Koen commentary 2 pollution

Article: http://www.guardian.co.uk/environment/2010/feb/18/worlds-top-firms-environmental-damage

Firms cause $2.2 trillion environmental damage.

 

A recent UN study has shown that if the top firms "were forced to pay for use, loss and damage of environment" "one-third of profits would be lost".  Environmentalists have a growing concern that "no one is made to pay for most of the use, loss and damage of the environment."

 

Market failure exists when an unregulated market under or over allocation of resources towards a good or service resulting in a negative externality. In this case a demerit good is over allocated towards the production of a particular product. Demerit goods are goods towards which resources are over allocated by the free market, examples include, cigarettes and alcohol as well as pollution. Governments need to regulate the production of demerit goods, if a socially optimal level of output is to be achieved through taxation or limiting output of a firm.  

During an economic transaction, the firm emits costs and benefits towards society and itself. During production the firm has one cost: the marginal private cost, MPC. However, firms externalize their costs which society bears, represented as the firm's marginal social costs, MPC. The firm also has a benefit, marginal social benefit, MSB, the output demanded by society. As seen on the graph the MSC and MPC are not equal. This has to do with the fact that the firm is not bearing all of its costs of production, namely part of its costs are born by society. Because of this, negative externalities occur, the costs passed on to a third party by the polluting firm, for instance, dumping factory waste into a river that is used as the local water supply. The gap between the MSC and MPC represents the negative externality, in this case, of production. Furthermore, the gap between MSC and MPC represents the loss of welfare, and is represented by DWL, dead weight loss. MPC intersects MSB at Q_e and C_e, this is the point where the firm is producing at its equilibrium cost and quantity. MSC intersects MSB at Q_so and C_so, this is the social optimal point, allocative efficiency. Since market failure is described as the under or over allocation of resources towards a good or service.

 

With firms externalizing their costs the environment is being damaged. For example, fresh water supplies are poisoned, fish is over fished and will no longer be around in a couple of decades, and acid rain deteriorates the soil. When factories dump their waste into water supplies to lower their cost they are damaging the society. Locals will not be able to drink from their source due to chances of deadly illnesses caused by the pollution as well as high costs for a new source of drinking water. The fish in the oceans are depleting, making it difficult for poor local farmers to compete with the fishery industry because they have to go out farther at see. Moreover, fishing at high rates is unsustainable; firms have not thought about the long run, this bears society for finding a new way of obtaining food. Vegetables might be a solution; unfortunately, the agricultural industry is suffering due to the acid rain, caused by air pollution, which deteriorates the soil making it unfertile. Air pollution caused by CO₂ emissions further drives up the environmental damage; global warming as side effects as well as a rise in sea level. All the waste produced by firms has environmental damage which society bears.

 

The solution that governments should enforce to correct the market failure would be polluting permits. The government will auction off a certain amount of permits to polluting industries which allows them to pollute up to a certain point. If the firm wishes to pollute more than their permits allow, they will require buying more permits from other firms that do not need all their permits. Since the quantity of permits is fixed it get more expensive for firms to pollute more because more permits have to be bought. As a result, there is a huge incentive to minimize their pollution; furthermore, if firms do not need all their permits then they can sell them to other firms. As seen on the graph, the price of pollution permits rises when the total demand for permits among firms rises from Dpp to Dpp1. This way, as demand for permits rises, the cost to pollute increases, and the incentive to reduce pollution increases.

 

3000 firm’s profits could help society

A recent UN study on pollution has shown that if the 3000 largest firms would have paid their social costs than one third of their profits would have been lost and gone to protecting the environment.

Market failure exists when an unregulated market under or over allocation of resources towards a good or service. In this case a demerit good is over allocated towards the production of a particular product. Demerit goods are goods over-provided or over allocated by the free market, examples include, cigarettes and alcohol as well as pollution. Government need to regulate the production of demerit goods through taxation or limiting output of a firm.

During an economical transaction, the firm emits costs and benefits towards society and itself. During production the firm has two costs, marginal social cost, MSC, and marginal private costs, MPC. The firm also emits a benefit, marginal social benefit, MSB. As seen on the graph the MSC and MPC are not equal. This has to do with the fact that the firm is not burdening all of its costs on itself, namely part of its costs are burdened by society. Because of this, negative externalities occur. The gap between the MSC and MPC represents the negative externality, in this case, of production. Furthermore, the gap between MSC and MPC represents the loss of welfare, and is represented by DWL, dead weight loss. MPC intersects MSB at Q_e and C_e, this is the point where the firm is producing at its equilibrium cost and quantity. MSC intersects MSB at Q_so and C_so, this is the social optimal point, allocative efficiency. Since market failure is described as the under or over allocation of resources towards a good or service.

The government solution would be to have a corrective tax. The equilibrium quantity is greater that the socially optimal quantity therefore there is an over allocation towards production of a good or service. With a corrective tax the government increases the cost of production for the firm. This means that the supply will decrease, the equilibrium quantity will decrease to social optimal quantity. This way fewer resources will be allocated towards the production of a good. The amount of tax that has to be inflicted must be the gap between the MPC and MSC. As one can see, the tax is burden by bother consumers and producers. Since the price has increase to buy the good, the demand has decreased. Since the supply has also decreased to the socially optimal level, there is no loss of welfare because the demand has also decreased. The tax that the government receives can be used to repair the damage done by the good.

