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CERTIFICATE IN ENVIRONMENTAL HEALTH AND SAFETY MANAGEMENT

NATIONAL OFFICEDZIDZO HOUSEENTERPRISE RD SOUTHLONDONDERRY AVENUEEASTLEA, HARARE

P.O. BOX 3733, HARARETELEPHONE: 263-04-705291/2707434 / 796509/ 731478/0779775844/[email protected]

“Bridging the Gap between Theory & Practice

Est. 1957

WRITTEN BY: ISSAC KWESU

CONTENT REVIEWER: NELSON CHANZA

Publisher: ZIMBABWE INSTITUTE OF MANAGEMENT

Coordinator: Dr. S. Karambwe

Editor: E. Muzanenhamo

Layout and Design: E. Muzanenhamo

All rights reserved: No part of this module may be reproduced or distributed in any form without the prior written permission of the Zimbabwe Institute of Management.

Copyright (c) 2013

DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT

Table of ContentsDIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT

MODULE OVERVIEW iii OVERALL MODULE OBJECTIVES iii UNIT ONE 1OCCUPATIONAL HYGIENE AS A SUBJECT 1SUMMARY 4BIBLIOGRAPHY 4

UNIT TWO 5NOISE AND VIBRATION 5SUMMARY 10BIBLIOGRAPHY 11

UNIT THREE 12OCCUPATIONAL HEALTH EXPOSURE LIMITS 12SUMMARY 15BIBLIOGRAPHY 15 UNIT FOUR 17MEASUREMENT OF HAZARDOUS SUBSTANCES 17SUMMARY 22BIBLIOGRAPHY 23

UNIT FIVE 24THERMAL ENVIRONMENT AND NON-IONISING RADIATION 24SUMMARY 30BIBLIOGRAPHY 31

UNIT SIX 32ERGONOMICS 32SUMMARY 36BIBLIOGRAPHY 36

UNIT SEVEN 37ASBESTOS AND OTHER FIBRES 37SUMMARY 41BIBLIOGRAPHY 42

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DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENTMODULE OVERVIEW

OVERALL OBJECTIVES OF THE MODULE

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UNIT ONE

THE NATURE AND SCOPE OF ECONOMICS

1.0 INTRODUCTION

UNIT CONTENTSLearning OutcomesDefinition of EconomicsEconomic systemsMarket EconomyCommmand EconomyMixed EconomyIntroduction to Environmemtal and Resource EconomicsSummaryBibliography

1.2 LEARNING OUTCOMES

By the end of this unit, you should be able to:

Definethetermeconomics List three principles of economics Explain the concept of opportunity cost, and Discuss different economic systems.

1.3 DEFINITION OF ECONOMICS

Economics is a social science which studies human behaviour as a relationship between ends and scarcemeanswhichhavealternativecompetinguses.Itiseasytorememberthedefinitionofeco-nomics by reducing it into three principles ( principles of economics).

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DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT Thefirstprincipleofeconomicsisthatweliveinaworldofscarcity. The second principle of economics is that we have unlimited wants and needs Thethirdprincipleofeconomicsisthatgiventhefirstandthesecondprinciple,wehave to make choices. The problem of limited resources and unlimited wants also applies to society as a whole. Can you think of any societies in which all wants are satisfied? Most societies would pre-fer to have better health care, quality education, higher standard of living and a cleaner envi-ronment. Unfortunately, there are not enough resources available to satisfy all of these goals.

1.4 UNLIMITED WANTS

Human material wants arise for two main reasons. First, each of us has basic biological needs: the need for food, shelter and clothing. But there is also a second reason. Clearly we are prepared to work more than is required to meet our minimum needs. We want more than the basic diet of vegetables and water needed to sustain life. We want more than the mini-mum clothing needed to protect us from the cold. In other words, we want not only the es-sentials that make life possible, but also some of the non essentials that make life pleasant.

1.5 FACTORS OF PRODUCTION

Resources are the basic inputs used in the production of goods and services. Therefore, they are also frequently known as factors of production. Factors of production can be categorized under four main headings: land, labour, capital and entrepreneurship.1. Land includes all natural resources: These natural resources include the land itself, as well as any minerals, oil deposits, timber, or water that exists on or below the ground. This category is sometimes described as including only the “free gifts of nature,” those resources that exist inde-pendent of human action.2. Labour refers to human resources: The physical and mental talents that people apply to the pro-duction of goods and services. The construction worker provides labour, and so does the college professor or the physician. The professor provides educational services and the doctor provides medical services.3. Capital: Refers to the body of materials that has been produced by humankind at some point in time. Examples of capital goods include buildings, equipment and inventory of materials. The use oftheterm“capital”differsfromtheeverydayuseofthisterm.Stocks,bonds,andotherfinancialassetsarenotcapitalunderdefinitionofthisterm.Theproductionandaccumulationofcapitaliscalled investment. Unlike consumer goods (such as food or shoes), capital or investment goods are not produced to satisfy human wants directly. Rather, they are intended for use in the produc-tion of other goods. Capital can be distinguished from land. Land is given by nature, while capital ismadebyhumankind.Landisfixedinsupply(youcannotcreateanothersunoranotherplanetearth) while capital can be increased in quantity. Land has zero cost of production (it takes people nothing to create land apart from the rental exchange charges).

4. Entrepreneurship is derived from the French word entrepreneur, which means “someone whoundertakes.”Morespecifically,itmeanssomeonewho: a) organizesproduction,bringingtogetherthefactorsofproduction:landlabourand capital to make goods and services b) makesbusinessdecisions,takingtheinitiativeandfiguringoutwhatgoodsto produce and how to produce them c) takes risks, knowing that there is no guarantee that business decisions will turn to becorrect.Ifthebusinessiscorrecttheentrepreneurreapsallprofitand,ifwrong, the entrepreneur bears all the risk or losses, and d) innovates, introducing new ideas, new products, and new ways of organising business.

1.6 THE CONCEPT OF SCARCITY, CHOICE AND OPPORTUNITY COST

Economicsis,generally,defined,asthestudyofhowourlimitedresourcesareallocatedtosatisfyour unlimited wants for goods and services. The combination of limited resources and unlimited wants implies a shortage, or scarcity. Scarcity forces us to make choices. Whenever we make choices, we give up something else that we also desire. Scarcity requires choice and implies costs. A scarce resource used to satisfy one need means there is some other need that is foregone. The use of scarce resources to produce a good is always costly. Costs may be hidden, or non-monetary, or delayed, but there is always a cost. Economists use opportunity cost as a broad concept of cost that involves monetary and non-monetary, implicit and explicit cost. Opportunity cost can bedefinedasthenexthighestvaluedalternativethatmustbesacrificedasaresultofchoosingan alternative option. It is the real as opposed to mere monetary cost of an economic choice.

ExamplesAll economic agents face the problem of scarce resources. Take the following scenarios:(a)Ahouseholdfamilyhasmanythingstobesatisfiedbyitslimitedmonthlyincomee.g.itmaywantto pay school fees for its children while at the same time it wants to paint its house. If the income isnotsufficienttomeetboththedemandsthenithastochooseamongstthesetwoalternatives.Assume for some reasons it opted for the school fees then it implies no painting of the old house. In this case the real cost (opportunity cost) of the school fees is the painting of the house forgone.(b) Simplest case is when we have to choose between A and B (work full-time or go to school full-time, go to movie A or movie B, vacation at destination A or B, choose between friend A or B, choose between job A or B. In all these cases, the opportunity cost of A is option B forgone.

1.7 ECONOMIC GOODS, FREE GOODS, AND ECONOMIC BADS

A good is said to be an economic good (also known as a scarce good) if the quantity of the good demanded exceeds the quantity supplied at a zero price. In other words, a good is an economic


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good if people want more of it than would be available if the good were available for free. A good is said to be a free good if the quantity of the good supplied exceeds the quantity de-manded at a zero price. In other words, a good is a free good if there is more than enough available for everyone even when the good is free. Economists argue that there are rel-atively few, if any, free goods. There is an opportunity cost associated with consump-tion of an economic good, but there is no opportunity cost with consumption of a free good.

For example, if you take a drink of water from the Zambezi River, you are not denying some other use of that water. There is enough to go around. But the doctor you see to treat you for an illness from drinking polluted water is not free because the doctor’s time is no longer available to satisfy the needs of another sick person. An item is said to be an economic bad if people are willing to pay to avoid the item. Examples of economic bads include things like garbage, pollution, and illness.

ACTIVITY

DEFINE THE TERM ECONOMICS.

LIST AND EXPLAIN THE CATEGORIES OF FACTORS OF PRODUCTION.

DISCUSS THE CONCEPT OF OPPORTUNITY COST.

