Putu Harsha Narayanan

3. (a) Explain how the overuse of common access resources can lead to negative
externalities. [10]

Negative externalities are the negative costs for third parties that are not involved in the
transactions of goods and services and whose interests are not taken into account. Therefore, the
market does not achieve allocative efficiency as the marginal social benefits (MSB) is not equal to
the marginal social costs (MSC). The overuse of common access resources are natural resources
that do not have ownership status and are non-excludable resources, meaning that no one can be
deprived of it but are also rivalrous goods, where one’s usage of the resources diminishes the
benefit to others in society. This results in the tragedy of the commons, where the lack of private
ownership results in firms acting on their self interest, and thus causing the depletion of natural
resources such as forestry, oceans and air.

The diagram illustrates the negative externalities arising from overconsumption of common access
resources. Common access resources are being consumed at the quantity level Qm, where the
MPB are greater than the MSB - where the vertical shift represents the value of external costs, as
these firms are acting on self interest in producing from these resources. Due to the demand durve
representing the MPB, the price is above its equilibrium where the firms earn an increased amount
of revenue. As a result of the MPB being greater than MSB, a welfare loss is present as seen from
the shaded region beneath the supply curve.

The mass exploitation of common access resources results in market failure, as the consumption
and production of common access resources such as forestry and oceans can lead to detrimental
environmental damage and resource depletion for future production. With the environmental
depletion and damage caused, this in turn, affects third parties that are not involved with the action
of producing from common access resources - thus representing the creation of negative
externality consumption.
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For instance, widespread overuse or consumption of common access resources, such as
over-fishing in international waters causes a depletion in available seafood in a specific period of
time - which ecologically disturbs food chain cycles and prohibits the development of further
available seafood in the future. By also overfishing in waters without ownership such as
international waters, this consumption also depletes the supply of natural resources available at
sea for other countries - which arose during the South China Sea conflicts involving southeast
Asian nations.

3. (b) Discuss the view that the best way to reduce the threat to sustainability, arising from
the burning of fossil fuels, is for the government to provide subsidies to firms that produce
energy through renewable sources. [15]

Subsidies are payments by the government to firms in order to lower costs and price and increase
supply of certain goods and services. Sustainability is the rate at which society consumes
resources in ways that do not deplete future supply of a good. In the case of fossil fuels, for
instance, causes the increase of negative externalities for third parties, such as increased air
pollution which may put a strain on a country’s healthcare system, depletion of the ozone layer,
and acid rain which harms agriculture and public health. This negative externality of production of
one good or service causes market failure.

The first diagram showcases the effects of a subsidy imposed on renewable sources, where a
subsidy shifts the supply curve rightwards, as shown with the policy change. This results in the
quantity being shifted from Qm, the market quantity, towards the socially optimal level Qopt - as
well as decreasing the price from Pm to Pc. In turn, this creates a leftward shift in demand for
non-renewable resources from the MPB towards the MSB as seen on the second diagram, and a
reduction in Qm towards Qopt.
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The imposition of a subsidy on renewable resources will result in an increase in supply, as the
reductions in the cost of production covered by the subsidy; land, labour, entrepreneurship, will
incentivise firms to produce renewable forms of energy, thus also reducing the prices for
consumers for energy. This also reduces the demand for non-renewable energy sources which
achieves the aims of governments to reduce negative externalities in both the short and long-run.
By reducing non-renewable sources of energy, this promotes greater sustainability in the energy
market.

With a subsidy, consumers benefit from the lower prices of energy due to the subsidy, which may
incentivise them in the long term to purchase energy solely from renewable resources due to its
price. This in turn, reduces negative externalities that arise from the consumption of non-renewable
resources by pivoting the demand from non-renewable to renewable energies. This further affects
households with lower incomes that do not have access to cheap electricity, in which a subsidy will
provide low-income households with affordable energy. However, this assumption is only made if
the price elasticity of supply is elastic - as if the PES is inelastic, this contributes to a smaller
decrease in demand relative to the decrease in price. For instance, government subsidies in
renewable energies in Germany has increased the demand for renewable energies whilst also
decreasing the level of production and demand for coal-based energy industries. The development
in renewable energies also has made other industries such as electric cars more prevalent due to
the subsidy, whilst progressing the elimination of negative externalities such as air pollution.

However, governments do not benefit from the imposition of a subsidy as governments have to pay
these subsidies using limited government funding. This presents an issue in determining the
amount of government provision that will be equal to the marginal benefits as well as the issue of
opportunity cost - whether or not these funds should be spent on renewable resources or
elsewhere such as education or healthcare. This also has a further impact on society, as there are
opportunity costs in implementing a subsidy in employment of workers and society as a whole.
Workers working in the renewable energy sector will experience further employment as the
increase in supply incentivises firms to boost the production of energy, however, firms in the
non-renewable energy sector will experience a decrease in production and demand, thus leading
to unemployment with the assumption that the energy industry follows an oligopolistic market
structure. Furthermore, implementing a subsidy is difficult, as there are various difficulties in
establishing the value of the external benefits that a subsidy would provide in an underconsumed
good.

In conclusion, a subsidy would increase the supply of renewable resources, and reduce the
negative externalities that arise from the use of non-renewable energies. However, as a result of
Putu Harsha Narayanan
increased supply of renewable energies, workers in the non-renewable sector will experience an
increase in unemployment due to the reduction in demand and supply. In the long-term, a subsidy
will provide firms with the necessary infrastructure to develop its supply of renewable energies -
making it cheaper for consumers. However, a subsidy cannot be maintained in the long-term due
to opportunity costs spending the subsidy elsewhere such as education and healthcare.