01 environmental economics

8/12/2019 01 Environmental Economics

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How much is clean air worth?

Can you charge somebody fordamaging your air?

How much are you willing to pay for

clean air? Should you have to pay for clean air?


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Have you ever caught a fish off the sea?

Is cutting down the rainforests efficient? What market incentives are there for

research on the environment?

How can the environment be priced and

Does Indonesia have any mechanisms forvaluing its environment?


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Lecture Objectives:

Review Advantages and Limitations ofMarket Economics

Understand how economics is creatingnew principles and guidelines for

business activity.


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Comparing:

Neo-classical Economics

Environmental Economics

Ecolo ical Economics

To reveal policy implications


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"Environmental Economics" should not be confused with"Ecological Economics."

The two fields are related, but are in some ways very different.Most environmental economists have been trained aseconomists. They apply the tools of economics to addressenvironmental problems, many of which are related to so-calledmarket failures--circumstances wherein the "invisible hand" ofeconomics is unreliable.

,but have expanded the scope of their work to consider theimpacts of humans and their economic activity on ecologicalsystems and services, and vice-versa. This field takes as itspremise that economics is a strict subfield of ecology. Ecological

economics is sometimes described as taking a more pluralisticapproach to environmental problems and focuses more explicitlyon long-term environmental sustainability and issues of scale.


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What is an economy supposed to

do?

What is the Neo-classical

approach?


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What is a market?

A system of exchange


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What is exchanged?

Resources: land, labor, capital

(ie. goods or services in some

orm


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How does the market work?

Matchin of su l anddemand


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Why is the market such a good system?

Optimal use of resources: buyers force

competition on suppliers; greatest return for theefforts of suppliers

Pareto efficiency: a situation where it isimpossible to make one person better off without

making anyone else worse off Meaning: allocation of resources to the uses

that will bring the greatest overall increase inproduction and monetary value by matching

producers with the highest bidders


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What enables the

market to work?

Price or Value setting

Profit motivePrivate property

Government and otherregulating institutions


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Does the market operate

perfectly?

1. General Market Failures:

Monopoly;

information as mmetr missing markets;

transaction costs.

k l


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Market Failures What company did you buy your air from?

How much did you pay for your air? How was thatprice set?

How clean was the air you bought? How do youknow?

How can a com an sto other com anies fromdirtying its air? What can you do if someonemakes your air dirty after you bought it?

What rate of return should a company expect to

get from investing in air quality?


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2. Environmental Market Failures:

Failure to value the environment:

unpriced use values; option values; existencevalues; bequest values

Lack of information

Common Access Resources/Sinks

Discounting the future

Missing Markets


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Externalities

An unintended cost or benefit ofproduction or consumption that is not

reflected in the price of the relatedransac ons. x erna es are o enborne by people who are not parties tothe transactions that create them.


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Externalities

Define the externalities of yourcompany: who are the parties to the

monetary transaction and who or whatpays or e mpac s o e ransac on


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Discounting the Future withNet Present Value (NPV)

NPV = x/(1+.10)nyrs

X + your present money value

.

nyrs = the power of how many years down the future

you are looking at

NPV of 100 dollars in five years with a discount rate

of 10% is 100/(1+.10)5 or $62.09


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Environmental Economics: From

Market Failure to Government Failure

Limited information of how to deal withspecific environmental problems (of area orindustry) and of firms capability to deal with

or hide environmental impact Limited resources to regulate, monitor and

enforce

Command and Control regulations:

uniform standards and technologies

P li G id li f E i l E i


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Policy Guidelines from Environmental Economics:

I. Benefits of Using the Market (as

opposed to Command and Control) 1. Cost effectiveness: example, emission

trading credits

2. Substitution and technolo ical advance:example, green taxes

3. Other institution/market based schemes:

deposit refund schemes, environmentalbonds, transferable quotas, transfer ofdevelopment rights.

P li G id li f E i t l E i


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Policy Guidelines from Environmental Economics

II. Better Valuation of Non-

market Valued Assets 1. Financial Costs

2. Averting Behavior For: Better 3. Travel Cost Method

4. Hedonic Pricing

5. Contingent Evaluation

Cost-Benefit

Analysis,

regulations,fines


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Environmental Economics andEcological Economics

Weak vs. Strong

Sustainability


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The Environmental Economics Trade off


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The Environmental Economics Trade-off

Neo-classical Environmental


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Economy H

M

E E

M

S

Recycle?