1.8 ECONOMIC SYSTEMS

An economic system is an institutional arrangement of a country’s production system. In simple terms think of an economic system as the way in which a country’ production and distribution systems are organized. An economic system answers the central economic problem manifested in questions such as: Whoistoproduce-i.e.whoownsthescarceresources?Isitthestateortheprivate individuals?Thisistheownershipquestion. How to produce - i.e. the determination of the mix of resources that are to be used to produce output. This is the production question. Whattoproduce-i.e.whatmixofgoodsandserviceswillbeproduced?”Thisisthe product question. Forwhomtoproduce?-i.e.whogetswhat?”Thisisthedistributionquestion.Inamarket economy, this is determined by the interaction of buyers and sellers in both output and re source markets.

1.9 TYPES OF ECONOMIC SYSTEMSThere are three main types of economic systems. These are market economy, command economy and mixed economy.

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(A) MARKET ECONOMY

A market economy is a production system whereby private individuals own the factors of pro-duction: the land and capital. The role of the government in this system is very minor. A pure market economy (a concept that is idealist) is when there is complete absence of government or central planning. In a market economy, production and distribution activities are decentralised to private individuals. Production is regulated by price and distribution is coordinated by the market mechanisms. The incentive of individual behaviour is self-interest. Firms will produce goods if theycanmakeprofit,whilsthouseholdswillonlybuyiftheybenefitorgainsatisfaction(utility).Because of its features, a market economy is also called capitalism, lasses-faire (do it yourself) or freehold economy. Examples of economies that practice capitalism include the USA and Japan.

(B) COMMAND ECONOMY

In a command economy, the factors of production (land and capital) belongs to the State. Under this system, all decisions pertaining to what, how and for whom to produce are centralised by the government. The central planning authority will, at its discretion, determine the type and quantity of goods a country can produce and consume at each point in time. The role of the consumer is very minor. Rationing and waiting lists are used to try and solve the problem of scarcity and short-ages. The command economy is also called communism, centralization or collectivism. Examples of economies that practiced communism include China and Cuba and former communist states are Poland, Bulgaria, East Germany, Hungary, Yugoslavia, Czechoslovakia and the USSR (now Russia).

(C) MIXED ECONOMY

In a real situation, there are no pure market economies. There is no economy that can exist in isolation to the government. The government has a duty to regulate the economy and correct market failures such as providing public and merit goods, regulating monopoly activities and unfair competition, regulating externalities (spillovers) and equitable distribution and redistribution of wealth. An economic system that has features of both market and command economies is called a mixed economy. A good example is the United Kingdom. Therefore, a mixed economy combines the market mechanisms with government directives to determine economic outcomes. There are certainservicesthatdonotworkwellinthemarketsystemsuchasdefense,policeandfireprotec-tion. These are commonly referred to as market failures and become part of the public sector.

1.10 PITFALLS TO AVOID IN ECONOMIC THINKING

The fallacy of composition occurs when one incorrectly attempts to generalise from a relationship that is true for each individual, but is not true for the whole group. As an example of this, note that any person can get a better view at a concert by standing (regardless of the actions of those in front of him or her). It is incorrect, though, to state that everyone can get a better view if everyone stands.

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Similarly, one would commit the fallacy of composition if one were to claim that, since anyone could increase his or her wealth by stealing from his or her neighbours (assuming there is no detection), that everyone can become wealthier if everyone steals from their neighbours. The association as causation fallacy, also known less technically as the post hoc, ergo propter hoc fallacy, occurs if one incorrectly assumes that one event is the cause of another simply because it precedes the other event. For example, a situation where unemployment increases just after the government announces an increase in its budget expenditure and people start to consider unemployment as resulting from an increase in government expenditure.

1.11 INTRODUCTION TO ENVIRONMENTAL AND RESOURCE ECONOMICS

I.11.1 RESOURCE TAXONOMY

For pedagogical purposes, we can categorise natural endowment of resources into three types: (i) Natural resources a). Resources that can be subdivided into smaller units. Example: barrels of oil, pounds of fish,andcubicfeetofwood.b). To utilise these resources, one needs to employ other inputs, like labour, capita and energy. c). They belong to one of the two types:

Exhaustible resources Exhaustible resources have fixed stocks available, and the regeneration of stock is negligible.As they are extracted, their stock starts depleting, and the cost of extraction may increase with depletion of stock. The complete physical or economic depletion of stock is certain if extraction continues; economic depletion is the depletion of stock to a level where further extraction is not economically feasible. Examples are oil, metals, and coal. Renewable resourcesThe stock of a renewable resource has a regeneration capability, and the rate of regeneration could beafunctionofthecurrentstocksize(example:fish)ortheageorthetimeallowedforgrowth(example: tree). A renewable resource may become extinct if the rate of extraction continuously exceeds the rate of regeneration.

(ii) Environmental resourcesa). These resources are indivisible. Examples are ecosystem, ozone layer, and ambient air or wa-ter. b). They are examined at the margin qualitatively but not in terms of quantity.c). These resources are not consumed directly but the services they provide.

(iii) Resource flowsa).Theseresourcesdonotexistasastock;theyareavailableasnever-endingflows.Ex.

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Solar energy, wind power b). There is no issue of exhaustion or regeneration.c).HumanconsumptionoractionhasnoeffectonstockorflowavailableinthefutureSomeresourcescanbeclassifiedinmorethanonegroup.Forexample,individualtreesarerenew-able natural resources in the form of the timber they provide, but collectively, they are a part of the forest ecological system and hence, an environmental resource.

1.12 WHAT IS ENVIRONMENTAL ECONOMICS?

Environmentaleconomicsisthesubsetofeconomicsthatisconcernedwiththeefficientallocationof environmental resources. The environment provides both a direct value as well as raw material intended for economic activity, thus making the environment and the economy interdependent. For that reason, the way in which the economy is managed has an impact on the environment which, in turn, affects both welfare and the performance of the economy. One of the best known critics oftraditionaleconomicthinkingabouttheenvironmentisHermanDaly.Inhisfirstbook,Steady-State Economics, Daly suggested that “enough is best,” arguing that economic growth leads to environmental degradation and inequalities in wealth. He asserted that the economy is a subset of ourenvironment,whichisfinite.Thereforehisnotionofasteady-stateeconomyisoneinwhichthere is an optimal level of population and economic activity which leads to sustainability. Daly calls for a qualitative improvement in people’s lives – development – without perpetual growth.

Today, many of his ideas are associated with the concept of sustainable development.By the late 1970s, the late economist Julian Simon began countering arguments against eco-nomic growth. His keystone work was The Ultimate Resource, published in 1981 and updated in 1996 as The Ultimate Resource 2, in which he concludes there is no reason why welfare should not continue to improve and that increasing population contributes to that improve-ment in the long run. His theory was that population growth and increased income puts pres-sure on resource supplies; this increases prices, which provides both opportunity and incen-tive for innovation; eventually the innovations are so successful that prices end up below what they were before the resource shortages occurred. In Simon’s view, a key factor in economic growth is the human capacity for creating new ideas and contributing to the knowledge base. Therefore, the more people who can be trained to help solve arising problems, the faster ob-stacles are removed, and the greater the economic condition for current and future generations.

Environmental economics takes into consideration issues such as the conservation and valuation of naturalresources,pollutioncontrol,wastemanagementandrecycling,andtheefficientcreationofemission standards. Economics is an important tool for making decisions about the use, conserva-tion, and protection of natural resources because it provides information and the likely outcome of environmental and other policies. Since resources – whether human, natural, or monetary – are notinfinite,thesepublicpoliciesaremosteffectivewhentheyachievethemaximumpossible

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benefit in themostefficientway.Therefore,one jobofpolicymakers is tounderstandhowre-sourcescanbeutilizedmostefficientlyinordertoaccomplishthedesiredgoalsbyweighingthecostsofvariousalternativestotheirpotentialbenefits.

In competitive markets, information exists about how much consumers value a particular good be-cause we know how much they are willing to pay. When natural resources are involved in the pro-duction of that particular good, there may be other factors – scarcity issues, the generation of pol-lution – that are not included in its production cost. In these instances, scarcity issues or pollution become externalities, costs that are external to the market price of the product. If these full costs were included, the cost of the good may be higher than the value placed on it by the consumer.A classic example of an externality is discussed in Garrett Hardin’s Tragedy of the Commons, which occurs in connection to public commons or resources – areas that are open and accessible to all, such as the seas or the atmosphere. Hardin observed that individuals will use the commons more than if they had to pay to use them, leading to overuse and possibly to increased degradation.There are three general schools of thought associated with reducing or eliminating environmen-talexternalities.Mostwelfareeconomistsbelievethattheexistenceofexternalities issufficientjustificationforgovernmentintervention,typicallyinvolvingtaxesandoftenreferredtoasPigov-ian taxes after economist Arthur Pigou (1877-1959) who developed the concept of economic externalities. Market economists tend to advocate the use of incentives to reduce environmental externalities, rather thancommand-andcontrol approaches,because incentivesallowflexibilityin responding to problems rather than forcing a singular approach on all individuals. Free mar-ket economists focus on eliminating obstacles that prevent the market from functioning freely, which they believe would lead to an optimal level of environmental protection and resource use. The key objective of environmental economics is to identify those particular tools or policy al-ternatives thatwillmove themarket toward themost efficient allocationof natural resources.