Another alternative for the government would be to directly control the polluting firm. This way firms are limited to what they are allowed to emit. This is however easier said than done. First, monitoring the emissions of a firm can be very difficult and thus costly for the government. The government has to have a way to enforce it limitation on polluting firms. Another question raised is: Can we put a price tag on environmental damage? The punishment has to have a greater incentive to not pollute than pollute otherwise firms will continue to pollute to lower their costs.

Monopolistic competition and Oligopoly questions

Monopolistic competition page 118

Productively efficient is the point where the cost is minimized. This is at MC = AC (Q2). Allocative efficiency is the social optimum point, where MC = MR (Q3). All firms wish to maximize their profits so they will produce at MC = MR (Q1). As seen on the graph, the firm is producing at Q1 so there for it cannot be allocatively efficient or productively efficient if it is not producing at Q2 or Q3.

Oligopoly page 125

When firms are non-collusive they do not agree on a price to sell. This is an advantage to consumers because the price will be lower and more will be produced opposed to a collusive oligopoly. Since changing their price will have drastic changes in demand firms need to be aware of the reaction of other firms. If an oligopoly, that is non-collusive, raises the price and the other oligopoly doesn't it, will lose consumers and thus revenues and finally profits. If, on the other hand, a firm lowers its price, then the firm will receive more profits. Other firms will follow but undercut the price to make up for lost profits. This will result in a "price war" and the price of a good will keep decreasing until at one point the firm will be selling it at a loss. The price thus remains stable in a non-collusive oligopoly market because the price cannot change without erupting into a "price war" or a loss of profits.

Monopoly question

1. Explain the level of output at which a monopoly firm will produce.
   

All firms with to receive profits, monopolies included. A monopoly will produce at the profit maximization point, where the marginal cost meets the marginal revenue. If the monopoly's average costs are below the demand curve then the firm will be making abnormal profits. Because the monopoly's demand curve is the same as the industry's demand curve, because the monopoly is the industry it will be a downward sloping demand curve. A monopoly can change its price and level of output, but not both at the same time. If a monopoly wishes to increase its profits it will reduce it output, this way the price will increase.

1. Using a diagram, explain the concept of a natural monopoly.
   

A natural monopoly states that there is only room for one firm because there are not enough economies to scale. The economies of scale set the position of the average total cost curve.

When the revenue is higher than the cost the firm is making abnormal profits. When the first is producing between q1 and q2 the monopoly is earning abnormal profits. If another firm entered the market then the demand would decrease to D2. This way the firm will not be covering its average total cost and earn losses.

So it is more productively efficient for an industry to have one firm with limited economies of scale. If there is only one firm and it produces in the demand satisfying area on the graph then that firm will earn abnormal profits. The government usually helps regulate the monopolies, blocking barriers to entry, making the firms more productively efficient.

1. Using appropriate diagrams, explain whether a monopoly is likely to be more efficient or less efficient than a firm in perfect competition.
   

A monopoly, like all firms will produce at the point where marginal cost is equal to marginal revenue. The price will be set high with low output to increase profits, but the monopoly will not be allocative or productively efficient. With large economies to scale, the marginal cost decreases making it possible for the firm to produce more and charge a higher price.

The monopoly will produce where marginal cost is equal to marginal revenue to maximize its profit. At p1, the price of the good is higher than p2, which is the monopoly's cost; thus the monopoly is earning an abnormal profit marked in green. Allocative efficiency is where marginal cost equals average revenue at q2, but the monopoly is not producing there so it is not allocatively efficient. Productive efficiency is where marginal cost is average cost at q1. However the monopoly is not producing there either so it is not productively efficient.

A perfect competition firm needs to be very efficient both allocative and productive because by raising its price, it leaves the market.

Winemaker Monopoly

In a small town next to Pfäffikon, the town where I live, there is a wine maker and seller. It is the only wine maker in the area. When you drive through the area you will see many sloped fields filled with grape plants. These fields are owned by the wine maker. Since it is the only wine sell and producer in the area it can be regarded as a monopoly for wine. Consumers do not have to buy the wine from the wine maker in the town because they could go to the neighboring village and get foreign wine but not enjoy the local wine.

The wine maker in my town is a monopoly. It is the only firm in the market that supplies local wine from the region. It can thus make its own prices because it is unique and regional, it is a price maker. It is also the only producer of the unique wine from the region. Lastly, it frequently uses non-price competition such as free wine tasting gatherings and advertisements in the local newspaper. Furthermore, the winemaker is a monopoly because it has set high barriers to entry. For the most part the winemaker owns the entire agricultural region where he grows his grape plants.

If the winemaker were to be a pure monopoly, it would have to set higher barrier of entry, buying even more agricultural land in the region, owning all the resources and making it impossible for other firms to enter the market for the regional wine.

Monopoly