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Farmers in the rain forests of South America cut down vast stands of trees daily, workers on oil rigs pump
thousands of gallons of oil per day out of the North Sea, and coal miners in Russia take the long ride into the
earth each morning. All of these people are involved in harvesting the world’s natural resources, which bring
wealth and prosperity to many countries.
This chapter applies the microeconomic theory that we have developed throughout the text to a “real-world”
problem: How does an economy decide how to use its natural resources? Societies have addressed this
question for centuries, some deciding that nature is wild and in need of taming through technology, and others
fearing the inherent power of nature and its mysterious forces. In either case, the situation calls for allocation of
scarce resources, and economists should be able to provide some answers!
This chapter begins with a brief description of alternative types of natural resources and the severity of the
scarcity problem. The second section addresses a market allocation of natural resources and investigates issues
which make the questions more complex than they might seem at first glance. How quickly should exhaustible
resources be depleted? How do differences in ownership rights affect these decisions? The final section
addresses the problem of externalities, which occur when production imposes costs on outside individuals or on
society at large. When externalities occur, the market has failed because demand or supply cannot capture the
true costs and benefits of actions; as we learned in the last two chapters, this tends to lead to a role for
government in the marketplace.


After you have read Chapter 18 in your text and completed the exercises in this Study Guide chapter, you
should be able to:
1. Discuss why the theory on overpopulation growth developed by Malthus had such a great impact on
the way people think about resource use. Explain why Malthus’s somewhat gloomy predictions have not
come about.
2. Describe the relationship between the economy and the environment, as well as the relationship
between economic development, and the environment.
3. Differentiate between appropriable and inappropriable resources, and between renewable and
nonrenewable resources. Explain how decisions concerning the optimal use of environmental resources
differ depending upon the category in which they fall.
4. Review the path of resource prices over the past several decades. Respond to the notion that resource
prices should tend to increase as population increases and demand for many goods and services shifts to the
5. Define the term externality. Describe the mechanism by which inefficiencies develop in markets when
external costs and benefits are present.
6. Use cost-benefit analysis to find the socially efficient quantity of pollution that will occur. Construct
a diagram that illustrates this decision-making process.
7. Review alternative policies that are designed to correct externalities, such as emissions fees, markets
for pollution permits, private contracts, and liability rules. Compare the pros and cons of these


Match the following terms from column A with their definitions in column B.
__ Malthusian 1. Method by which efficient environmental standards are set by balancing the
population theory marginal costs of abatement against the marginal benefits of pollution reduction.
__ Exponential 2. Posits that voluntary negotiations among parties affected by an externality will,
growth under some circumstances, lead to an efficient market outcome.

__ Rule of 70 3. A good which can be provided to everyone as easily as it can be provided to one
__ Appropriable 4. Argued that the universal tendency for population to grow exponentially
resources but for agriculture to grow arithmetically leads to periodic famine.
__ Inappropriable 5. Allow firms to settle on the optimal method and allocation of pollution
resources abatement once the regulators determine the allowable level of pollution.
__ Externalities 6. A commodity whose full economic value can be captured by firms or
__ Public goods 7. Occurs when a variable increases at a constant proportional rate from period to
__ Private goods 8. Involves asking people how much they would be willing to pay in a
hypothetical situation to keep some natural resource undamaged.
__ Cost-benefit 9. States that a magnitude growing at a rate of r per year will double in (70 / r)
analysis years.
__ Contingent 10. A commodity whose costs and benefits do not accrue to their owners.
__ Coase theorem 11. A good that can be divided up and provided separately to different individuals,
with no external benefits or costs to others.
__ Tradable 12. Occur when costs or benefits of a market transaction “spill over” onto other
emissions permits people.


This section summarizes the key concepts from the chapter.

A. Population and Resource Limitations

1. Resources are limited, but society’s wants are unlimited. Thomas Malthus was one of the first people to
address this basic economic “fact of life” as it relates to land and natural resources. Malthus hypothesized that
the overpopulation of the earth would be its ultimate downfall. Because population grows exponentially, but
agriculture grows only arithmetically, periodic famines are inevitable. As the population grows, it becomes
increasingly difficult to feed everyone. Therefore, some people will starve, causing the population to fall back
down to a sustainable level.
Although this theory opened an important debate, it was inherently flawed. Malthus failed to consider the
importance of technology, which has led to tremendous increases in the ability of people around the globe to
feed themselves. In spite of these flaws, the ideas had a tremendous impact on the nature of public policy in
the British Empire, and they generated an extreme lack of sympathy for the poor.
2. Some simple correlations can be found between groups of people and environmental factors. First,
pollution trends tend to follow an inverse U-shaped curve across different stages of economic development.
Early stages of development tend to generate increases in pollution as subsistence farming is replaced by
manufacturing; later stages of development tend to generate decreases in pollution as increased incomes and
standards of living change preferences in favor of a cleaner natural environment. Second, human health is very
positively correlated with per capita incomes, leading many to conclude that the only way for a society to
generate a clean environment is to become wealthy enough to “buy” it.