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1.13 WHY STUDY NATURAL RESOURCE ECONOMICS AS A SEPARATE FIELD? Primarily for four reasons:

(i)Natural resources often involve dynamic decisions Time is an element in the decision. Microeconomics mostly talks about static decisions (this period’s de-cisionhasnoeffectonthenextyear’sdecision).But,whenitcomestotheextractionofoilfromafixedstock or reserve in oil wells, a decision of how much to extract this year affects how much stock remains for extraction in future years. Therefore, decisions are not time independent in natural resource economics.

(ii)Current decisions may have irreversible consequences Excessharvestingmayleadtoextinctionoffishspecies.Denudationofforestscanpermanentlydamage the ecosystem.

(iii)Market failure is common in natural resource economics In microeconomics there is emphasis on learning behavior of perfectly competitive markets; market failureiscoveredasanexceptiontotheruleofeconomicefficiencyofperfectcompetition.But,intheutilization of natural/environmental resources, one more generally observes market failure, which, there-fore, needs to be learned more deeply. Examples are leeching of acids during mining activities and the absence of market price and/or public good nature of certain resources which may be ignored by a market.

(iv)Natural resource economics requires multi disciplinary knowledge Whenonethinksofutilizationoffisheryortimberforestry,itbecomesnecessarytointegratethebiologicalgrowthprocessoffishortreesintotheeconomicmodel,formakingefficientharvestingdecisions.

1.14 BROAD ISSUES OF DISCUSSION IN NATURAL RESOURCE ECONOMICS

(i) Resources are scarce; there is no argument. The primary focus of the course would be on learn-ingmodelsandprinciplesofdeterminingefficientrateofutilizationofresourcesandonexploringpublic policy alternatives to correct any market failures, especially in the context of current issues related to natural resources.(ii)Areresourcesgettingmorescarceovertime?Whatistheevidencepresentedbyeconomicsliterature?Wewilllearnabouteconomists’perspectiveandrecommendationsabouttheissueofsustainability.

1.15 ECONOMICS APPROACH

Howdoeconomistslookatresources?Someofyoumaydisagreewiththeeconomicsapproach;many ecologists disagree. The economics approach looks at a natural resource as an input

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or amenity or life-support mechanism which needs to be used to maimize the collective welfare of thesocietyofhumanbeings.Therefore,thisapproachestimatesbenefitsandcostsofaresourcetohumansandanybeneficialordetrimentaleffectonotherbeingsorspeciesisaccountedwithvalues estimated by humans. Hence, economics approach is completely human centered, anthro-pocentric.Economistsrecommendutilizingaresourceifitsmarginalbenefitexceedsmarginalcostandkeeputilizinguntilthemarginalbenefitbecomesequaltomarginalcost,forattainingmaximumnetbenefitfortheuseofresource.Ontheotherhand,ecologistsandenvironmentalistsattimesargue for the principle of minimum interference with nature and for preservation of a resource, regardless of the cost of preservation and regardless of the importance of resource to people.

1.15 IMPORTANCE OF PRIVATE PROPERTY RIGHTS

Efficientfunctioningofacompetitivemarketassumestheexistenceofasystemofprivateprop-erty rights. Most market failures in the utilization of natural resources arise from the lack of a well-functioningprivateproperty right system.Onlywhenanownerhasawell-definedprivateproperty right, (s)hewouldhave the incentive tomakethemostefficientuseof theresource.

There are four main characteristics of an efficient property right system:(i) Universality Resourcesareprivatelyowned,andentitlementsarecompletelyspecified.(ii) Exclusivity Allbenefitsandcostsaccruedfromowningandusingaresourceshouldaccruetothe owner and only to the owner, either directly or indirectly by sale to others.(iii) Transferability Property right should be transferable from one owner to another in a voluntary exchange.(iv) Enforceability Property right should be secure from involuntary seizure or encroachment by others.Common property resources and/or open access resources lack universality characteristics. The ecologicalbenefitsofaforestarenotonlyaccruedtotheforestowner,butalsotoothers;thus,forests lack exclusivity characteristics.

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ACTIVITY

COMPARE AND CONTRAST MARKET ECONOMY AND COMMAND ECONOMY.

GIVEN THE ANALYSIS PRESENTED IN THIS MODULE, WHICH ECONOMIC SYSTEM WOULD YOU RECOM-MEND FOR ZIMBABWE AND WHY?

1.16 BIBLIOGRAPHY

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1.15 SUMMARY

UNIT TWO

MARKET AND PRICE MECHANISMS

2.0 INTRODUCTION

UNIT CONTENTSLearning Outcomes


By the end of this Unit, you should be able to:

Explain the functions of price, Definedemand, Explain the law of demand, Defineandexplainthelawofsupply, Explain the conditions of demand and supply, Explain how price is determined on a market, Determine the impact of changes in conditions of the market on price, and Discuss the effects of price controls.

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2.3 MARKETS AND PRICES Allmarketparticipantsattempttosatisfyspecificgoals.Everyrationalconsumertriestomaximisesatisfaction. She can’t afford everything, so choices (tradeoffs) must be made about how to spend his scarce dollars. Every market transaction involves an exchange and thus some elements of both supply and demand.In a factor market, a factor of production is exchanged. Participants buy or sell land, labour, capi-tal, or entrepreneurial skill that can be used in the production process. Consumers are sellers in the factor market. Businesses (and government) are buyers in the factor market. Goods are produced from the product market. Consumers are buyers in the product market. Businesses (and government) are sellers in the product market.

2.4 ROLE OF PRICES IN THE MARKET

The scope of a market is the area over which a single price prevails. Price serves the following functions, namely transmission of information, correctly influence incentives, and coordinatingeconomic activity between buyers and sellers

(a) Transmit Information - Information content of pricesAn individual’s dollar expenditure transmits very valuable information about his preferences. We tell producers/suppliers what we like by what we spend money on and how much we spend. If we want to see whether people like Lee or Levis jeans, we look at how much they spend. Spending money transmits very valuable information to producers about what we like. Suppliers are able to extract our desires through the price system. Prices are a measure of relative scarcity, they trans-mit very valuable information about the relative scarcity of a good.

(b) Prices correctly influence incentives Market prices create an atmosphere of incentives that motivate people. Prices are the foundation of theprofit/loss system that createsa reward/penalty systemoforganisations.Marketpricesfor our labour service motivate us to study and prepare for years through education and training to develop our human capital. If prices change, incentives change automatically and behaviour changes are always correct. At a higher price, suppliers are willing to supply more of a good.

(c) Prices coordinate economic activity between buyers and suppliersPricesandprofitsguidethe invisiblehandofself-interestandmaximiseconsumersatisfaction,optimise production and maximise our standard of living. Prices are the basis of the self-correcting mechanism of the free market by transmitting valuable, accurate information as part of the feed-back loop of the market.

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2.5 THE CONCEPT OF DEMAND

Demand can be defined as thewillingness and ability to possess a good at given prices overa given period of time, ceteris paribus (holding all other factors constant). Demand is not a mere wish. Effective demand is demand backed by money (ability to pay a price). When econ-omists talk of demand, they will be referring to planned demand and not realised demand. Planned demand is what you are prepared to buy and realised demand is what you actually buy.(a)Effective demandOnly when the consumers’ desire to buy something is backed up by willingness and an abil-ity to pay for it do we speak of demand. To emphasize this point economists use the term ef-fective demand. There are an unlimited number of human wants and needs - but in the market-place these can only be bought / purchased if there is sufficient purchasing power.(b)Latent demandLatent demand exists when there is willingness to purchase a good or service, but where the consumer lacks the real purchasing power to be able to afford the product. Latent demand is affected by per-suasiveadvertising-wheretheproducerisseekingtoinfluenceconsumertastesandpreferences.

2.5.1 THE LAW OF DEMAND

The Law of Demand simply proposes that as the price of a good declines, the quantity you would be willing and able to purchase during some period of time increases, given that every-thing else remains unchanged. Conversely, less of a good would be demanded as its price rises. When we described the Law of Demand, we made a statement: given that everything else re-mains unchanged. This is referred to as the ceteris paribus assumption. This is not an assump-tion we make for convenience, but is a necessary condition for each law to hold. When we draw a demand curve, we hold constant the many other variables that can affect it such as income.

2.5.2 DEMAND SCHEDULE

We can represent a single person’s decision about how many kilograms of beef to purchase over a month in a table called a demand schedule:

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Table 2.1: Single Consumer Demand Schedule

Average Priceof Beef

$5 0$4 2$3 4$2 5$1 8

QuantityDemanded (kg) per month

The demand schedule we presented above is for one individual consumer. But what we are really interested in is the total demand for a particular good or service for all the consumers in an econo-my. This is called the market demand curve. To derive a market demand schedule we add up all the individual demand schedules. If the demand schedule for each consumer conforms to the Law of Demand, then the market demand schedule will also conform to the Law of Demand. For example, let’s assume we have a market that has only three consumers: Susan, Melissa, and Prince. We create a market demand schedule by adding up the quantities demanded at each price by each consumer:

Table 2.2: Market Demand Schedule

Average priceof beef per kg

Total (market demabd) per month

Quantity purchased by

Susan Prince Mellissa

$5 0 1 0 1

$4 2 2 1 5

$3 4 3 2 9

$2 5 4 3 13

$1 8 5 4 17

Themarketdemandscheduleappliestoaspecificpopulationandtoaspecifictimeperiod.

