Market Failures and

Biotic Resources
 Outline of Topics
 Stock Flow vs. Fund Service Biotic Resources
 Sustainable yield and Maximum sustainable yield
 Absorptive capacity
 Per unit effort curve
 Stable and Unstable Equilibrium
 Maximizing Annual Profit vs. Maximizing Net Present Value
 Exploitation of Wild vs. Bred (‘farmed’) popuations
 Natural Dividend

Question:

Do biotic resources meet the criteria necessary for

efficient market allocation?
Renewable Resource Stocks & Flows
Renewable Resource stocks and flows are rival and potentially
excludable depending on whether or not institutions exist that
can regulate access to them.

Renewable Resource Stocks and Flows are nonrival between

generations as long as they are depleted at rates less than
regeneration rates.

Economic incentives can nonetheless lead us to deplete reenwable

resources at rates greater than regeneration rates.

There are many externalities associated with the depletion of

renewable resource stocks and flows that are difficult to quantify,
characterize, and place a dollar value on.
Sustainable Yield Curve
Note: ‘K’ on x axis is carrying capacity where growth [y axis] is zero
MSY is Maximum Sustainable Yield. ‘S’ is a stable equilibrium point
‘U’ is an unstable equilibrium point. At Q” QQ” is harvest, Q”Q’ is growth, net
result is reduction of total Stock to R”. The different Y = qXE lines represent
different levels of ‘Effort’ to catch fish. Note that there are unsustainable
levels of effort e.g. E”
 Maximizing Annual Profits from
Renewable Biotic Resources

Y axis is now total revenue (Price of Fish * lbs of Fish or P f*N); N starts at 0 on the Right at ‘K’,
and increases as you go left (thus N3 > N2 > N1). TC is total cost of ‘effort’ which is cost of effort
times price of effort. In this graph TC increases linearly with size of catch (N). Profit (∏) is given
by: ∏ = TR – TC. Profit is maximized at point N1. This occurs at the point where Marginal
Revenue (MR – slope of TR curve) is equal to Marginal Cost (MC – slope of TC curve) – this our
old ‘When to stop’ rule in action. Note that this is not at the MSY.
Some Comments on Maximizing
Annual Profits (Previous Slide)
 Even if harvest cost was ZERO the a profit
maximizing owner of this renewable resource
would not harvest beyond the sustainable yield.
 This analysis only optimized ‘flow yield’. It did not
optimize ‘Net Present Value’. If fish could be
harvested and sold; and the profits put in a bank
and those monies accrue interest at a rate greater
than the growth rate of the fish it would be more
profitable to harvest to extinction.
 Question: Can you find the tacit assumption
responsible for the happy result that profit-maximizing
exploitation does not require much stock depletion?
 Profit (Flow) Maximization in Wild vs
Bred Populations
 Maximum profits for
fish catchers occurs at a
stock that is greater
than the stock that
could produce maximum
sustainable yield.
 Maximum profits for
fish farmers occurs at a
stock that is lower than
the stock that would
produce maximum
sustainable yield.
 This has to do with their
costs. Fish farmers pay
to feed the stock (less $
when stock is small).
Fish catchers pay to
catch the fish (less $
when stock is large and
fish are easier to catch)
 Profit-Maximizing Harvest when Profits can
be Invested: Net Present Value
 Smart capitalists act to maximize Net Present Value or NPV.
NPV is the value to us today of all cost and benefit streams
from now into the future.
 Economists calculate NPV by using a ‘discount rate’ to give
less weight to costs and benefits the farther in the future they
occur.
 If you owned the rights to
all of the world’s bluefin
tuna and that stock grew
at a lower annual growth
rate than a savings
account – SORRY CHARLIE*
• (obscure Star-Kist reference Re “Sorry Charlie” 
• http://www.youtube.com/watch?v=_El2_enNFaI )
 This only gets worse in an
Open Access Regime $150,000 for a Bluefin Tuna?!
Global Fish Harvest Data
 Goodbye Old Growth Forest
 What are the implications of this scenario in an
extreme but not at all unrealistic case where
harvest costs (PEE) are negligible compared to
harvest revenue (PYY), even for very low
resource stocks? Timber is a good example. Say
that a forest of redwoods not yet biologically
mature increases in size and thus value by 3.5%
per year. In contrast, the average real growth
rate of money on the U.S. Stock market over the
last 70 years was about 7%. Clearly, it makes
economic sense to harvest the resource now and
invest the profits in the bank. In fact, for any
species that is relatively inexpensive to harvest
and grows more slowly than alternative
investments, it makes economic sense to
harvest the species to extinction. In general,
averaged over the time it takes to reach harvest
size, many valuable species grow quite slowly
relative to alternative investments, and
technology tends to reduce unit harvest costs
over time. And for such resources it is, once
again, ‘goodbye golden eggs, hello bank’.
Renewable Resource Funds and Services
 So far, we have only treated the idea of optimal harvests of
renewable resources by treating them as stocks and flows of raw
materials.
 Many biotic renewable resources are also funds that proved
ecosystem services. We cannot ignore the ecosystem service funds
while we are allocating raw material flows.
 The raw material flows (timber, fish, etc.) have some characteristics
of market goods; however, the services generated by ecosystems
typically do not.
 Ecosystem services are generally nonexcludable and for many no
feasible institutions or technologies could make them excludable.
 Consequently, Free Markets will not produce these services.
 They are also nonrival and noncongestible therefore selling them in
the market would not equate marginal costs with marginal benefits.
 A common approach is to treat the destruction of ecosystem services
as a negative externality.
Optimal Harvest of renewable resources
when accounting for ecosystem services
 TPC (below) is ‘total private cost’; TSC is ‘total social cost’ which is TPC
plus costs imposed on society via lost ecosystem services. TSC should
go to infinity as harvest approaches critical depensation point CD.
Optimal harvest is where MSC (slope of TSC) = MR (slope of TR).
 In the graph below optimal social harvest is at N4 whereas the profit
maximizing harvest is at N1 (if social costs are not born by harvester).
Ecosystem Service Valuation
 Optimality requires micro-level internalization into prices of all ecosystem
services.
 Ignorance of human impacts is huge (we can’t even come close to agreement on
relatively well understood phenomena such as global warming)
 We are probably ignorant of many of the ecosystem services we are benefiting
from (ozone hole story)
 The marginal value of an ecosystem service changes with the quantity of the
ecosystem service supplied.
 The crude calculation in this paper involved a lot of work by economists,
ecologists, and geographers:
Costanza, R; d’Arge, R; de Groot, R; Farber, S; Grasso, M; Hannon, B; Naeem, S;
Limburg, K; Paruelo, J; O’Neill, R; Raskin, R; Sutton, P; van den Belt, M; (1997) The
Value of the World’s Ecosystem Services and Natural Capital Nature Vol 387 May 15
 The notion of calculating the constantly changing values of all externalities for
all goods would be a Promethean Task. Once achieved, it would still require
some institution to incorporate the fees into market prices.
 And, attempting to do so would defeat the ‘magic of the marketplace’.
 Attempting to internalize external costs is a flawed attempt to patch up the
growing and glowing failures of the neoclassical economic paradigm
 Geoffrey Heal: Valuing the Future
 The ‘Green Golden Rule’
 We should seek to maximize
well-being from renewable
natural resources for the
current generation without
diminishing the capacity of
future generations to benefit
from those resources.