B. Natural-Resource Economics
1. A commodity is appropriable when firms or consumers can capture its full economic value. This means
that owners can expect some sort of return from use of the resource. Inappropriable commodities are those
whose costs and benefits do not accrue to their owners. Thus, a 40-acre plot of land is appropriable; the owner
can allow a farmer to use it in exchange for a rent payment. However, Lake Michigan is inappropriable, since I
could freely dump all my garbage into it, making the water less pleasant for all others who use it.
2. A nonrenewable resource is one whose services are essentially fixed in supply and not regenerated quickly
enough to be economically relevant. Oil is essentially nonrenewable. The earth produces more of it but it
takes thousands of years. Renewable resources are those whose services can be replenished regularly. Notice
that people may choose not to replenish those resources. For example, for years timber companies cut acres and
acres of timber without replanting. The trees would eventually replenish themselves, but not for hundreds of

3. Natural resources play a critical role in production and consumption activities in the U.S. economy.
Without these resources, we would not be able to play our stereos, drive our cars, or heat our homes. Why,
then, is there no concerted strategy on the part of nations and governments to conserve what seem to be the
sources of our prosperity—that is, fossil fuels and other natural resources?
The answer to this question is difficult. Some economists might argue that the resources are not truly
essential, because they are not needed to sustain life in most regions of the world. Air is essential, oil is not.
In a world of technological development and innovation, increasingly short supplies of one resource will be
replaced by some substitute resource.

Figure 18-1

4. The following illustration involves concepts presented in the Appendix to chapter 7. The isoquant AA in
Figure 18-1 shows combinations of capital and labor that can be used in a production process to generate the
same quantity of output. The isocost BB shows combinations of capital and labor that cost the same amount of
money. This firm will choose optimal levels of labor and capital usage such that the desired output level is
produced with least cost (point E). Notice that as the price of labor rises, the firm will have an incentive to
substitute capital for labor in the production process. It is this sort of substitutability that makes few resources
truly essential.
5. Although the world’s population has increased over the past several decades, resource prices have been
dropping rather than rising. This means that new technology as well as newfound reserves has allowed supply
increases to outstrip demand increases.

C. Environmental Economics
1. An externality is present when the benefits (in the case of a positive externality) or the costs (in the case of
a negative externality) of an activity spill over into the lives of other people without their paying or being
compensated. Public goods represent the extreme case of externality on the positive side; pollution, on the
negative side.
2. Consider the economic consequences of a negative externality—for example, the emission of heavy toxic
smoke from a factory chimney. No matter how disagreeable it might be to those who work or live nearby, the
factory’s owners might feel no obligation to clean up their act until public pressure, usually in the form of
legislation, forces them to do so. A more recent example is acid rain. Many utilities and manufacturers,
especially those involved in metal processing, emit sulfur dioxide and nitrogen oxide from their smokestacks.
These chemicals combine with moisture in the atmosphere to form sulfuric acid and nitric acid. The acidity of
falling rain and snow is thereby increased, creating a more acidic environment in lakes and rivers, in which fish
cannot reproduce. Moreover, there may be long-term impacts on human health from these and other chemical
3. Externalities lead to economic inefficiency. The above mentioned factory may have some incentive to clean
its emissions; for example, better health for the workers might be promoted, or more efficient burning of fuel.
These private benefits will be reflected in the market demand curve. The firm will clean its smoke until the
marginal benefits of additional abatement just equal the marginal cost of cleanup. However, the market demand
curve will fail to account for the public benefit that would derive from cleanup. Hence, unless the market
supply and demand can somehow account for these public benefits and costs, there will be an oversupply of
those goods that bring external costs and an undersupply of those goods that bring external benefits.