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2.5.3 DEMAND CURVE

A demand curve is a graphic representation of the market demand schedule or the Law of Demand. The demand curve represents the quantities of a good or service that consumers are willing and able to purchase at various prices. By tradition, the demand curve is drawn with prices on the vertical or y-axis and quantities demanded on the horizontal or x-axis. The demand curve slopes down to right based on the Law of Demand. Using our market demand schedule for beef above, we can draw a demand curve with price on the vertical axis (y-axis) and quantity demanded on the horizontal axis (x-axis).

Figure 2.1

Figure 2.1 above shows that when price decreases from $4 to $3 per kg quantity de-manded will increase from 5kg to 9kg per month.

The Law of Demand implies the following with respect to a demand curve (all of these say exactly the same thing): The demand curve is downward sloping. The demand curve has a negative slope. The demand curve shows an inverse relationship between price and quantity demanded.

2.5.4 WHY A DEMAND CURVE SLOPES DOWNWARDS

There are two reasons why a demand curve is downward sloping:The Income Effect: There is an income effect when the price of a good falls because the consumer can maintain current consumption for less expenditure. Provided that the good is normal, some of the resulting increase in real income is used by consumers to buy more of this product. The Substitution Effect: There is also a substitution effect when the price of a good falls because

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the product is now relatively cheaper than an alternative item and so some consumers switch their spending from the good in competitive demand to this product. Tutorial note: The demand curve is normally drawn in textbooks as a straight line suggesting a lin-ear relationship between price and demand but in reality, the demand curve will be non-linear! No business has a perfect idea of what the demand curve for a particular product looks like, they use real-time evidence from markets to estimate the demand conditions and they accumulated experi-ence of market conditions gives them an advantage in constructing demand-price relationships.

2.5.5 CHANGE IN DEMAND VERSUS CHANGE IN QUANTITY DEMANDED

A change in price will lead to a movement along a stable demand curve and result in a change in the quantity demanded. For example, more of a good would be purchased, but only at a lower price. The only thing that can change the quantity demanded is a change in the market price. If one of the ceteris paribus assumptions is relaxed (e.g., a change in income) there will be a change in demand. Economists use the term “demand” to refer to the entire demand curve. A change in demand is a shift of the demand curve in response to a change in one of the variables assumed to be held con-stant under the ceteris paribus assumption (e.g., income), holding the good’s price constant. Con-sequently, when we say there has been an increase in demand, we mean that the entire demand curve has shifted to the right. A decrease in demand is explained by the leftward shift of the demand curve.Thefigure2.2belowshowshowdemandincreasesordecreaseswhenincomechanges.Asincome increases (holding the price of beef at $3 per kg) demand curve will shift to the right from the original curve D0 to the new curve D2 the demand for beef increases to from the original 9 kg to 13kg per month. Alternatively, a decline in income without changing the price of beef will result in the demand curve to shift to the left (D1) and demand for beef will decline to 5kg per month.

Figure 2.2: Shift of Demand Curve

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2.5.6 CONDITIONS OF DEMAND

Apart from price, there are other factors of demand. Apart from the price, there are other factors of demand. Conditions of demand include size of the market and consumer tastes, income, prices of other related goods, weather and climatic conditions, government policy, international effects, expectations, and availability of credit facilities.

1. Size of the Market and Consumer TastesIf the number of consumers in the market increases, such as from population growth, there should be a greater number of willing and able buyers at some given price. This implies that market demand will increase and the market demand curve shifts to the right. A similar out-come results if there is a change in consumer tastes or desire for a particular product. If a product like low-cut jeans becomes the latest fashion fad, demand at any given price will in-crease and the demand curve shifts to the right. On the other hand, if there is a decline in the size of the market or a product becomes unfashionable or obsolete, then the demand curve shiftstotheleft.Consumertastescanbeinfluencedbyadvertisementorconsumerinterdepen-dence (social effect). For example, some consumers always want to conform to group behav-iour (band wagon effect), whichmeans their fashion and tastes are influenced by what ma-jority will be consuming. The second group is those who always refrain from consuming what the majority demands (snob effect). These people seek dignity and respect by being different.

2. Income: Normal Versus Inferior GoodsFor normal goods, an increase in income means a consumer will purchase more of the good at a particular price, which would cause the demand curve to shift to the right. But there are inferior goods for which an increase in income leads to a decrease in demand. We may com-pare the effect of an increase in the quantity purchased for a premium brand ice cream with a generic store-branded ice cream. As your income increases, you may begin to purchase more premium ice cream and less of the lower quality generic store-branded ice cream. The premi-um ice cream is a normal good while the generic store-branded ice cream is an inferior good.

3. Prices of Related Goods: Complements versus Substitutes in DemandThe demand for one good can be affected by the price of another related good. For example, consider demand for petrol. The demand for petrol not only depends on the price of petrol but also on the demand for or price of cars that use petrol. As the price of cars increases quantity less card will be demanded and less petrol will a be demanded as well. This is an example of complements in demand (joint demand). Of course, not all products complement each other. Some products may compete with each other like butter and margarine. As the price of butter increases, some people will reduce their purchases of butter and switch to margarine instead. As the price of butter increases, the demand for margarine will increase and the demand curve for margarine will shift to the right. This is an example of substitutes in demand (competing demand).

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Table 2.3: Changes in the Price of Related Goods

Nature of goods

Complements

Substitutes

Change in Price of Good B

Increase

Increase

Change in Demand for Good A

Decrease (shift left)

Increase (shift right)

Example

beef and rice

Beef and chicken

4. Weather and Climatic ConditionsDemandforcertainproductscanbe influencedbyweather.Forexample,demandforproductssuch as ice creams is high in summer, whilst demand for items such as jackets or jerseys will be high during the winter season.

5. Government PolicyGovernment legislature can promote or penalize the demand for a product. This is called forced de-mand. For example, the demand for certain drugs decreases as soon the government announces their consumption illegal.

6. ExpectationsIf individuals expect an increase in price, they are likely to buy more of a product today. The opposite is true if price is expected to decline in the near future.

7. Availability of credit facilitiesDemand for most durable goods increases with attractive terms of credit and low interest rates.

2.5.7 EXCEPTIONS TO THE LAW OF DEMAND

The demand for a product does not always vary inversely with the price. There are two possible reasons why more might be demanded even when the price of a good or service is increasing. We consider these briefly – ostentatious consumption and the effects of speculative demand.

(a) Ostentatious consumptionSome goods are luxurious items where satisfaction comes from knowing both the price of the good andbeingabletoflauntconsumptionofittootherpeople!Thedemandfortheproductisadirectfunctionofitsprice.Ahigherpricemayalsoberegardedasareflectionofproductquality

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and some consumers are prepared to pay this for the “snob value effect”. Examples might include perfumes, designer clothes, and top of the range cars. Consider the case of VI which is considered to be the most exclusive perfume in the world. Goods of ostenta-tious consumption are known as Veblen Goods and they have a high-income elastic-ity of demand. That is, demand rises more than proportionately to an increase in income.

(b) Speculative DemandThe demand for a product can also be affected by speculative demand. Here, potential buy-ers are interested not just in the satisfaction they may get from consuming the product, but also thepotential rise inmarketprice leading toa capital gainorprofit.Whenpricesare ris-ing, speculative demand may grow, adding to the upward pressure on prices. The speculative demand for housing and for shares might come into this category and we have also seen, in the last few years, strong speculative demand for many of the world’s essential commodities.

ACTIVITY

LIST AND EXPLAIN THE FUNCTION OF PRICE IN A MARKET ECONOMY.

EXPLAIN THE DIFFERENCE BETWEEN A CHANGE IN QUANTITY DEMANDED AND A CHANGE IN DEMAND.

2.6 THE CONCEPT OF SUPPLY

Supplycanbedefinedasthewillingnessandabilityoffirmstosellaproductatgivenpricesovera given period of time, ceteris paribus.

2.7 THE LAW OF SUPPLY Justasconsumersareinfluencedbyprices,soarefirms,butintheoppositedirection.Consum-erslikelowproductprices,firmslikehighproductprices.Whenproductpricesrise,firmshaveanincentive to employ additional scarce resources to increase production. The Law of Supply states thatfirmswillproduceandofferforsalegreaterquantitiesofagoodorservice,thehigherthemarket price, given that everything else remains unchanged. The theory behind the Law of Supply rests on the principle of increasing opportunity costs. When we produce something, we use the mostefficientresourcesfirst.Asweincreaseproduction,wemustdrawonless-efficientresources,which lead to increasing opportunity costs. We will not increase production and incur those higher opportunity costs unless we can sell our product at a higher price.