Empty World

Economy

M

E E

M

S

Recycle

Economics World

Figure 1: The Economy as an Open Subsystem of the Ecosystem

(Daly 1996:49).

S = solar energy H = heat M = matter E = energy

natural capital man-made capital

Ecosystem

Ecosystem H

Ecosystem

Environmental Ecological Economics


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Economy

M

E E

M

S

Recycle

Economics World

EconomyE

M M

E

S

Recycle

Full World

H H

Figure 1: The Economy as an Open Subsystem of the Ecosystem

(Daly 1996:49).

S = solar energy H = heat M = matter E = energy

natural capital man-made capital

EcosystemEcosystem


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Substitutability vs. Complementarity

Manufactured andknowledge capital fornatural capital

Land, labor and capital

Manufactured capitaldepends on natural capital

Uniqueness, uncertainty

Same service bydifferent product

Technological fixes Ecosystem resilience

Ecosystem services

Growth outpaces

substitution Ecosystem fragility

li fl f


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Policy Influences from

Ecological Economics

Strict demands for environmental protection

reflected in:

Environmental impact assessmentNatural preservation areas (parks, reserves)

Absolute limitations on chemicals

P li G id li f


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Policy Guidelines from


1. Daly Rule

2. Index of Sustainable Economice are

3. Ecological tariffs on free trade

4. Community based sustainabilitythrough self-sufficiency anddiversification

P li G id li f


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Policy Guidelines from


1. Daly Rule: "Never reduce the stock

of natural capital below a level that

generates a susta ne y e un ess goo

substitutes are available for the

services generated."

Index of Sustainable Economic Welfare


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Index of Sustainable Economic Welfare

ISEW=

total output+ unpaid work

- environmental destruction anddegradation

- environmental improvementmeasures

- depreciation of human-made

capital+/- welfare distribution effect


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Free Trade Limitations

Regional specialization obscures viewof resource exploitation, depressesecological and social laws, weakens

terms of trade and im overisheslandholders

Externalities from the shipping of goods

around the world Therefore, tariffs to compensate or

reduce free trade


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Community Based Development

Community rather than corporations orgovernment creates social conditions(wants and needs) that limit impacts

Greater self-sufficiency throughdecentralized control

Local synergies for recycling andenergy reduction

Ethical bonds amongst businesscommunity

Summing up:


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Summing up:

Market success in exchange efficiency Market failures in: valuation, common access,

externalities, and discount rate

Environmental economics guidelines: cost

effectiveness and market-based incentives Ecological economics guidelines: limiting

growth to within global and local ecosystems

*therefore reducing throughput of

economy within ecological carrying capacity


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l i l


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Total Economic Value

Total Economic Value

Use Values Non-Use Values

Direct Use Values Indirect Use Values

Consumptive/Extractive Uses

Non-Consumptive/Non-Extractive Uses

Direct values


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Outputs that can be consumed or processed

directly, such as timber, fodder, fuel, non-timber

forest products, meat, medicines, wild foods, etc.

Indirect valuesEcological services, such as flood control,

regulation of water flows and supplies, nutrient

retention, climate regulation, etc.

USE

VALUES

Existence valuesIntrinsic value of resources and landscapes,

irrespective of its use such as cultural,

aesthetic, bequest significance, etc.

Option valuesPremium placed on maintaining resources and

landscapes for future possible direct and indirect

uses, some of which may not be known now.

NON-USE

VALUES

Market PricesDirect values


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Market PricesGoods and products

Indirect values

Ecosystem services

Effect on Production

Replacement Costs

Productivity &

cost-based approaches

Option valuesExistence values

Direct values

Nature tourism

Substitutes

Cost of Avoided

Damage

Travel Costs

Contingent Valuation

Surrogate market & statedpreference approaches

Selecting the appropriate valuation technique


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Selecting the appropriate valuation technique

