Frontier Regions in Western Europe by Malcolm Anderson

Author:Malcolm Anderson [Anderson, Malcolm]
Language: eng
Format: epub
Tags: Political Science, General
ISBN: 9781135170738
Google: FENfWhUccPAC
Publisher: Routledge
Published: 2013-07-23T09:23:21+00:00

3. EXTERNALITIES, PROPERTY RIGHTS AND THE TRADING PROCESS

Under an externality there are potentially mutually advantageous trades that do not occur, and in the particular case of transfrontier externalities international trades, which are potentially mutually advantageous, fail to take place. If the trades are truly mutually advantageous, why do they not take place? Some insight into this problem can be gained by considering the following simple example.

Suppose that an individual A wishes to engage in some activity that would impose known pollution costs on individual B. More precisely, A’s activity gives rise to the following total private annual costs and revenues:

Total cost = 500 + 10Q2,

Total revenue = 200Q.

Where Q is the output from activity A. In addition A’s activity imposes costs on B of 404 per annum.

For the time being the nationalities of A and B will be ignored since they do not affect the central features of the example which may be thought of as describing a simple case of intra-national or transfrontier pollution. The eventual outcome will in part depend on the assignment of the relevant property rights. Three alternative cases will be considered here: the case where A has the legal right to engage in this activity irrespective of the costs imposed on B; the case where B has the legal right to stop A engaging in this activity; and the case where the relevant property rights are not clearly assigned.

In the former case where the property right is assigned to A, and if B were to simply accept the status quo then A would operate at his profit maximising output of 10 units per annum. At this output A makes a profit of £500 per annum and imposes pollution costs of £400 per annum on B. However, B may not have to face the status quo, there may be various alternative possibilities open to him. For example, B may relocate at an annual cost of £390 so as to avoid the pollution costs imposed by A. Under these circumstances, the worst possible outcome if no trade takes place is an annual profit of £500 for A and an annual relocation cost of £390 for B. These worst possible outcomes form the bargaining limits for possible trades between A and B: neither A nor B will accept a trade that gives an outcome that is worse than that which they could obtain in the absence of trade.

Trade between A and B may be conducted in two alternative ways. A and B may co-operate by forming a coalition or club to maximise their joint income and bargain about the distribution of this income within the bargaining limits. The total costs of the club include the external costs imposed on B which are internalised within the club. The club’s total costs are thus:

Total costs = 500 + 10Q2 + 40Q

and marginal costs = 40 + 20Q

Equating marginal costs and marginal revenue gives the maximum net income obtainable by the club. The club’s net income is maximised at an output of 8 units per annum which yields a total net income of £140 per annum.

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