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2.7.1 SUPPLY SCHEDULE

Wecancreateindividualfirmsupplyschedulesandamarketsupplyschedulejustaswedidforde-mand. The market supply schedules for beef may look something like the scenario in Table 2.4 below.

Table 2.4: Market Supply Schedule for Beef

Average Priceof beef

Qantity supplied(kg per month)

$5 16

$4 13

$3 9

$2 5

$1 1

2.7.2 SUPPLY CURVE

The supply curve is a graphic representation of the market supply schedule and the Law of Supply. Thesupplycurverepresentsthequantitiesofagoodorservicethatfirmsarewillingtoproduceand sell at various prices. The supply curve slopes upwards to right based on the Law of Supply. As thepriceofagoodincreaserelativetopriceofallothergoods,firmsswitchresourcesandproduc-tionfromothergoods,increasingthequantitysupplied.Thisisillustratedbyinfigure2.3below.

Figure 2.3

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The Law of Supply ceteris paribus (everything else unchanged) assumption means the following do not change: Prices of inputs to the production process (labour, raw materials, cost of capital). Technology. The prices of other products from the same resources or production process.

This does not mean these factors cannot change. The importance of a change in each of these variables will hopefully become clearer later.

2.7.3 CHANGE IN SUPPLY VERSUS CHANGE IN QUANTITY SUPPLIED

Just like on the demand side, we have introduced two different ways that the production quantity ofagoodcanchange.Again,wemusthighlightthespecificlanguagewehaveusedtodistinguishbetween the two: First, we said that according to the Law of Supply that a change in price will lead to a movement along a stable supply curve and result in a change in the quantity supplied. For example, more will be produced for sale, but only at a higher price. Second, we said that if one of the ceteris paribus assumptions is violated or relaxed (e.g., a change in technology) there will be a change in supply. Economists use the term “supply” to refer to the entire supply curve. Consequently, when we say there has been an increase in supply, we mean that the entire supply curve has shifted to the right. More will now be produced at the same price.

Figure 2.4 Shifts of the Supply Curve

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2.7.4 CONDITIONS OF SUPPLY

Conditions of supply are non-price factors of supply. Conditions of supply include cost of produc-tion and changes in technology and prices of other products from the same production process.

1. Cost of production and changes in technologyCosts of production relate to the costs of the human and non-human inputs to the pro-duction process. An increase in the costs of inputs,, such as raw materials, energy, or la-bour, will shift the supply curve to the left. For example, as the price of fertilizer goes up, somefarmerswillfind itno longereconomicalandviable togrowwheat.Atsomegivenpriceless wheat will be produced. Costs of production can also decline, such as from the ben-efits of technological innovation. With improvements in technology and lower productioncosts, the supply curve will shift to the right. At some given price, more will be produced.

2. Prices of Other Products from the Same Production ProcessMany production processes yield more than one product from the same inputs. For example, crude oilisrefinedintopropane,petrol,diesel,heatingoil,andotherrelatedproducts.Thesearebyprod-ucts of the same production process and are referred to as complements in production. If the price ofjustoneofthebyproductschangesthisaffectstheprofitabilityoftheentireproductionprocessand the economics of producing all of the byproducts is affected. When the price of petrol increases, oilrefinershaveanincentivetoincreasetheircrudeoilrefineryprocessingratestoproducemore.This also yields increases in the output of all the other by products. An increase in the market price of petrol leads to an increase in supply (shift of the supply curve to the right) of the propane, diesel fuel, and heating oil products. Substitutes in production, on the other hand, are goods that are pro-duced as alternatives to each other using the same inputs to the production process. For example, wheatandryegrainsaresubstitutesinproductionwhereeitherisgrownonthesamefield.Iftheprice of rye grain increases, farmers have incentive to switch from growing wheat to growing rye. As the price of rye increases, the supply curve for its substitute in production, wheat, shifts to the left.


Table 2.5: Changes in the Price of Related Goods

Nature of the goods

Complements

Substitutes

Change in price of Good B

Increase

Increase

Change in supply of Good A

Increase(shift right)

Decrease (shift left)

Example

Beeef and leather

Rye and wheat grains

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ACTIVITY

DEFINE THE TERM SUPPLY.

EXPLAIN THE DIFFERENCE BETWEEN A CHANGE IN QUANTITY SUPPLIED AND A CHANGE IN SUPPLIED

2.8 MARKET PRICE DETERMINATION AND DEMAND-SUPPLY EQUILIBRIUM

When we combine a demand curve and supply curve on the same graph we create a model of demand and supply equilibrium. The model helps explain how prices and quantities are determined in a market.

2.8.1 MARKET EQUILIBRIUM

A market is in equilibrium when the quantity demanded is equal to quantity supplied at the mar-ket price. When a market is in equilibrium, there is no tendency for price or quantity to change. Themarketequilibriumforbeefcanbeidentifiedinourmarketdemandandsupplyschedules.

Table 2.6 Market Demand and Supply Schedules for beef

Average price of beef

Quantity demanded

Quantity supplied

Explanation

$5 1 17 Excess supply

$4 5 13 Excess supply

$3 9 9 Equilibrium

$2 13 5 Excess demand

$1 17 1 Excess demand

A more convenient depiction of market equilibrium is where the demand and supply curves intersect. When a market price is below or above the equilibrium level, there will be an imbalance (disequilibria) between the quantity demanded and the quantity supplied.

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2.8.2 EQUILIBRIUM PRICE

Equilibrium price is the price at which the quantity demanded is equal to the quantity supplied. Other things being unchanged, there is no tendency for this price to change. How can you tell if the mar-ketisnotinequilibrium?Theeasiestwayforthefirmtotellisbymonitoringitsinventory.Whenthequantity supplied is not equal to the quantity demanded at the current market price there is either undesiredinventorybuildorundesiredinventorydecline.Storeshelvesstartoverflowingbecausethefirmisproducingmorethanisbeingsoldorthestoreshelvesgobarebecausepeoplearebuy-ingtheproductfasterthanthefirmcansupply.Whatprocessoccurstobringthemarketbackintoequilibrium?Simple,themarketpriceadjusts.Whenthequantitysuppliedbyfirmsisgreaterthanthe quantity demanded by consumers there is more being produced than is being consumed. Un-sold production starts to accumulate. Firms respond by cutting prices to stimulate demand. Lower pricesalsomeanthatfirmswillbegintoproduceless.Thequantitydemandedincreasesandthequantity supplied declines until the desired level of inventory is attained and equilibrium is restored.

When the quantity supplied is less than the quantity demanded, the opposite happens. Inven-toriesdeclinebelowthedesiredlevel.Thisisasignforfirmstoraiseprices.Withhigherprices,thequantitydemandeddeclinesandfirmsaremotivatedbythehigherpricestoproducemore,which returns the market to equilibrium. The market attains equilibrium as if led by an invisible hand. It requires no leadership or direction from a central planner (such as a government) or a dominantfirm.Butmarketsarenotalwaysfreetofunctionefficiently.Weassumethemarketisperfectlycompetitiveinthatthereisnotasinglefirm(monopolist)orverysmallnumberoffirms(oligopolists) that have the power to set market prices. Similarly, we assume there is not a single consumer(monopsonist)withmarket-settingpower.Andfinally,weassumethereisnogovern-ment intervention.

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2.9 MARKET FAILURES

Markets do not always perform in a desired manner. Market failure means that the best attainable outcome has not been achieved. In this unit, we look at those areas in which a free market may give risetovarioustypesofinefficiency.Whenmarketsdonotprovideuswiththebestoutcomeintermsofefficiencyandfairness,thenwesaythatthereexistsmarketfailure.Thisunitintroducesyoutosome of the main causes of market failure; we will explore them in more detail in succeeding units.

Whatismarketfailure?Market failure occurs whenever freely-functioning markets operating without government interven-tion,failtodeliveranefficientallocationofresourcesandtheresultisalossofeconomicandsocialwelfare. Market failure exists when the competitive outcome of markets is not satisfactory from thepointofviewofsociety.Thisisusuallybecausethebenefitsthatthefree-marketconfersonindividualsorbusinessescarryingoutanactivitydivergefromthebenefitstosocietyasawhole.

MarketfailureandeconomicefficiencyWhenmarketsfunctionwellweexperienceanefficientandfair(equitable)allocationofresources.Market failure results in: Productive inefficiency: Businesses are not maximising output from given factor inputs. Thisisaproblembecausethelostoutputfrominefficientproductioncouldhavebeen used to satisfy more wants and needs. Costs are higher and productivity is lower than it might have been. Allocative inefficiency: Resources are misallocated and the economy is producing goods and services that are not wanted or not valued by consumers. This is a problem because resources might be put to a better use making products that we value more highly.

