Question

a. Several rivers (Red Deer, Oldman, and Bow) flow eastward into the South
Saskatchewan river basin. The South Saskatchewan river flows eastward towards
the province of Saskatchewan. There is significant irrigation in southern Alberta
primarily along the Oldman and Bow rivers. Some farmers in Saskatchewan also
irrigate along segments of the South Saskatchewan river. These Saskatchewan
farmers complain that there is not enough water for their purposes.

1.What is the fundamental market failure? Explain what it is and describe a possible remedy.

b. There is significant nitrogen leaching off fields in southern Alberta. The city of
Saskatoon, Saskatchewan draws its water supply from the South Saskatchewan
river yet it incurs significant water treatment costs to make the city water safe to
drink.

2.What is the fundamental market failure? Explain how this failure occurs.
Discuss two possible remedies and explain the trade-offs of using each.

Answer 1

a. fundamental market failure is a situation where the allocation of resource turns out to be inefficient if it is done through the market mechanism. this occurs when private individuals act according to their private cost and private benefit. there are some cases where there are externalities such as if you get the education your benefit as an individual may be less than the benefit to the society as a whole as your benefits from education spills over to the society through lower crime rate, good behaviour and good knowledge spillover to others. hence society's demand for education is far more than that of the private individuals. hence if private demand is allowed to determine the equilibrium quantity education will always be undersupplied. situations like this are called fundamental market failure.

In our question:

due to those who irrigate without any restriction from the river the farmers from Saskatchewan doesn't enough water. this is an inefficiency as farmers from southern Alberta over irrigate. this happens due to the fact that farmers of southern Alberta irrigate according to their marginal private benefits and doesn't take into the account of the cost to the society. they can irritate the water without paying much at all hence they over irrigate. hence this is a problem of fundamental market failure.

Here one solution to tackle the problem is: assigning the property right to anyone party(farmers from southern Alberta or from Saskatchewan) then this is how the problem will get solved:

i. if the property right is in the hands of Saskatchewan: then the farmers from southern Alberta has to pay the farmers from Saskatchewan to irrigate the water. then a price will get set according to their benefits and costs and both parties will get to enjoy the benefit of irrigation accordingly and efficiently.

ii.if the property right is in the hands of southern Alberta: now the farmers from Saskatchewan will pay the southern Alberta to irrigate and efficient quantity will be determined through that.

2. here the fundamental market failure will be:

the costs will be entirely borne by the people of the Saskatchewan to treat the water pollution and the benefit will be enjoyed by them along with the people from southern Alberta. now the problem will be that the people from southern Alberta will be getting all the benefit without paying anything at all. hence this is inefficiency.

how to solve this problem:

1. tax: the government can tax the southern Alberta people and distribute them into the people of Saskatchewan

2. Soliciting Donations: people wouldn't mind if they are asked to give small donations(assuming the cost of pollution treatment is low enough), then the extra cost of the people from Saskatchewan can be recovered to make the allocation efficient.

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