Ostrom 2003
Ostrom v. Hardin Fran: So, are you saying that Hardin is sometimes right? Elinor:Yes. People say I disproved him, and I come back and say No, that s not right. I ve not disproved him. I ve shown that his assertion that common property will always be degraded is wrong. But he was addressing a problem of considerable significance that we need to take seriously. It s just that he went too far. He said people could never manage the commons well. Elinor: No panaceas! We tend to want simple formulas. We have two main prescriptions: privatize the resource or make it state property with uniform rules. But sometimes the people who are living on the resource are in the best position to figure out how to manage it as a commons. Fran: Is there a role for government in those situations? Elinor: We need institutions that enable people to carry out their management roles. For example, if there s conflict, you need an open, fair court system at a higher level than the people s resource management unit. You also need institutions that provide accurate knowledge. The United States Geological Survey is one that I point to repeatedly. They don t come in and try to make proposals as to what you should do. They just do a really good job of providing accurate scientific knowledge, particularly for groundwater basins such as where I did my Ph.D. research years ago. I m not against government. I m just against the idea that it s got to be some bureaucracy that figures everything out for people. Korten and Ostrom (2010)
