Market Inefficiencies (Part 2): Tragedy of the Commons

This is part 2 of a series on what can make free markets break sometimes. Here's a second form of free market inefficiency.

This is a common one (ehhhhh.... ok, no more jokes). But it's very important for understanding basic economic theory. So let's do a short post on the Tragedy of the Commons.

Sounds like a bad space movie from the 80's. So let's go with that theme.

In this movie we travel to a far off world, Alpha Ruminant. Alpha Ruminant is inhabited by space-ranchers who herd space-cattle.

Space cow

There's only one thing for space cows to eat on Alpha Ruminant and that's space grass.

Space grass

Space grass is a great resource, and it grows back every year so the cows can keep on eating, keep on growing, and keep on living the dream. As longs as the cows are happy, the ranchers get their space cow burgers and are happy too.

Now, the reason that space ranchers space ranch at all is because space cow's milk is VERY valuable. People on the nearby planet of CookieTron drink the stuff like it's water and are willing to pay big bucks for it. 

And because it's so valuable, it is in a space rancher's interest to own as many cows as he can to produce as much space milk as he can. All the ranchers invest and grow their herds over time. 

The production of space grass on Alpha Ruminant is about 1,000 kilograms per year, and each space cow eats 1 kilogram per year. The ranchers have an incentive to grow their herd as much as possible and grab as much of the grass as they can, but there is a limited production of grass. Eventually, if the 10 ranchers on Alpha Ruminant each own 100 space cattle, then the cows are eating the space grass as fast as Alpha Ruminant can grow it (1,000 kilograms of production and consumption). 

First reaction: hmmm... ok, I guess that sucks but the lack of grass will regulate the market and just limit the number of cows. 

Here's the problem: time. If the ranchers invest to grow the heard to make more money, and then grow the collective number of space cows beyond 1,000 in the beginning of the year, all the cows might eat all the space grass in (for example) 11 months. And then there's no more grass for a month. And I don't know a lot of space cows that can go for a month without food. 

And then all the space cows die. And everyone's life sucks. 

If the ranchers had all just come to an agreement beforehand that no individual could own more than 100 cows (or that the number of cows was somehow capped at 1,000), then everyone would still have cows and be making crazy money off those suckers in CookieTron. Instead, they all just have a bunch of dead cows.

The most disappointing version of this scenario is when the individual ranchers can foresee the problem and KNOW that it is in everyone's best interest to limit their consumption. But they don't trust everyone else to scale back. So they decide to get what they can while they can, even though in the end the costs far outweigh the profits. And everyone does the same thing. (This happens in the real world)

The grass in this example is known as a commons (this example actually comes from real cows eating real grass on real commons in the centers of real towns, I just added the space). A commons is a resource that is either directly owned by nobody, or owned collectively by society. In this example -and many real life examples- free market behavior can lead to the destruction of common resources that benefit all business and individuals. And the destruction of those resources can make everyone in the system ultimately worse off. 

Examples of real world commons and ways they can be destroyed by over-competition:

• Air 
• Pollution 
• Fish populations
• Over-fishing
• Water resources for farmers (wells, rivers)
• Over-irrigation
• Oil supplies
• Over production
• Low orbit outer space 
• Space debris rendering certain orbits too dangerous for satellite use.