IB Docs (2) Team
Unit 2.9: Economics of the environment and public goods
Introduction
This lesson aims to introduce the concept of market failure. I like to start by asking my classes two questions. Number one what is a market place? You can even draw this on the whiteboard and then ask your classes to consider what might prevent failure, in other words what might prevent the correct number of resources being used to produce a good or service and what might prevent a product being either over or under-demanded in a free market?
I find that many IB students often find the concept of market failure difficult to grasp - I will sometimes read that market failure means that prices are too expensive e.t.c. Students also get confused with the difference between public goods and merit goods provided by the public sector. This lesson focuses on the difference between the two as well as explaining why a lack of public goods in a free market will cause market failure.
Enquiry question
Why might free market systems fail to allocate resources efficiently, i.e. a failure of some markets to achieve allocative efficiency, resulting in an over-allocation of resources (over-provision of a good) or an under-allocation of resources (under-provision of a good). Why the production of public goods such as Defence or access to national parks represents an example of market failure.(1).jpg)
Teacher notes
Lesson time: 90 minutes
Lesson objectives:
Recognise that market failure is a failure to allocate resources efficiently, i.e. a failure of some markets to achieve allocative efficiency, resulting in an over-allocation of resources (over-provision of a good) or an under-allocation of resources (under-provision of a good).
Use the concepts of rivalry and excludability to distinguish between public goods (non-rivalrous and non-excludable) and private goods (rivalrous and excludable)
Explain, with reference to the free rider problem, how the lack of public goods indicates market failure
Examine the consequences of the lack of a pricing mechanism for common access resources in terms of goods being overused/ depleted/degraded as a result of activities of producers and consumers who do not pay for the resources that they use and that this poses a threat to sustainability
Teacher notes:
1. Opening activity - Show the first video and then complete exercise 1. (15 minutes)
2. Processes - technical Vocabulary - your classes can learn the required vocabulary watching the second video and completing activities 2, 3 and 4. (20 minutes)
3. Reinforcement activities - attached to the class handout are a number of activities to test the students skills in this topic. (20 minutes).
4. TOK reflection exercise - this lesson finishes with two TOK reflection questions: 'Must public goods be financed out of central taxation' and are we 'legally required to pay our taxes' (10 minutes)
5. TOK discussion exercise - what is the ideal level of taxation and government spending? (15 minutes)
6. Link to the assessment - this page concludes with a paper one style question and a mark scheme that your classes can reflect on or complete as a homework exercise. (10 minutes)
Key terms:
Externalities - the spillover costs to a third party caused by the production, or consumption of a good (or service). Externalities occur when MSC ≠ MSB in the market for a good or service.
Social benefit - the total benefit to a society, measured the private marginal benefit of an action plus the external marginal benefit.
Social cost - the total cost to society, measured by private marginal cost plus the external marginal cost.
Social efficiency - this occurs when the resources in an economy are used in the most efficient way possible and are represented by the output level where the social marginal costs = the social marginal benefits of production.
Public goods - public services such as defence, the police force and public access resources, which are non-excludable and non-rivalrous.
Non-excludable - when a person cannot be excluded from using a service, regardless of whether they have paid for it or not? For example, all residents of a nation are protected by the army, should their country be invaded, whether they pay their taxes or not?
Non-rivalrous - when one person using the service does not prevent anyone else from doing so - when the MC of providing the public good for one extra person is zero.
Free rider - a person using a service that they do not pay for.
Common access resources - natural resources including forests and pastures, fisheries, oil and gas fields, national parks, grazing lands and irrigation systems. They can be differentiated from public goods because while the are non-excludable, they are rivalrous. Excluding people from using a common access resource requires greater cost than any benefit gained from doing so.
The activities on this page are available as a PDF at: 
Public goods
Activity 1
(a) Draw the market for any good or service, showing the supply and demand in equilibrium. The demand curve should be labelled D=MSB and the supply curve S=MSC.
(b) Why is the market for your product efficient at the equilibrium level?
At the equilibrium point MSC=MSB, in other words the marginal cost (in terms of resources used to produce the good or service) is equal to MSB (the utility enjoyed by society in consuming the product). This can be illustrated on the diagram to the left. Any price except P will result in either too many resources diverted towards the production of this product, or two (MSC>MSB) or (MSC<MSB).
