Neoclassical theory has been applied in order to cure or circumvent inefficiency and whatconditions are necessary for the efficient allocation of resources and how market failures lead toinefficiencies and to suggest ways in which these distortions can be corrected.Figure 1.1 below shows that total net benefit is maximized when the marginal cost of producingor extracting one more units of the resources is equal to its marginal benefit to the consumer.This occurs at Q*, where the demand and supply curves intersect. In a perfectly competitivemarket, the invisible hand will ensure that Q* is the quantity produced. The marginal cost curve inthe figure is upward sloping because extraction costs increase as a resource becomes scarcer.The resulting producer surplus, or profit is called a scarcity rent. In this diagram, the producersurplus is area aPb, and the consumer surplus is area DPb. Together they yield a maximumbenefit equal to Dab. In principle, some of these scarcity rents could be taxed and used forenvironmental protection or other socially purposes.If resources are scarce and are rationed over time, scarcity rents may arise even when themarginal cost of production is constant as in figure 1.2. The owner of a scarce has a finite volumeof resources X to sell (75 units) and knows that by saving a portion of it for future sales, the ownercan charge a higher price today. In fig 1.2, assume that the owner has 75 units available. If theowner is willing to offer only 50 units for sale today, the market price for the scarce resource is Ps.The scarcity rent collected by the owner of the resource is equal to Psabp, the shaded region
between price and marginal cost. In the absence of scarcity, all of the resources will be sold atthe extraction cost P = MC, 75 units will be consumed at one time, and no rents will be collected. The proponents of the neoclassical free-market theory stress that inefficiency in the allocation ofresources result from impediments to the operation of the free market or imperfections in theproperty rights system. So long all resources are privately owned and there are no marketsdistortions, resources are allocated efficiently. Perfect market property rights have 4 conditions.a.Universality: all resources are privately owned;b.Exclusivity: it must be possible to prevent others from benefiting from a privately owned resource;c.Transferability: the owner of the resource may sell the resource when desired; andd.Enforceability: the intended market distribution of the benefits from resources must be enforceable.