4. The discussion above can be illustrated graphically. Figure 18-2 shows the marginal cost of abatement
(MC) and marginal private benefit (MPB) in the market for pollution abatement. Note that the marginal benefit
curve is downward-sloping; as the most significant problems are eliminated, the benefit received from an
additional unit of abatement will get smaller. The marginal cost curve is upward-sloping, indicating that as the
area gets cleaner and cleaner, it becomes increasingly costly to produce an additional unit of abatement.

Figure 18-2

If the private demand curve could reflect the total public demand—not just the demand by a single firm—
for pollution abatement, it would look something like MSB. In this case, the quantity of abatement would be
higher and there would be less pollution.
5. Several policies exist to correct externalities. Governments can use direct controls, or social regulation, to
impose standards and guidelines on markets. The regulator simply sets standards, expects compliance, and
punishes or imposes sanctions on those who do not comply. In other cases, the government has used market
solutions to limit pollution. The regulators establish a total amount of pollution to be tolerated, issue permits
for the “right to pollute” to this extreme, and then let the market determine how the permits are to be
distributed among firms, how the pollution is to be eliminated, and, thus, what the ultimate distribution of
pollution will be. We would expect that firms who can most easily (and cheaply) eliminate pollution will sell
their permits to firms who find it more difficult (and costly) to reduce pollution. Critics of this system argue
that permits will be distributed such that firms with high pollution-abatement costs will buy up all the permits
and continue to pollute, maybe even to a greater extent.
6. Private approaches also exist to correct externalities. Ronald Coase, a Nobel Prize-winning economist,
argued that as long as property rights are well defined and negotiation costs are low, voluntary negotiations
among the parties affected by an externality will lead to the efficient outcome. Return to our smoking factory
above. Coase would argue that the local townspeople have a powerful incentive to get together with the firm
owner and agree on an optimal level of pollution. Coase would further argue that this requires no government
antipollution program!
Liability rules and litigation can also lead to the elimination of externalities without direct government
intervention. As you can imagine, the game-theoretic analysis introduced in Chapter 12 can help to illustrate
these negotiation processes.
7. Global “greenhouse” warming poses a true challenge to formulators of environmental policy. Because the
solution to the problem involves an international public good, it is very difficult to imagine any individual
firm, or country, spending the resources necessary to solve the problem.


1. The prevalence of severe environmental problems in socialist economies seems odd. At first glance, it
seems like government ownership and direction of resources would lead to a decrease in the severity of these
sorts of problems. However, in the absence of private property rights, no single individual has responsibility
for resources. In this setting, many resources become “public goods,” available for free use and abuse by all.
This appears to be a real flaw in the allocative system.

2. Figure 18-3 in your text describes an isoquant and isocost map; a similar diagram is shown here in Figure
This material was covered in the appendix to Chapter 7. Remember that an isoquant shows combinations
of two inputs (labor and capital) that can be used to produce a given level of output. This gives us information
about the production process; for example, between points A and B, 2 units of capital can be substituted for 1
unit of labor, and output will remain unchanged. This notion of input substitutability is important when
determining whether or not a particular resource is essential.

Figure 18-3

3. The oil embargo of 1972-1973 brought the reality of scarcity home to the American people. The oil
supply decreased dramatically as OPEC’s policies took hold, and oil prices soared. Energy policy was at the
top of all politicians’ lists of priorities, and people talked endlessly of their conservation efforts. It seemed as
though we would have to face the fact that our oil reserves are not unlimited.
Almost 30 years later, oil prices (adjusted for inflation) have fallen and supplies again seem plentiful.
Most people have returned to their old consumption habits, warming homes above 72°F in winter and cooling
below 65°F in summer. What happened? In two words, market forces. The extra-normal profits earned by
OPEC encouraged further exploration. As a result, significant reserves were found in Alaska, in Mexico, and in
the North Sea. When these new, nonOPEC reserves hit the market, supply swung back out to the right and has
generally kept moving. However, in the spring of 2000, OPEC again seemed to exercise some market muscle,
restricting supply. Market prices shot up once again.
This example helps to illustrate the difficulty inherent in questions of resource allocation. What is the
actual supply? How can we measure it? How can we possibly anticipate the technological developments that
will allow us to gather and to use our resources more efficiently in the future? How does imperfect competition
lead to market power for producers? These types of questions make the study of natural resources and
environmental economics challenging and fascinating.