A.1 ECONOMIC AND TECHNICAL EFFICIENCY

Technicalefficiency is said tooccurwhenaneconomyoperateson theproductionpossibilitiescurve.Inthiscase,therearenounemployedandnounderemployedresources.Economicefficien-cyisamoregeneralconceptthatoccurswhenanychangethatbenefitssomeoneresultsinlossforsomeoneelse.Notethattechnicalefficiencyisanecessaryconditionforeconomicefficiencysinceamovementtowardtheproductionpossibilitiescurvebenefitsoneormoreindividuals.

A.2 IMPERFECT INFORMATION

Theeffectofimperfectinformationoneconomicefficiencycannotbeunderestimated.Buyersorsellers may not gain from voluntary trade if they do not know the quality of the product being bought or sold. Everyone has made at least one purchase that they regretted later. Government may correct this type of market failure by:

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requiring that product labels list ingredients, requiring guarantees for some products (such as the “lemon law” for used cars), banning fraudulent claims and requiring “truth in advertising,” licensing workers in certain professions, and By providing public information about products.

ACTIVITY

GIVE A CONCRETE EXAMPLE OF EACH OF THE LISTED CORRECTIVE MEASURES TAKEN BY THE ZIMBABWEAN GOVERNMENT TO REMEDY MARKET FAILURE.

2.10 PUBLIC GOODS

A public good is a good that is non-rival in consumption. This means that one person’s consump-tion does not reduce the quantity or quality of the good available to other consumers. Examples of public goods include national defense and television and radio signals broadcast through the airwaves. Some public goods have some congestion costs inwhich the benefits do decline abitasthenumberofpeopleconsumingthemrises.Townparks,highways,policeandfirepro-tection,andothersimilarcommoditiesandservicesfit thisdefinition.Theproblemwithpublicgoodsisthatnoindividualhasanincentivetopayforthegood.Sinceit is inefficient,andnotalways feasible, to exclude people from consuming a public good, people can consume it even if they do not pay for it at all. In such a situation, each person has an incentive to be a “free rider” and to let others pay for the good. The problem, of course, is that the good will be either under produced or not produced at all if the provision of such goods were left to the market. A government attempts to correct this type of market failure by either providing or subsidizing the production of public goods.

2.11 THE ABSENCE OF PROPERTY RIGHTS

A related problem occurs when no one has private property rights to a good. This problem oc-curs in the case of common property resources in which no individual has private property rights. Wheneveryonesharesownershipofsomeresource,eachindividualreceivesallofthebenefitsfrom using the resource, but the costs are shared by everyone. Consider, for example, the case ofbuffalo,fisheries,andsimilarresources.Ineachcase,thehunter,orfishermanreceivesprop-ertyrightsonlyaftercatchingandkillingtheanimal.Eachpersongetsthefullbenefitfromtheiractivity, but the cost of a reduced breeding stock is shared by everyone. If you are an individual fishinginanendangeredfishery,youhavenoincentivetoreduceyourindividualharvestoffish

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becauseyouknowthatifyoudonotcatchanadditionalfish,someoneelsemight.Insuchasituation,the resource is over utilised. Governments deal with this problem by setting restrictions on consump-tion or by introducing property rights when feasible. This “tragedy of the commons” (as it is also known) explains why public parks and highways often have more litter than most individual’s back yards, why bathrooms and common rooms in dormitories are messier than those in private houses and apart-ments, and why many species of animals have been hunted to extinction or threatened with extinction.

2.12 MONOPOLY

When monopolies are present, prices will tend to be higher and output lower than would occur under competitive market conditions. Government may respond to this problem through anti-trust enforcement, by regulating the monopoly, or by public production of the good or service.

2.14 MACROECONOMIC INSTABILITY

The business cycle results in periodic stages of recession in which unemployment rates rise. This resultsinastateofeconomicinefficiencythatthegovernmentmayattempttoremedybyimple-menting policies designed to ameliorate the business cycle. (This is a topic discussed in much more detail in macroeconomics units that follow).

2.15 PUBLIC CHOICE THEORY OF GOVERNMENT

The public choice theory of government suggests that self-interested individuals, who are likely to work for their own interests, rather than “public interest”, make government policy. Advocates of the public choice theory argue that special interest groups will engage in “rent-seeking behaviour” that is designed to increase their wealth at the expense of society as a whole. Many expenditures on lobbyists and political contributions do not result in increases in output and may result in eco-nomicinefficiencyifthelobbyistsaresuccessfulinredistributingincometothegroupsthattheyrepresent.

2.16 MICROECONOMIC AND MACROECONOMIC POLICY

The government engages in both microeconomic and macroeconomic policy to achieve its set objectives. Microeconomic policy involves policies designed to correct for imperfect information, externalities, public goods, the absence of property rights, and monopolies. Macroeconomic policy is policy designed to enhance macroeconomic stability and encourage economic growth. Mac-roeconomicpolicyinvolvestheuseoffiscalandmonetarypolicies.Fiscalpolicyinvolveschang-ing government spending, taxes, and transfer payments. (Transfer payments are payments made to individuals for which no good or service is provided in return. This category of spend-ing includes unemployment compensation, social security payments, and welfare spending.)

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2.17 SUMMARY


ACTIVITY

IN EACH CASE, IDENTIFY THE NATURE OF THE MARKET FAILURE - WHY ARE THESE PROBLEMS ARISING?

IDENTIFY POTENTIAL MEASURES THE GOVERNMENT MIGHT USE TO INTERVENE IN THE MARKET TO CORRECT THE PERCEIVED FAILURE. THERE MAY NEED TO BE A VARIETY OF SOLUTIONS USED, EACH OF WHICH CONTRIBUTES IN SOME WAY TO THE SO-LUTION.

REFER TO THE INFORMATION ON ‘RENT SEEKING’ AND ‘LOG-ROLLING’ IN THE PRESENTATION. WHAT RELEVANCE HAVE THESE CONCEPTS GOT TO THE PROBLEMS IDENTIFIED? WHO MIGHT THE SPECIAL INTEREST GROUPS BE WHO MIGHT SEEK TO GAIN BENEFITS AT THE EXPENSE OF OTHERS?

HOW MIGHT THE GOVERNMENT MEASURE THE EFFECT OF THE INTERVENTION STRATEGIES YOU HAVE IDENTIFIED IN QUES-TION 2 ABOVE? WHAT PROBLEMS MIGHT THEY FACE IN GAIN-ING AN ACCURATE MEASURE OF SUCH EFFECTS?

CHOOSE ONE OF THE PROBLEMS YOU HAVE INVESTIGATED AND PRODUCE A 750-WORD REPORT SUMMARISING THE PROBLEM, THE SOLUTIONS AND THE LIKELY OUTCOMES OF THE SOLU-TIONS ON CORRECTING THE MARKET FAILURE.

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2.18 BIBLIOGRAPHY

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UNIT THREE

EXTERNALITIES3.0 INTRODUCTION




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3.3 DEFINITION

Externalities are unintentional side effects of an activity affecting people other than those di-rectly involved in the activity. A negative externality is one that creates side effects that could be harmful to either the general public directly or through the environment. An example would be a factory that pollutes as a result of its production process. This pollution may pose health risks for nearby residents or degrade the quality of the air or water. Either way, the owner of the factory does not directly pay the additional cost to address any health issues or to help maintain the cleanliness of the air or water. In some cases, however, the harmed parties can use legal measures to receive compensation for damages. A positive externality, on the other hand, is an unpaid benefit that extends beyond those directly initiating the activity. One ex-ample would be a neighborhood resident who creates a private garden, the aesthetic beauty of which benefits other people in the community. Also,when a group voluntarily chooses tocreateabenefit,suchasacommunitypark,othersmaybenefitwithoutcontributingtotheproj-ect.Any individuals or groups that gain additional benefitswithout contributingare knownas“free riders”. Traditionally, both negative and positive externalities are considered to be forms ofmarket failure -whena freemarketdoesnotallocate resourcesefficiently.ArthurPigou,aBritish economist best known for his work in welfare economics, argued that the existence of externalitiesjustifiedgovernmentinterventionthroughlegislationorregulation.Pigousupportedtaxes to discourage activities that created harmful effects and subsidies for those creating ben-efitstofurtherencouragethoseactivities.ThesearenowknownasPigoviantaxesandsubsidies.

ManyeconomistsbelievethatplacingPigoviantaxesonpollutionisamuchmoreefficientwayof dealing with pollution as an externality than government imposed regulatory standards. Taxes leave the decision of how to deal with pollution to individual sources by assessing a fee or “tax” on the amount of pollution that is generated. Therefore, in theory, a source that is looking to maxi-mizeitsprofitwillreduce,orcontrol,theirpollutionemissionswheneveritischeapertodoso.Othereconomistsbelieve that themostefficient solution toexternalities is to include them inthe cost for those engaged in the activity. Thus, the externality is “internalized.” Under this framework externalities are not necessarily market failures, which weaken the case for gov-ernment intervention. Many externalities (pollution, free rider benefits) can be internal-ized through the creation of well defined property rights. Throughmuch of his work, econ-omist Ronald Coase showed that taxes and subsidies were typically not necessary as long as the parties involved could strike a voluntary bargain. According to Coase’s theorem, it does not matter who has ownership, so long as property rights exist and free trade is possible.