(c) Now consider some markets where the market will not operate so efficiently, where the number of goods and services required by a society will not necessarily be the same as the number of people willing and able to purchase that product, e.g. the Police force, the military or public parks. What price would you be willing and able to pay for those services and if the response is zero (why should you after all) then consider the question, does this mean that those products are worthless, not worthy of a society even producing them?
The answer of course is no, it is essential for certain services to be provided by any society - after all without an adequate defence, police force e.t.c. a nation could soon find itself open to attack. Similarly, without the provision of green spaces and other national parks overall public welfare would soon diminish. Providing such services highlights one example of market failure.
Activity 2: Market failure and public goods
Start by watching the following video and then explain why the production of public goods can cause market failure.
Hint:
In every society there are certain essential services such as public goods, which if left up to the market would not be produced at all e.g. police and lighthouses. This is because it is impossible for the free market to produce a sufficient number of these services, when they are non excludable and non rivalrous. This means that consumers cannot be forced to pay for them and so many citizens will not do so.
Start with a simple question, how many would voluntarily pay for the fire service? Some of you would and others would not. However, should your property burn to the ground it is unlikely that yours would be the only one damaged, with the effects of the fire likely to spread to your neighbours properties. If the fire brigade arrives they cannot check which households have paid for protection and which have not and so the fire service extinguishes the fire for everyone. This creates the free rider problem as citizens will know that should their house catch fire and quickly spread, then they will still get help from the fire service, regardless of whether they have paid for the service or not?Activity 3: What causes market failure
Complete the following sentences by adding in the missing blanks:
In economics, the most efficient allocation of resources is where ______=______. At this output level the __________ _______ _________ of production will be equal to the _________ __________ of producing it. Social costs includes any negative externalities associated with the production of the product e.g. any pollution created as a by-product of production. When a market is not operating ____________ we have market failure - a failure to allocate resources ___________, where _____≠_____. One such example concerns the provision of public goods.
MSB=MSC, marginal social benefit, social costs, efficiently, efficiently, MSB≠MSC.
Activity 4: Market failure caused by a lack of public goods
(a) Why is it that national defence and the Police are public goods where as other public services such as schools and health services are not?
Unlike other public services such as education or health services, public goods such as Defence are non-excludable and non-rivalrous.
(b) Are national parks and beaches public goods?
Yes because it would be very difficult to actively exclude any individual (s) from using a national park or public beach, without employing significant enforcement units that would be more expensive to pay for than any supposed benefit from doing so.
(c) Is the MC of producing a public service in the long run 0?
No, eventually as more and more people live in a country / city the government may have to increase the number of parks or police officers.
(d) In many European nations health services are available free of charge at the point of delivery. Does this make those services public goods?
No, because the service does not fulfil the criteria of being non-excludable. There are rules governing which individuals can receive free medical treatment and such public services are only available to residents of the UK and patients must provide proof of residency if requested.
Activity 5
Use the following short video to answer the following questions:
1. Explain using the concepts of free riders and non excludable why the following government services cannot be considered public goods?
- public roads
- free nursery education
- subsidised public transport.
All three of the above public services offer clear social benefits to society, which is why many governments around the world provide for them. However, there is a clear difference between these public services, which are considered merit goods (see the next page) and public services such as the armed forces and the police service. This is the question of whether those services are excludable and rivalrous. For example, there are so many places available in a nursery or on a public bus, meaning that they cannot be considered non-rivalrous. By contrast, once a nation has an army, air force or police force, there is no theoretical limit to the number of people those departments can support.
2. Explain why common access resources, including fishing grounds, natural lakes, mountains and forests are non-excludable but rivalrous.
Common use resources are generally natural resources and include fishing grounds, natural lakes, mountains and forests. These are non-excludable but rivalrous because it is very expensive to prevent anyone from using them, but once one person uses this good e.g. taking fish from a lake then it prevents others from doing so. This differentiates those goods from public goods which are both non-excludable and non-rivalrous.
Activity 6: Common access resources (HL syllabus includes calculations of welfare loss)
1. The following photograph illustrates one of the worlds most famous landmarks, the worlds highest mountain peak, Mount Everest. How does this photograph highlight the difficulty governments face protecting common access resources from exploitation?
Like many common access goods, the MC of each additional user is 0, but as more individuals use those resources their value reduces, impacting on all citizens.
When such goods such as lakes and seas are over exploited, fishing stocks diminish and the price of fish rises.
