Open access with overlapping usage rights
Under the open access legal rule, in deciding whether to exploit the resource or not, each downstream firm compares its marginal private benefit of extraction with its private marginal cost. Under open access, the private marginal cost is assumed to be zero, and for any number
Figure 7.3.3 Marginal and average benefits
of users N, the net private benefit accruing to each user is simply the aggregate net benefit divided by N:
This is positive but declining with N. Each downstream firm either extracts one unit, or none. Each downstream firm will therefore find extraction worthwhile as long as:
Thus, individual firms would continue to choose to extract the resource until the individual (and therefore total) benefits are driven down to zero. In other words, under an open access regime with overlapping usage rights the sustainable level of extraction yields individual and aggregate benefits of zero:
Under an open access rule, these are the benefits that are enjoyed each period into the indefinite future. The resource is depleted to the point where the sustainable individual, average and total benefits are zero. The welfare loss from this legal rule is the difference between the extraction level that yields the maximum sustainable aggregate benefits and the open access benefits:
The source of this inefficiency is quite clear. The marginal social benefit at any N is B'(N), whereas the marginal private benefit at any N is the average benefit b(N) = B(N)/N. Since B(N)/N is positive but declining, this means that:
which means that B'(N) < B(N)/N. That is, the marginal social benefit is less than the marginal private benefit, but individual firms ignore the former and only take into account the latter, and so the resource is inefficiently overexploited.
Figure 7.3.4 shades in the loss that is incurred when NOA > N* firms use the asset. This loss is incurred because for each firm that exceeds N*, the marginal social cost of extraction (which is zero) exceeds the marginal social benefit of extraction (which is negative for N > N*). The benefits up to N* and the costs from N* to NOA offset each other exactly, and so total benefits under the open access regime are zero.
Since marginal private benefits exceed marginal social benefits under the open access regime, each user imposes an unpriced negative externality on the other users. For any N the value of this externality is equal to:
Figure 7.3.4 The welfare loss from an open access regime
This leads to overexploitation of the resource. The lesson is that 'com- munalising' property encourages social waste - it tends to encourage people to use goods and services in a way which takes no account of the possible negative effects of their use on others. This is the well-known resource overexploitation or 'tragedy of the commons' problem, which economists as far back as Hume (1739) have noted. By encouraging overuse, legal regimes which communalise property encourage people to continually exploit others. This is ultimately destructive of economic cooperation and sustainable participation in groups.
Note that if the number of firms using the resource could somehow be restricted (say, by direct regulation or legal fiat) or if there was a tax on usage, then this could reduce the welfare loss. Thus, one view of this situation is that it is competition and the unfettered pursuit of profit (combined with an absence of appropriate taxation) in the downstream market that is the source of the problem here, and that regulation and/or taxation is the solution. But this view is obviously incorrect. The actual economic problem, as we will see, is that the legal rule is inappropriate. More specifically, as we will now show, the source of the problem lies in overlapping usage rights.