Two methods of controlling negative externalities loosely related to property rights include cap and trade and individual transferable quotas (ITQs). The cap and trade approach sets a maximum amountofemissionsforagroupofsourcesoveraspecifictimeperiod.Thevarioussourcesarethen given emissions allowances which can be traded, bought or sold, or banked for future use, but-overthecourseofthespecifiedperiodoftime-overallemissionswillnotexceedthe

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amount of the cap and may even decline. Therefore, individual sources, or facilities, can determine their level of production and/or the application of pollution reduction technologies or the purchase of additional allowances. Individual transferable quotas are a market-based solution that is often usedtomanagefisheries.Regulatorsfirstdetermineatotalannualcatchthatwillpreservethehealthoftheecosystem,andthenitisdividedintoindividualquotastopreventover-fishing.EachITQallows foracertainamountoffish tobecaught inanygivenyear. ITQsare transferable,whichallowsfishingvesselowners tobuyandsell theirquotasdependingonhowmuch theywanttocatch.TheITQprogramalsotriestocreateacommercialfishingindustrythatismorestableandprofitable.Theoptionsfordealingwithexternalities-positiveornegative-arenu-merous, and often depend on the type of externality. The key is to identify the particular tool or policyalternativethatwillbestmovethemarkettowardthemostefficientallocationofresources.

Whatever solution or combination of solutions are used to help reduce the problem of negative externalities, the main aim is to try to ‘internalise the externality’ - what we mean by this is that the decision maker takes into consideration the impact of his or her decisions on a third party.

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ACTIVITY

EXPLAIN HOW THE REFERENCE TO ‘REPEAT OFFENDERS’ IN THE NEWS STORY HIGHLIGHTS THE ISSUE OF MAR-KET FAILURE. (8 MARKS)

DISCUSS THE DEGREE OF SUCCESS EXPERIENCED BY THE ENVIRONMENT AGENCY IN DEALING WITH CASES OF ENVIRONMENTAL DAMAGE. CITE AT LEAST TWO CASE STUDY EXAMPLES TO ILLUSTRATE THE POINTS YOU ARE MAKING IN YOUR ANSWER. (12 MARKS)

3.4 THE LAW OF DIMINISHING RETURNS

The“lawofdiminishingreturns”isoneofthebest-knownprinciplesoutsidethefieldofeconomics.Itwasfirstdevelopedin1767bytheFrencheconomistTurgotinrelationtoagriculturalproduction,but it is most often associated with Thomas Malthus and David Ricardo. They believed that human population would eventually outpace the production of food since land was an integral factor in lim-ited supply. In order to increase production to feed the population, farmers would have to use less fertile land and/or increase production intensity on land currently under production. In both cases, there would be diminishing returns. The law of diminishing returns – which is related to the concept ofmarginalreturnormarginalbenefit–statesthatifonefactorofproductionisincreasedwhiletheothersremainconstant,themarginalbenefitswilldeclineand,afteracertainpoint,overallproduc-tion will also decline. While initially there may be an increase in production as more of the variable factor is used, eventually it will suffer diminishing returns as more and more of the variable factor is appliedtothesameleveloffixedfactors,increasingthecostsinordertogetthesameoutput.Di-minishingreturnsreflectthepointinwhichthemarginalbenefitbeginstodeclineforagivenproduc-tion process. For example, the table below sets the following conditions on a farm producing corn:

Number of Workers Corn Produced Marginal Benefit

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Itiswiththreeworkersthatthefarmproductionismostefficientbecausethemarginalbenefitis at its highest. Beyond this point, the farm begins to experience diminishing returns and, at the level of 6 workers, the farm actually begins to see decreasing returns as production lev-els decline, even though costs continue to increase. In this example, the number of workers changed, while the land used, seeds planted, water consumed, and any other inputs remained the same. If more than one input were to change, the production results would vary and the law of diminishing returns may not apply if all of the inputs could be increased. If this case were to lead to increased production at lower average costs, economies of scale would be realized.

The concept of diminishing returns is as important for individuals and society as it is for businesses because it can have far-reaching effects on a wide variety of things, including the environment. This principle–althoughfirstthoughttoapplyonlytoagriculture–isnowwidelyacceptedasaneconom-ic law that underlies all productive endeavors, including resource use and the cleanup of pollution.

The theory was effectively applied by Garrett Hardin in his 1968 article on the tragedy of the commons in which he looked at many common property resources, such as air, water, and for-ests, and described their use as being subject to diminishing returns. It is in this case that in-dividuals acting in their own self-interest may “overuse” a resource because they do not take into consideration the impact it will have on a larger, societal scale. It can also be expanded to include limitationsonour common resources.The services thatfixednatural resourcesareabletoprovide–forexample,inactingasnaturalfiltrationsystems–willbegintodiminishascontaminants and pollutants in the environment continue to increase. It is externalities such as these that can lead to the depletion of our resources and/or create other environmental problems.

However,thepointatwhichdiminishingreturnscanbeillustratedisoftenverydifficulttopinpointbecause it varies with improved production techniques and other factors. In agriculture, for exam-ple, the debate about adequate supply remains unclear due to the uneven distribution of population and agricultural production around the globe and improvement in agricultural technology over time.The challenge – whether it be local, regional, national, or global – is how best to manage the prob-lem of declining resource-to-people ratios that could lead to a reduced standard of living. Widely used solutions for internalizing potential externalities include taxes, subsidies, and quotas. Often, thereareattemptstofind“biggerpicture”solutionsthatfocusonwhatmanyseeastheprimarycauses, namely population growth and resource scarcity. Reducing population growth, along with increased technological innovation, may slow the growth in resource use and possibly offset the impactofdiminishingreturns.Thesepotentialbenefitsareakeyreasonwhypopulationgrowthandtechnological innovation are most often used in analyzing sustainable development possibilities.

3.5 CARRYING CAPACITY

Changes in population can have a variety of economic, ecological, and social implications. One population issue is that of carrying capacity – the number of individuals an ecosystem can support

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without having any negative effects. It also includes a limit of resources and pollution levels that can be maintained without experiencing high levels of change. If carrying capacity is exceeded, livingorganismsmustadapttonewlevelsofconsumptionorfindalternativeresources.Carry-ing capacity can be affected by the size of the human population, consumption of resources, and the level of pollution and environmental degradation that results. Carrying capacity, however, neednotbefixedandcanbeexpandedthroughgoodmanagementandthedevelopmentofnewresource-saving technologies. The relationship between carrying capacity and population growth has long been controversial. One of the original arguments appeared in 1798 by English economist Thomas Malthus who stated that continued population growth would cause over-consumption of resources. Malthus further argued that population was likely to grow at an exponential rate while food supplies would increase at an arithmetic rate, not keeping up with the exponential population growth. Malthus believed that an ever increasing population would continually strain society’s abil-ity to provide for itself and, as a result, mankind would be doomed to forever live in poverty.

Over a century later, American economist Julian Simon countered Malthus’ arguments, asserting that an increase in population would improve the environment rather than degrade it. He believed humanintellecttobethemostvaluablerenewablenaturalresourcethatwouldcontinuetofindinnovative solutions to any problems that might arise – environmental, economical, or otherwise.Simonwasalsooneofthefoundersoffreemarketenvironmentalism,findingthatafreemarket,together with appropriate property rights, was the best tool in order to preserve both the health and sustainability of the environment.

Throughout the late 1960s and 1970s, the controversy over the effect that an increasing pop-ulation has on the Earth’s limited resources reemerged. Garrett Hardin and Paul Ehrlich, both authors on overpopulation, believed that human population had already exceeded the carry-ing capacity. Hardin is best known for his paper The Tragedy of the Commons, in which he argues that overpopulation of any species will deplete shared natural resources. Ehrlich, who wrote The Population Bomb in 1968, predicted a population explosion accompanied by in-creasing famine and starvation. Although his prediction did not come true – in fact, in 1970 there was a slight decline in the population growth rate – he was correct in pointing out that, with the exception of solar energy, the Earth is a closed system with limited natural resources.

The standard of living in a region can help to alter an area’s carrying capacity. Areas with a higher standard of living tend to have a reduced carrying capacity compared to areas with a lower stan-dard of living due to the access to and demand for more resources. Nevertheless, the environ-mental Kuznets Curve – an observed phenomenon – suggests that beyond some point, increased income and environmental improvement often goes hand-in-hand. While population growth rates have stabilized and, in fact, are declining in many developed nations, consumption of resources and the generation of pollution and waste continue to grow. The effect this has on an ecosystem is called an “ecological footprint,” which can be used to measure and manage the use of resources throughout an economy. It is also widely used as an indicator of environmental sustainability.

