Regulatory Approaches

Markets coordinate the exchange of goods and services between producers and consumers. Under an ideal market arrangement, resources are efficiently allocated in such a way that no person can be made better off without making another person worse off. Among other conditions, this requires that all costs and benefits are accounted for by the participants of the transaction so that the true value of goods is reflected. When these conditions are not met, costs and benefits are passed on to third parties, and inefficiencies result. Environmental pollution can be thought of as the product of inefficient markets, where the burden of environmental protection is passed on to third parties and the true value of goods and services is not reflected in their market exchange. These shortcomings in market allocation, also referred to as market failure, serve as economic rationale for government intervention into markets.

The regulatory approach that governments choose to address market failures depends on the type of market failure that is to be addressed. Market failures associated with environmental pollution are often problems of public goods, externalities, and information asymmetry. Public goods are goods that are characterized by nonrivalry, nonexcludability, or both. Nonrivalry occurs when more than one consumer can enjoy the benefits of a good without reducing the benefits for other consumers. Nonexcludability occurs when a single person cannot control the use of the good. Public goods often have varying degrees of rivalry and excludability. For example, many consumers enjoy the benefits of clean air without infringing on the enjoyment of others, and no single person can control its consumption. Therefore clean air is both nonrivalrous and nonexcludable. An ocean fishery, however, is a public good that is nonexcludable in its accessibility but rivalrous in the scarcity of its fish population. Private markets fail to provide for public goods, and thus the inefficiencies of market failure occur under these circumstances.

Negative externalities are costs that are passed off to a third party that has not consented to a voluntary exchange. As the third party must assume these costs, the true value of the good is no longer reflected in the exchange, resulting in a market failure. For example, pollution from automobile emissions that present costs to society is an example of negative externalities that are passed from the consumer to society. An oil company may pollute the air of the surrounding community, passing on the costs of production from the producer to society. Positive externalities may also result from market transactions. The upkeep of an [Page 346]outdoor area may provide aesthetic value to the surrounding community, although it has not contributed to the costs of maintenance. In this way benefits are received by those who are third parties to market transactions.

Information asymmetries are a third type of market failure that occurs when producers and consumers have unequal information about the quality of a good. This presents a problem for inefficiency, as the true value of the good may not be revealed in the transaction. Producers may choose to pass on costs to uninformed consumers, who unknowingly pay a price that is higher than an alternative price under conditions of complete information. For example, in recent years many producers have marketed products as having environmentally friendly characteristics. Lacking the ability to assess the credibility of these claims, consumers often buy products with the belief that they are contributing to the environment, when in many circumstances no such contribution is made at all. Without the intervention of a third party supervisor, the producer might continue to sell a product at a price that does not reveal the consumers' true willingness to pay for the good, further contributing to environmentally damaging production practices. Several regulatory approaches are available for government intervention to address these market failures. These include incentives for voluntary actions, conventional commandand–control regulations, and market mechanisms such as carbon taxes and permit systems. Each approach varies in its ability to mitigate environmental impacts while meeting competing societal goals of economic efficiency, distributive equity, and political feasibility.

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