These questions are organized by topic from the chapter outline. Choose the best answer from the options

A. Population and Resource Limitations

1. Malthus believed that:
a. population increases geometrically while agricultural production remains fixed.
b. overpopulation is not a worry, since the resources available to the world are infinite.
c. population increases geometrically while agricultural production increases only arithmetically.
d. total population tends to remain fixed over time, while agriculture increases arithmetically.
e. poor relief must be improved, so that famine, war, and disease would not destroy the work force.

2. The major flaw in Malthus’s argument was that he failed to account for:
a. increased government intervention in the economy.
b. the tremendous impact of improvements in technology.
c. the redistribution efforts of government that occur through taxing and spending.
d. diminishing returns to a fixed supply of land.
e. all the above.
3. Which of the following hypotheses has generally been found to be true?
a. Human health is highly correlated with per capita incomes.
b. Pollution tends to decrease in the early stages of development.
c. Pollution tends to increase in the later stages of development.
d. Human health tends to be unaffected by development.
e. The best way for a society to maintain a decent environment is to avoid development and remain poor.

B. Natural-Resource Economics
4. Inappropriable resources are:
a. free to the individual and the society.
b. goods whose costs and benefits do not accrue to their owners.
c. expensive for an individual to produce but can be provided efficiently by government.
d. efficiently priced and allocated by a market economy.
e. the side-products of externalities.
5. Appropriable resources are:
a. free to the individual and the society.
b. free to the individual but costly to the society.
c. expensive for an individual to produce but can be provided efficiently by government.
d. efficiently priced and allocated by a market economy.
e. the side-products of externalities.
6. All of the following resources are nonrenewable except:
a. oil.
b. fisheries.
c. copper.
d. diamonds.
e. coal.
Use the isoquant diagram in Figure 18-4 to answer question 7.

Figure 18-4

7. Between points A and B, output will remain constant when ___ labor units are substituted for ___ capital
a. 2 for 4.
b. 4 for 2.
c. 0 for 4.
d. 2 for 6.
e. 5 for 5.
8. If the isoquants for capital and labor are L-shaped, we can say:

a. that capital is nonrenewable.

b. that capital is appropriable.
c. that capital is essential.
d. there are no other products left to produce.
e. all the above.
9. Over the past several decades, the prices of resources have actually been:
a. rising.
b. falling.
c. remaining constant.
d. falling proportionally.
e. doubling.
10. Which of the general diagrams in Figure 18-5 explains your answer to question 9?
a. (a)
b. (b)
c. (c)
d. (d)
e. (e)

Figure 18-5

11. Natural resources are appropriable when firms or consumer:

a. can capture the full benefits of their services.
b. cannot capture the full benefits of their services.
c. can yield useful services indefinitely.
d. cannot yield useful services indefinitely.
e. none of the above.

C. Environmental Economics
12. Which of the following cannot be called a public good?
a. national defense.
b. a dam that protects a region from flooding.
c. a measles vaccine.
d. a public concert.
e. a ham sandwich.
13. In the course of production, a firm with a constant marginal cost of $125 per unit of output emits a
pollutant that causes a harm of $5 per unit. What will be the market price if the economy is perfectly efficient?
a. $125.
b. $130.
c. $5.
d. $120.
e. The firm will go out of business.
The diagram in Figure 18-6 indicates the private costs and benefits accruing from pollution abatement in a
particular firm. Use it to answer questions 13 and 14.

Figure 18-6

14. The efficient level of pollution abatement when only private benefits are considered is indicated by:
a. A.
b. B.
c. C.
d. D.
e. none of the above.
15. If there is a $3 social benefit per unit of pollution abatement and the market is perfectly competitive, the
price will be:
a. $25.
b. $20.
c. $18.
d. $15.
e. $12.
16. The Coase result states that:
a. negotiation would always solve an externality problem if only government would get out of the way.
b. the potential exists for negotiation to diminish the magnitude of an externality if property rights are
well defined and negotiation costs are not too severe.
c. negotiation must be forgone in lieu of direct governmental intervention whenever an externality
problem becomes too severe.
d. negotiation will always generate an efficient solution as long as negotiation costs are not too high and
property rights are clearly defined.
e. none of the above.
17. Liability laws help to eliminate externalities because:
a. the FTC can use them to establish absolute levels of pollution to allow.
b. expensive lawsuits will eliminate the need for public goods.
c. the difference between the marginal social benefit and the marginal private benefit of pollution
abatement will be redistributed in the courts.
d. individuals are no longer legally liable for the damage they cause others.
e. none of the above.
18. Environmental problems arise because of:
a. population increases at a geometric rate.
b. externalities.
c. natural resources are nonrenewable.
d. natural resources are renewable.
e. none of the above.



