To begin, a story

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 A classic example of this: the Tragedy of the
Commons

w Hardin (1968), “The Tragedy of the Commons”

w Picture a small fishing village on a lake

w The more fish I catch, the fewer
fish are left in the lake…
w …and the harder it is for everyone
else in the village to catch fish
w So my fishing imposes a cost
(externality) on everyone else
w So everyone ends up fishing
more than the efficient amount

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 Tragedy of the Commons – example

w 10 fishermen Total fish

caught
“Maximum
Sustainable Yield”
w Cost of fishing is 12 fish per hour H (100 – H)

w Notation
w h = how many hours I fish Efficient
Level of
w H = combined hours everyone in the Fishing
village fishes
w Fishermen catch 100 – H fish per hour 0 2.5 5 7.5 10
Hours fishing, per day, per fisherman

(a) What is the efficient level of fishing? How much utility would that
give to each fisherman?
4.4 hours per day per fisherman; 193.6 fish/day
(b) Left to their own devices, how much will each person choose to
fish? How much utility will each person get?

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 Tragedy of the Commons – example

w 10 fishermen Total fish

caught
“Maximum
Sustainable Yield”
w Cost of fishing is 12 fish per hour H (100 – H)
“Equilibrium”
w Notation Level of
Fishing
w h = how many hours I fish Efficient
Level of
w H = combined hours everyone in the Fishing
village fishes
w Fishermen catch 100 – H fish per hour 0 2.5 5 7.5 10
Hours fishing, per day, per fisherman

(a) What is the efficient level of fishing? How much utility would that
give to each fisherman?
4.4 hours per day per fisherman; 193.6 fish/day
(b) Left to their own devices, how much will each person choose to
fish? How much utility will each person get?
8 hours per day per fisherman; 64 fish/day
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 What’s going on here?

w Fishing imposes a negative externality on other fishermen

w Each one ignores this externality when deciding how much to fish…
w …so they all end up fishing more than the efficient amount

w Same thing happens with other communal resources

w Cattle grazing, whaling, overhunting, oyster beds
w Aristotle: “That which is common to the greatest number has the
least care bestowed upon it”
w Elinor Ostrom, who shared the 2009 Nobel Prize in Economics,
studies how different societies solve this problem

w Positive externalities work the opposite way

w Activities which create positive externalities are naturally done
less than the efficient amount 5
 So externalities can lead to inefficiency

w Without some sort of regulation/intervention…

w Activities which impose a negative externality will tend to happen
more than the efficient amount…
w …and activities which impose a positive externality will tend to
happen less than the efficient amount

w One recurring theme we’ll see in this class:

if we want the law to lead to efficient outcomes,
we can try to design the law or property right to
eliminate externalities!
w “Internalization”
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 Why do we need property right in the first
place?

w We already saw one reason

w Tragedy of Commons – overuse of land is held in common

w For another example, imagine two neighboring farmers

w Each has two choices: farm his own land, or steal crops
from his neighbor
w Stealing is less efficient than planting my own crops
Ÿ Have to carry the crops from your land to mine
Ÿ Might drop some along the way
Ÿ Have to steal at night à move slower
w If I steal your crops, I avoid the effort of planting and watering 7
 Why do we need property right in the first
place?
w Suppose that planting and watering costs 5, the crops either
farmer could grow are worth 15, and stealing costs 3
Player 2
w With no legal system, Farm Steal
the game has the
following payoffs: Farm 10, 10 -5, 12

Player 1
w We look for equilibrium Steal 12, -5 0, 0

w Like Prisoner’s Dilemma

w both farmers stealing is the only equilibrium
w but that outcome is Pareto-dominated by both farmers farming
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 So how do we fix the problem?

w Suppose there were lots of farmers facing this same

problem

w They come up with an idea:

w Institute some property rights
w And some type of government that would punish people who steal

w Setting up the system would cost something

w Suppose it imposes a cost c on everyone who plays by the rules

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 So how do we fix the problem?

ORIGINAL GAME MODIFIED GAME

Player 2 Player 2
Farm Steal Farm Steal

Farm 10, 10 -5, 12 Farm 10 – c, 10 – c -5 – c, 12 – P

Player 1

Player 1
Steal 12, -5 0, 0 Steal 12 – P, -5 – c -P, -P

w If P is big, and c is not too big, then 12 – P < 10 – c

w In that case, (Farm, Farm) is an equilibrium
w Payoffs are (10 – c, 10 – c), instead of (0, 0) from before 10
 So the idea here…

w Anarchy is inefficient
w I spend time and effort stealing from you
w You spend time and effort defending your property from thieves
w Instead of doing productive work

w Establishing property rights, and a legal process for when

they’re violated, is one way around the problem

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