 EE optimum harvest is at
values less than those who
would maximize Net Present
Value. Varying Ecosystem
Service valuations influence
where the EE optima is;
whereas, varying discount
rates influence where the NPV
maximizing optima is.
The Natural Dividend from Renewable Resources
 A single owner of a renewable natural resource such as a forest
or fishery can limit harvest to the profit maximizing level (NAPM).
The natural dividend can be thought of as the value of the
resource in the ground (or sea). To whom should the natural
dividend belong? This is a political decision, more in the realm
of just or fair distribution than efficient allocation.
Waste Absorption Capacity
 Waste absorption capacity is the ability
of the ecosystem to absorb and
process pollution.
 The economics of pollution is the
predominant focus of neoclassical
economics
 Waste absorption capacity is a rival
Needless to say, The great Pacific
good.
Garbage Gyre suggests the ocean
 “Cap and Trade” policy proposals are is way past its waste absorption
an attempt to make waste absorption capacity for plastic garbage.
capacity into a private excludable good.
 Let’s not lose sight of the fact that
pollution is a public bad. It is nonrival,
nonexcludable, and undesirable.
 The “Optimal Pollution Level” is not an
oxymoron and it is not zero
Waste Absorption Capacity
Marginal External Costs (MEC)
Marginal Net Private Benefits (MNPB)

There are high levels of uncertainty and ignorance concerning waste absorption
Capacity – Therefore the MEC curve below should be a broad fuzzy smear 

There are aggregate total population effects on the MNPB curve.

Marginal External costs

Do go to infinity with the
Collapse of the ecosystem

Pollution permits will fail to

Generate all the wonderful
Properties associated with
The free market because
People are essentially forced
To be price takers of a the
Public Bad.
 Biotic and Abiotic Resources:
The Whole System

 Read the
last three
paragraphs
of the
chapter on
page 218
and 219.

Fun TED talk by Barry Schwartz, author of “The Paradox of Choice” with a
Significant criticism of neoclassical economics. Check it out.
http://www.youtube.com/watch?v=VO6XEQIsCoM