The following problems are designed to help you apply the concepts that you learned in this chapter.

A. Population and Resource Limitations

1. Overpopulation was a serious issue in the early 1960s, when Rachel Carson’s book Silent Spring opened
environmental concerns to public debate in 1963. Although population growth has slowed in recent years in
industrialized countries, in many less developed countries in Africa and South America the population
explosion is still a matter of grave concern.
a. (Adam Smith / Thomas Malthus / Rachel Carson) developed some of the earliest views on
population growth in the book An Essay on the Principle of Population, written in (1745 / 1798 / 1876 /
1945). This text presented the theory that there is a universal tendency for population to increase
(arithmetically / geometrically / exponentially) while the food supply grows only (arithmetically /
geometrically / exponentially). Because of the (laws of supply and demand / equality of marginal
utilities / law of diminishing returns), as society continues to increase production of agricultural goods,
it becomes increasingly harder to produce additional units of those goods. Malthus overlooked the fact
that this is a (short-run / long-run) phenomenon, and that over time, changes in resource availability and
technology will allow society to overcome these problems.
b. Very few general conclusions can be drawn concerning the relationship between populations and their
environments. It seems pollution tends to follow (a U-shaped curve / an inverse U-shaped curve) as
economic development increases. Also, it seems as though human health is (positively / negatively)
correlated with per capita income.
2. As stated in your text, “Exponential growth and compound interest are important tools in economics.”
You learned some of the basic concepts surrounding these tools in Chapter 14; let’s put them to work in the
area of natural resource economics.
a. Suppose a resource such as labor is growing at 5 percent per year. If there are 100 people in the labor
force today, there will be ___ people in the labor force in five years.
b. Notice that your answer to part a (is / is not) 125. The notion of compound interest implies that the
increase each year is 5 percent over the labor force base that existed at the close of the previous year.
c. What growth rate per year would you need in your labor force if you must have 150 people at the end
of the five-year time horizon? ___.

B. Natural-Resource Economics

Figure 18-7

3. Before we can talk about markets for resources, we have to distinguish between two broad categories for
resources. A resource is (appropriable / inappropriable) if firms or consumers can capture its full economic
value. A resource is (appropriable / inappropriable) if it is free to the individual but costly to society.
a. Many markets exist for appropriable resources. Consider the hypothetical data on the market for oil
given in Table 18-1. (Quantities are in barrels per day.)

TABLE 18-1
Price Quantity Quantity
per Barrel Supplied Demanded
$50 150,000 0
40 120,000 20,000
30 90,000 40,000
20 60,000 60,000
10 30,000 80,000
0 0 100,000

Use Figure 18-7 to plot these supply and demand curves. The equilibrium price in the market will be $___ per
barrel and the quantity exchanged will be ___ barrels.
b. Suppose firms form a cartel and attempt to control the market supply and hence the market price.
They manage to cut supply in half. Show this new supply curve in Figure 18-7 and show the new
equilibrium. Price will (rise / fall) to $___ and quantity will (rise / fall) to ___.

C. Environmental Economics
4. Externalities occur when production or consumption inflicts involuntary costs or benefits on others.
Pollution is one of the best examples of a negative externality, because many people have to pay the cost of the
behavior of firms who dump trash into the air or water.
We will employ cost-benefit analysis to determine how a private firm makes decisions concerning
pollution abatement. Figure 18-8 shows the marginal cost and marginal benefits that firm A will incur if it
chooses different levels of pollution abatement.

Figure 18-8

a. Suppose the government imposes a requirement that 200 units of pollution be removed. Describe the
impact of this policy.

b. Suppose instead that the government charges a $100 emissions fee. Describe the impact of this

c. Let’s compare these two policy actions. The absolute requirement yields ___ units of pollution
abatement. The emissions fee yields ___ units of pollution abatement and $___ collected by government.
The fee leads to (a greater / a lesser / an equal) amount of pollution abatement.
5. Consider Figure 18-9, which depicts the marginal private and social benefits of pollution abatement, along
with the marginal costs.

