Efficiency of alternative property right allocations when farmers produce multiple environmental goods under the condition of economies of scope

The efficiency implications of different property right allocations when two environmental goods can be produced under the condition of economies of scope are analysed. It is assumed that an environmental agency – acting on behalf of the community – employs an auction‐based mechanism to buy biodiversity services from farmers. However, farmers’ production of biodiversity produces a second good as a by‐product (e.g., mitigation of a river pollutant) that is valued by point‐source emitters who are engaged in a pollution trading market. The efficiency implications of allocating the property right of the good, mitigation, to either the agency or farmers are analysed. If the agency owns the mitigation then the agency can sell mitigation to point‐source emitters, offsetting the cost of biodiversity. If farmers own mitigation, then they sell it directly to point‐source emitters. Assuming similar transaction costs associated with each property‐right allocation, allocating the property right to farmers improves efficiency, as farmers take account of their private information to make profit‐maximising decisions about the supply of biodiversity and mitigation; the agency would have trouble accessing this private information.