Similarly, as mountains and forests are over used then their value also diminishes - no longer being the places of peace and tranquillity that they were before. There over use is inevitable because the users of those resources do not consider others when using them. In other words each consumers MPB outweighs the external cost of consumption. Only when the level of overuse becomes so obvious does it impact on the individual and by then it is too late. No more so than the case of the once deserted Mount Everest, but now due to package tourism and a lack of regulation it has become a magnet for tourist groups.
2. Explain some of the options that a government should consider when deciding how to prevent the further deterioration of common access resources.
The solution, as far as it is possible to implement one, is for the government to limit the use of such resources (as far as they can) or charge an entrance fee to reduce the number of visitors. Examples of such policies include fishing permits or entrance fees to enter a national park − though such policies can be expensive to enforce.
Activity 7: Link to TOK
Watch the following short video and then answer the question, must a nation collect taxes to pay for the provision of public goods? Can they be financed in alternative ways and how would nations look without taxation?
Hint:
The video tries to illustrate what America would look like without Federal taxation. The video highlights more questions than answers, but returning to the central question, without Federal taxation the number of public goods provided in a nation would be significantly reduced. The general public would certainly enjoy lower taxes but would have to go without services such as Defence, the Police e.t.c. - great news for criminals but perhaps not for the rest of the community.
Activity 8: Link to TOK
Watch the following video and then answer the question, 'Are we legally or morally obliged to pay taxes'?
Activity 9: Group discussion
You are given a choice by the government to select the level of tax you will be prepared to pay, as well as the level of public spending on public services. You have the following options:
- to maintain taxation and public services at their current level
- to pay a higher rate of tax, which will then mean greater levels of government spending on public services
- you can also vote to pay less tax but will receive a lower quality of public services.
How will you choose to vote?
Hint:
Your response will depend on a number of factors, some of which include:
The current level of taxation in the country where you reside?
Your political persuasion?
Your own particular economic circumstances. For instance wealthier households will generally pay a larger share of the tax burden while the benefits of improved public services are generally enjoyed by everyone, whether they pay for them or not?
10. Link to the assessment
Examples of relevant HL question in paper one:
(a) Explain why public access resources e.g. fishing grounds might become depleted without government intervention. [10 marks]
Command term: Explain
Key terms to be explained: public access goods, external costs, private costs, market failure.
An explanation for this statement revolves around the issue of externalities. While in a free market the consumption of private goods and services is normally at the socially optimum level, where MSB = MSC, this will not be the case in the use of public access goods e.g. national parks, beaches or fishing lakes.
Public access goods are non-excludable and therefore are free to use at the point of consumption. This will lead to an over consumption of those goods as the public do not consider the external costs of consumption when choosing whether to use the public access good or not.
Appropriate government action to limit the use of these resources to its socially optimum level could be through the use of a charge on entry (although difficult to enforce) or limits on their use such as fishing permits or periods of the year when those resources cannot be used.
A suitable diagram showing the unregulated market for public access goods should be included.
(b) Using real world examples, evaluate the argument that public access resources are best served by direct government intervention. [15 marks]
Command term: Evaluate
Evaluate requires IB students to consider the relative strengths and weaknesses of the above statement.
Key terms to define: public access resources
Relevant real life examples might include a comparison of different nations, where in one public access resources are provided by governments, while in another they are provided by the private sector e.g. a comparison of public v private beaches, national parks e.t.c.
Answers should include some or all of the following:
A suitable diagram illustrating the negative externalities associated with overuse of common access resources. This could be market for national parks, with consumption above the MSB level or perhaps a PPC diagram, showing the reduction of production possibilities.
Relevant theory explaining how due to the lack of ownership or a price mechanism, common access resources are likely to be overused.
An explanation that due to the fact that public goods are non-rivalrous and non-excludable, finding a market based solution to their use is very difficult. For example, responses could provide an example of how excluding an individual from paying to enter a national park would require considerable money spent on policing the resource, making the policy ineffective.
Examples of some existing government responses that have seen some success - licensing, international agreement, allocation of property rights.
Responses in the higher mark bands should also provide synthesis or evaluation, including the merits and limitations associated with any government policy aimed at protecting common access resources. This should also include a discussion of whether the price mechanism is compatible with sustainability.
An essay template for the above question can be downloaded at: 
Section A essay template
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