Figure 18-9

a. Given the curves defined in Figure 18-9, some government action is required because the privately
determined level of pollution abatement would be ___ tons, at which the marginal cost of abatement equals
(the marginal social damage caused by the pollution / zero / the marginal private benefit of the
pollution abatement). That quantity (is greater than / is less than) the efficient level of pollution
abatement, ___ tons, defined by the equality of the marginal cost of abatement and (the marginal social
damage caused by the pollution / zero / the marginal social benefits of pollution abatement).
b. Suppose that those hurt by the pollution offer to pay the polluter $4 for every unit of pollution not
emitted. This would mean that the marginal private benefit of pollution abatement would (climb by $4 /
remain the same / fall by $4) because each unit of pollution abated would mean an additional gain of $4
in compensation.


Answer the following questions, making sure that you can explain the work you did to arrive at the answers.

1. Review Malthus’s ideas concerning population growth. How did these ideas affect the attitudes of the
British toward the poor? How might they continue to affect attitudes of some Americans toward immigrants?
2. Why might we expect the switch to a market economy lead to improvements in the environment in
3. During the Carter administration in the late 1970s, politicians and private citizens alike debated the proper
formulation of an “energy policy” for the United States. However, as oil supplies again became more plentiful,
this notion was forgotten by most people. Should we be concerned about creating a long-term strategy for
resource use? Why or why not?
4. Use supply and demand curves to illustrate why the prices of natural resources have declined over the
course of the century.
5. Explain why externalities lead to inefficiencies in the distribution of resources.
6. Compare and contrast command methods of regulation with market-oriented methods of regulation. Which
methods tend to eliminate externalities most efficiently?
7. Why is the “greenhouse effect” referred to by the authors of your text as the “granddaddy of public goods
problems?” What makes this problem so difficult to solve? How did the Kyoto Protocol attempt to solve this



III. Review of Key Concepts

4 Malthusian population theory
7 Exponential growth

9 Rule of 70
11 Appropriable resources
10 Inappropriable resources
12 Externalities
3 Public goods
6 Private goods
1 Cost-benefit analysis
8 Contingent valuation
2 Coase theorem
5 Tradable emissions permits

VI. Multiple Choice Questions

1. C 2. B 3. A 4. B 5. D 6. B
7. B 8. C 9. B 10. A 11. A 12. E
13. B 14. D 15. C 16. B 17. C 18. B

VII. Problem Solving

l. a. Thomas Malthus, 1798, exponentially, arithmetically, law of diminishing returns, short-run
b. an inverse U-shaped curve, positively
2. a. 128
b. is
c. 8.5 percent
3. appropriable, inappropriable
a. See Figure 18-7. $20, 60,000

Figure 18-7

b. rise, $28.58, fall, 42.8

4. a. The marginal cost of pollution abatement is equal to the marginal benefits of pollution abatement.
b. The firm will equate the fee with the marginal cost and choose abatement of 200 units.
c. 200, 200, $20,000, an equal
5. a. 50, the marginal private benefit of the pollution abatement, is less than, 150, the marginal social
benefits of pollution abatement.
b. climb by $4

VIII. Discussion Questions

1. Malthus was concerned about the fact that population was growing much too fast for production in
agriculture to keep up. Thus, he thought that many poor people would starve, serving as a natural check on
overpopulation. These ideas hardened the attitudes of the British toward the poor in nineteenth-century Britain.
Many middle-class merchants became more willing to allow the poor to starve based on the Malthusian theory
that this was just part of a natural adjustment process.

2. A switch to a market economy in Russia might improve the environment by distributing private ownership
rights to natural resources.
3. Given the fact that oil is a nonrenewable resource, some sort of energy policy seems to be in order.
4. Supply has increased more dramatically than demand.
5. Externalities lead to inefficiencies in the distribution of resources. This is because private demand and
supply curves cannot account for all of the costs and benefits that occur as a result of production and
6. Command methods involve regulators in establishing standards with which the firms must comply.
Regulators give firms detailed instructions on the type of controls to use and the technology involved. Market-
oriented methods allow each firm to determine its own best solutions to pollution problems. Markets tend to
work most efficiently because each firm is allowed to make its own decisions with respect to the best methods
to employ.
7. The “greenhouse effect” is a particularly difficult problem to solve because the solution will provide
benefits to many people; once the solution is available, it will be impossible to exclude anyone from enjoying
the benefits. Hence, few are willing to pay to implement the solutions to the problem. The Kyoto Protocol
was an agreement among countries to limit emissions of greenhouse gases by 2010. The agreement allowed
countries to purchase emissions trading rights from other countries, harnessing market forces to solve a problem
generated by market failure!