The Tragedy of the commons occurs in markets for common goods in which the invisible hand makes everyone worse off, instead of better. The reason is that it is impossible to exclude people from using a common good. This leads to over-exploitation of the common good.

The usual story explaining the Tragedy of the commons is as follows. Every day two ranchers bring their herds of sheep to a common pasture. A bigger herd means that its herder can earn more. However, if both herders expand their herds they may deplete the grass on the pasture. When that happens herds actually fetch less income for the herder. However, for each individual herder it is rational to expand its herd, because the marginal cost is lower than the marginal benefit. These individually rational decisions deteriorate the pasture so the sheep become undernourished and harder to sell. In the end, indeed, everyone is worse off.

More strategic behavior: Prisoner’s dilemma

Tragedy of the real estate market

Space is more or less a common good and a factor in the ‘production’ of real estate (services). As space is a common good it runs the risk of over-exploitation. This for example might happen when municipalities compete for companies to operate facilities in their area. Competition between municipalities, mostly, does not raise the number of companies. So it could be that each individual municipality hands out plots cheaper, or lowers taxes, to attract companies. In the meanwhile for all municipalities in total that means that plots, or taxes, merely raise less money, just like the sheep became undernourished. For all municipalities it is best to cooperate and prevent a race-to-the-bottom, but in practice the marginal benefit of attracting an extra company might be bigger than the cost. The rational outcome in this real estate market is evidently not the optimal outcome.

A way out in these situations is a so-called social planner that interferes to achieve the optimal outcome. This social planner can achieve the optimal outcome for example by getting parties to the table, ‘decreeing’ the preferred outcome or by fining parties that do not cooperate. Nobel Prize winner Elinor Ostrom has written extensively about governing these commons.