Markets and Partial Controls

One way to answer the questions that Blackstone theory of environmental rights
leaves unanswered is to see environmental problems as market defects. If an
industry pollutes he environment, the market prices of its commodities will no
longer reflect the true costs of producing the commodities; the result is a
misallocation of resources, a rise in waste, and a inefficient distribution of
commodities. Consequently, society as a whole is harmed as its overall economic
welfare declines. Individuals, then, should avoid pollution because they should
avoid harming societys welfare.
Private costs and social costs
Economists often distinguish between what it cost a private manufacturer to make a
product and what the manufacture of that product cost society as a whole.
Suppose, for example, that an electric firm consumes a certain amount of fuel,
labor, and equipment to produce 1 kilowatt of electricity. The cost of these
resources is its private cost. He price is must pay out of its own pocke o
manufacture 1 kilowatt of electricity. However, producing the kilowatt of electricity
may also involve other external coss for which the firm does not pay. When the firm
burn fuel, for example, I may generate smoke and soot that settles on surrounding
neighbours, who have o bear the costs of cleaning up the grime and paying for any
medical problems he smoke creates. From the view point of society as a whole,
then the costs of producing the kilowatt of electricity include not only the internal
costs of fuel, labor and equipment for which the manufacturer pays but also the
external cost of cleanup and medical care ha neighbours pay. This sum total of
costs ( private internal cost plus neighbours external costs) are the social costs of
producing the kilowatt of electricity: the total price society must pay to manufacture
1 kilowatt of electricity. Of course, private costs and social costs do not always
diverge as in this example; sometimes the two coincide. If a producer pays for all
the costs involved in manufacturing a product, for example, or if manufacturing a
product imposes no external costs, then he producers costs and the total social
costs are the same.
Thus, when a firm pollutes its environment in any way, the firms private costs are
always less than the total social costs involved. Pollution is fundamentally a
problem of this divergence between private and social costs.
Why should this divergence be a problem? It is a problem b/c when the private
costs of manufacturing a product diverge from the social costs involved in is
manufacture, markets no longer price commodities accurately. Consequently, they
no longer allocate resources efficiently. As a result, societys welfare declines. To
understand why markets become inefficient when private and social costs diverge,
let us suppose that the electrical power industry is perfectly competitive.
Suppose then, that market supply curve S reflects the private costs producers
must pay to manufacture each kilowatt of electricity. The market price will then be
at equilibrium point E, where supply curve based on these private costs crosses the
demand curve.