I read in a textbook that if we plot a PPF with automobile manufacturing and clean air as the axes and the company pollutes the state making clean air (a public good) scarce, automobile manufacturing becomes inefficient and the economy works inside the PPF instead of on it. Can you explain why. Shouldn't the automobile manufacturing increase?

  • $\begingroup$ My guess would be the following: If the air gets really polluted, workers get sick. If workers get sick, they can't build as many automobiles. $\endgroup$ – DornerA Apr 5 '16 at 13:12
  • $\begingroup$ But if the industries have any vested interest in protecting the environment, wouldn't they have been doing something about it rather than polluting it? For their sake at least? $\endgroup$ – Soham Ghosh Apr 5 '16 at 13:19
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    $\begingroup$ This question is just a twist on a very famous type of problem. The result to this problem is called "The Tragedy of the Commons." This is where firms acting independently and rationally according to their own self interest behave contrary to the common good of all firms and deplete the resource. In the end, it hurts all firms, but that does not change the result. $\endgroup$ – DornerA Apr 5 '16 at 13:26
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    $\begingroup$ If it's a widely discussed issue, then why do firms act against it? If it hurts all firms? $\endgroup$ – Soham Ghosh Apr 5 '16 at 13:29
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    $\begingroup$ It has been shown using a game theoretical approach, but the basic idea (in your context) is that, the representative firm expects that each other firm will produce automobiles because they will earn a profit this way (and a firm's objective is to maximize profits). Being self-interested, the representative firm will also decide to produce in order to earn a profit. This will lead to a Nash equilibrium where all firms in the market produce. This dynamic game will continue until the resource (in this case, clean air) is completely depleted. $\endgroup$ – DornerA Apr 5 '16 at 13:41

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