Environmental Impact

Measurable change

in production

Change in environmental

quality

Yes

Nondistorted market

Habitat

Opportunity-

Air and waterquality

No

Cost-

Health effects

Sickness Death

Recreation

Travel cost

Aesthetic,Biodiversity,Cultural,Historicalassets

Use change-in-

productivityapproach

Use surrogatemarket

approaches,apply shadow

prices tochanges in

production

Yes No Replacement

cost approach

Land valueapproaches

Contingent

Valuation

effectivenessof prevention

Preventive

expenditure

Replacement/relocation

costs

Medical

costs

Loss ofearnings

Human

capital

CEA ofprevention

Contingent

valuationContingen

Valuation

ContingentValuation

Hedonicwage

approach

ContingentValuation

Cost-Revealed Stated


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Surrogate

Market

Approaches

Productivity

Approach

Market

Price

Method

Based

Methods

Preference

Methods

Preference

Methods

Travel

Costs

Hedonic

Pricing

Effect on

ProductionReplacemen

t Costs

Cost of

providingsubstitute

services

Damage cost

avoided

Market

Prices

Contingent

Valuation

Conjoint

Analysis

Choice

Experiments


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Ecosystems products and services

Products

Food Fuel wood Non-timber forest products

Functions/Services

Hydrological services

Purification of water Capture, storage and release of surface

and groundwater

Marine products Wetlands products Medicinal and biomedical products Forage and agricultural products Water

Reeds Building material

Biodiversity

Maintenance of biodiversity (plants andanimals)

Climate

Partial stabilization of climate throughcarbon sequestration

Moderation of temperature extremesand the force of winds and waves

Market Prices/Production


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/Function

Also known as net benefits

Values direct uses, e.g., fisheries, tourism/rec

Uses market rices to determine value Should include both revenue and costs of providing the

service

Example:

Used to estimate the economic value of the commercial reeffishery in Belize~US$1.9mill net return on investment in 1998


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Market Prices

Advantages

Easy to use

Little modelling or statistical analysis

Disadvantages

Many goods/services do not have markets orhave highly distorted markets


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h d


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Change in Production

Advantages

Applicable to a wide range of goods and services

Difficult to collect data to accurately predict bio-physical response relationships

May be other market impacts that need to beincluded, e.g., change productionpriceschangepeople switch to different good

R l C


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Replacement Cost

Values indirect uses, e.g., shoreline protection

Cost of infrastructure for coastal protection is aproxy for the protection provided by coral reefs

Example:

~US$91,000 in coastal defenses had to be built onTarawa Atoll, Kiribati to replace coral reef protection

R l C


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Replacement Cost

Advantages

Simple to apply and analysis

Useful when there is limited time/finances available Disadvantages

Difficult to find perfect replacements that provide thesame quality as the coral reef.

It is questionable as whether (total) expenditure wouldbe made if resource disappeared

A id d D


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Avoided Damages

Also known as Stock at Risk

Values indirect uses, e.g., shoreline protection

Value based on the damage that is avoided by presence ofthe coral reef

This is a proxy for the protection provided by coral reefs

Example:

Annual cost of erosion from coral mining in Sri Lanka ranged from~US$160-172,000/km2 of reef, depending on land prices andlanduses.

A id d D


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Avoided Damages

Disadvantages

Values are hypothetical

Never sure whether the damages wouldever occur

H d i P i i


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Hedonic Pricing

Values non-consumptive direct uses and indirect uses,e.g., shoreline protection, enjoyment of a clean beach andhealthy reef

service (e.g., presence of a reef or clean beach)

Typically uses property values or wage rates

Example: Used to value the benefit of coral reefs on Kihei Coast, Hawaii

65% of total annual reef economic benefitbased on propertyvalue

H d i P i i


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Hedonic Pricing

Disadvantages

Need large data sets and detailed informationon all aspects that affect prices, e.g., distancefrom beach, housing characteristics, nearbyamenities, crime rates, etc.

Relies on assumption that prices are sensitive

to reef quality

T l C t


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Travel Cost

Values direct non-consumptive uses, e.g.,tourism/recreation related benefits

The travel time and cost spent to reach the destination is

construct a demand curve for the coral reef or its services

estimate consumer surplus

Examples:

Total consumer surplus of visitors to Bonaire Marine Park was~US$19.2 million

Value of Vessigny Beach in Trinidad, ~US$202,000

Tra el Cost


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Travel Cost

Disadvantages

Depends on large detailed data sets and

Surveys are expensive and timeconsuming

Reason for traveling to a place may bedifficult to isolatemay not be the reef



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Estimates non-value uses

Uses surveys to determine how much people are:

willingness to pay for a benefit (e.g., improvement in reef condition)

or

willingness to accept to compensate for a loss (e.g., loss in incomefrom reef-related activities)

Examples:

Estimate value of increased coral cover in Montego Bay andCuracao

Estimate consumer surplus for existing reef and reef improvementin Negril Marine Park, Hol Chan & Grand Anse



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Advantages

Doesnt rely on markets or observed behaviour

Applied to any good or service

Disadvantages

Requires large and costly surveys

Complex data sets and analytical techniques

Relies on hypothetical scenarios that may not reflectreality

Highly susceptible to bias as rely on people to state theirpreferences

Gross Value vs Net Benefit


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Gross Value vs Net Benefit

Gross Valueuse revenue only

Net benefitsuse revenue less costs

Net benefits is more correct form ofanalysis

Use net benefits for estimating marginalgains/losses associated with differentconditions of reef health

Economic vs Financial


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Analysis

Economic analysis

uses distortion-free prices to estimate gross revenue/netbenefits (e.g., price without govt subsidy)

Often difficult to get all the required info

Financial analysis

uses observed prices for fuel, labour, etc. to estimate

gross revenue/net benefits

Helps explain how people react

Often used as a first-best proxy for economic analysis

Avoiding Pitfalls


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Avoiding Pitfalls

Use net benefits rather than gross benefits

Include opportunity cost, where necessary

n y use rep acemen cos s n r g c rcums ances

Only use benefits transfer in right circumstances

Dont use estimates of small changes for large

changes

Avoiding Pitfalls


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Avoiding Pitfalls

Be careful of double counting

Only use national benefits when

Adjust price distortions

Do a reality check

Watershed services: supply and demand


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Supply of services:

Upstream land uses affect the Quantity,Quality, and Timing of water flows

Demand for services:

Possible downstreambeneficiaries: Domestic water use Irrigated agriculture Hydroelectric power

Fisheries Recreation Downstream ecosystems

Source: World Bank 2003


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In practice, not so simple


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In practice not so simple

Complex biophysical linkages (Brand 2003)


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Complex biophysical linkages (Brand 2003)


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Use-and non use- of economic valuation to design

payments for ecosystem services


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p y y

Public payments

Costa Rica: $20-44/ha/yr for forest conservation- based on oldsubsidy based on opportunity cost of land use change

USA (Conservation Reserve Program): $50/ha/yr. Opportunity cost

Ecuador: municipal water and electrical utility companies eachdonate 1% of total revenues for watershed protaction (oroginally 5%had been proposed by TNC)

Brazil a water utility in the city of Sao Paulo pays 1% of totalrevenues ($2,500 per month) for the restoration and conservation ofthe Corumbatai watershed. Funds are used to establish tree nurseriesand for reforestation along riverbanks. Payment is outcoem ofpolitical negotiation.

Use-and non use- of economic valuation to design

payments for ecosystem services


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p y y

Private payments

France: US$320/ha/year for 7 years, equivalent to 75% offarm income Opportunity cost and actual cost of switchingagricultural technology

Costa Rica: a hydropower company pays US$10 per ha/year toa local conservation NGO for hydrological services in thePeas Blancas watershed

Australia: Since 1999, farmers in the Murray Darling

watershed pay $AUD 85/ha/yr for forest conservation for 10years or $AUD 17 per million liters of transpired water. Basedon increase in marginal benefits due to reduced soil salinityresulting of 100 ha of reforested area.

Applicability and limitations of economicvaluation


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Economic valuation highlights costs and benefits and cost

bearers and beneficiaries that in the past have been ignored

But for policy makers it may not, and probably will not be, themost important factor. Ecosystem valuation only provides aset of tools with which to make better and more informed

.

Valuation is out of necessity partial. Case studiesunderestimate ecosystem values at larger scale because thelarger scale the more difficult it is to replace the ecosystem

goods and services and interactions are too complex tounderstand impacts of alternatives .

Some ecosystems will never be measurable or quantifiablebecause we do not have the necessary scientific, technical or

economic data


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Key Messages


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It is easy to spend tons of money on valuation.

It is easy to value everything, yet the results of

.

Info on total benefit flows, even if correct, cannotprovide guidance on specific conservation decisionswhich are about making incremental changes inthese flows.

More key messages


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1st. step: ask yourself what is the purpose of theanalysis, who should take its results into account

2nd. ste : what is our bud et can it be ad usted

what capacity is available, which time frame?

3rd. step: which process? Process may be as

important as the result. Consider stakeholders,including policy makers, participation into the study.

01 environmental economics

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