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Carrying capacity often serves as the basis for sustainable development policies that attempt to balance the needs of today against the resources that will be needed in the future. The 1995 World SummitonSocialDevelopmentdefinedsustainabilityas‘theframeworktoachieveahigherqualityof life for all people in which economic development, social development, and environmental pro-tectionareinterdependentandmutuallybeneficialcomponents’.The2002WorldSummitfurtheredthe process by identifying three key objectives of sustainable development: eradicating poverty, protecting natural resources, and changing unsustainable production and consumption patterns.While the exact value of the human carrying capacity is uncertain and continues to be under debate, there has been evidence of the strain that both overpopulation and over-consumption has placed on some societies and the environment. Economists, ecologists, and policy analysts continue to study global consumption patterns to determine what the human carrying capacity is and what steps can be taken to ensure it is not exceeded. In the meantime, actions to reduce the strain and ensure natural resource recovery for the future will depend on an increase of sustainable development policies worldwide.

3.6 SUMAARY

ACTIVITY

CONSIDER THE SOLUTIONS TO THE PROBLEM OF MARKET FAILURE IN THIS CONTEXT AND EXAMINE THE CASE FOR AND AGAINST EACH MEASURE. SUPPORT YOUR ANSWER WITH APPROPRIATE EXAMPLES. (30 MARKS)

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3.7 BIBLIOGRAPHY

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UNIT FOURSUSTAINABLE DEVELOPMENT4.0 INTRODUCTION




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4.3 DEFINITION OF SUSTAINABLE DEVELOPMENT

Overthepastfewdecades,manydefinitionsofsustainabledevelopmenthavebeensuggestedand debated, resulting in a concept that has become broad and somewhat vague. In recognition of the need for a clearer understanding of sustainable development, the United Nation’s World Commission on Environment and Development commissioned a study on the subject by what is now known as the Brundtland Commission. The resulting report, Our Common Future (1987), definedsustainabledevelopmentas“developmentthatmeetstheneedsofthepresentwithoutcompromising the ability of future generations to meet their own needs,” which has become the acceptedstandarddefinition.Thereportalsoidentifiedthreecomponentstosustainabledevel-opment: economic growth, environmental protection, and social equity, and suggested that all three can be achieved by gradually changing the ways in which we develop and use technologies.

Although sustainable development is a widely accepted goal by many governmental and non-govern-mental agencies, concerns about what it means in practice have often been raised. One point of con-tention is over the role of economic development in fostering sustainable development. Some argue that economic growth is the best way to help developing countries conserve their natural resources, while others argue that any economic growth is unsustainable because we already consume too much.TheUnitedNationsattemptedtoreconciletheseviewsin1992byconveningthefirstEarthSummitinRiodeJaneiro.Itwasherethattheinternationalcommunityfirstagreedonacomprehensivestrat-egy to address development and environmental challenges through a global partnership. The frame-work for this partnership was Agenda 21, which covered the key aspects of sustainability – economic development, environmental protection, social justice, and democratic and effective governance.

The second Earth Summit, held in Johannesburg in 2002, was an attempt by the UN to review the progressoftheexpectationsraisedinRioandtoreaffirmthecommitmentofworldleadersincontinu-ing to pursue actions towards sustainable development. The Report of the World Summit on Sustain-able Development outlined the challenges to, and commitments of, the international community in attaining these goals. The summit leaders also developed a plan of implementation, which included means of eradicating poverty, changing unsustainable patterns of consumption, and protecting bio-diversity and natural resources. Since sustainable development goes well beyond economic issues, linking the economy, environment, and society, no comprehensive economic theory related to sus-tainable development exists. However, progress toward sustainable development is often measured by a variety of indicators, which can be used at the local, regional, national or international level.

The primary components are economic performance, social equity, environmental measures, and institutional capacity. Examples of indicators within each component are located in the box to the left. Within the economic performance component, the indicators selected under economic struc-ture are well-known and commonly used measures at the national and international levels. They reflectimportantissuesofeconomicperformance,trade,andfinancialstatus.Consumptionandproduction patterns are also represented within the economic performance component, providing

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additional coverage of material consumption, energy use, waste generation and manage-ment, and transportation. For many nations, the ability of the economy to meet basic needs allows them to focus more on environmental issues. Historically, the general public is not will-ing to place a high priority on protecting the environment when there is concern about achiev-ing a certain level of welfare or economic goals. For example, when the economy was doing well in the United States in the late 1980s, there was an increased awareness about the en-vironment. However, as the economic conditions began to decline in the early 1990s, people became more concerned about their own well-being and less concerned with the environmentThe study of economics has always emphasized the relative scarcity of resources, whether they are natural, capital, or human, thereby placing constraints on what we can have and affecting the choices and decisions made by individuals or by society. Sustainable development encom-passes the view that a healthy environment is essential to support a thriving economy. Therefore, decisions should be made taking into account both the present and future value of our resourc-es in order to achieve continued economic development without a decline of the environment.

4.4 NET PRESENT VALUE

Economists focus much of their analyses on a marketplace where supply and demand are based on the perceptions of present value and scarcity. However, when going beyond the simplicity of the short-term,particularlywhencostsandbenefitsoccuratdifferentpointsintime,itisimportanttoutilizediscountingtoundertakelonger-termanalyses.Discountingadjustscostsandbenefitstoa common point in time. This approach can be useful in helping to determine how best to utilize many of our non-renewable natural resources. Net present value (NPV) is a calculation used to estimatethevalue–ornetbenefit–overthelifetimeofaparticularproject,oftenlonger-term

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investments,suchasbuildinganewtownhallorinstallingenergyefficientappliances.NPVallowsdecision makers to compare various alternatives on a similar time scale by converting all options tocurrentdollarfigures.Aprojectisdeemedacceptableifthenetpresentvalueispositiveoverthe expected lifetime of the project.The formula for NPV requires knowing the likely amount of time (t, usually in years) that cash will be invested in the project, the total length of time of the project (N, in the same unit of time as t),theinterestrate(i),andthecashflowatthatspecificpointintime(cashinflow–cashoutflow,C).

For example, take a business that is considering changing their lighting from traditional incan-descentbulbstofluorescents.The initial investmenttochangethe lightsthemselveswouldbe$40,000. After the initial investment, it is expected to cost $2,000 to operate the lighting system butwillalsoyield$15,000insavingseachyear;thus,thereisayearlycashflowof$13,000everyyear after the initial investment. For simplicity, assume a discount rate of 10% and an assumption that the lighting system will be utilized over a 5 year time period. This scenario would have the following NPV calculations:t = 0 NPV = (-40,000)/(1 + .10) 0 = -40,000.00t = 1 NPV = (13,000)/(1.10) 1 = 11,818.18t = 2 NPV = (13,000)/(1.10) 2 = 10,743.80t = 3 NPV = (13,000)/(1.10) 3 = 9,767.09t = 4 NPV = (13,000)/(1.10) 4 = 8,879.17t = 5 NPV = (13,000)/(1.10) 5 = 8,071.98Based on the information above, the total net present value over the lifetime of the project would be $9,280.22.

Once the net present value is calculated, various alternatives can be compared and/or choices can be made. Any proposal with a NPV < 0 should be dismissed because it means that a project will likelylosemoneyornotcreateenoughbenefit.TheclearchoiceisaprojectwhoseNPV>0or,if there are several alternatives with positive NPVs, the choice would be the alternative with the higher NPV. With most societal choices, the opportunity costs are also considered when making decisions. Net present value provides one way to minimize foregone opportunities and identify the best possible options.This particular example assumes that the interest rate does not change over time. Longer peri-ods of time will often require separate calculations for each year in order to adjust for anticipated changesintheinterestrate.Whendiscountingisusedittakesintoaccountthefactthatbenefitsin the future are not expected to be worth as much as in the present time. For example, $10 today may only be worth $9, $5, or even $1 in 2025. The rationale behind using a discount rate is two-fold:allthingsbeingequal,(1)individualsprefertobenefitnowratherthanlaterand(2)theytendto be risk averse, uncertain of what will occur in the future.

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Net present value calculations can also help account for depreciation. Over time most assets depre-ciate, or lose value. Companies or individuals must be able to calculate a rate that includes deprecia-tion for account balancing and tax purposes, as well to help predict replacement times for the asset in question. NPV and depreciation calculations are extremely valuable in the world of economics; they tell us what projects and businesses are better investments and what outcomes we may expect in the future. However, while depreciation rates can be reliably estimated for most physical items, such as computer equipment or buildings, their application to natural resources and other environ-mental issues is more uncertain. Natural resources do not necessarily lose value over time. Thus, in most cases natural resources should not be depreciated when calculating resource NPVs. Also, since there is uncertainty about the future and external effects exist, it is much easier to predict what a company can do and what the reaction will be in the structured world of business than to accurately assess, say, the value of a forest to a local economy in future years. Despite how helpful calculating NPV can be, using it to assess projects related to the environment will continue to be controversial. Ecosystem valuation is a complex process that does not always result in the assignment of accurate values to natural resources. And, while the use of discounting may make sense for money – being notasvaluableinthefutureasitistoday–itmaybemoredifficulttouseinassessingnaturalre-sources. Since many natural resources often increase in value, this type of evaluation method would need to recognize increased future resource values and/or that of other environmental services.

4.5 ECOSYSTEM VALUATION

Valuation can be a useful tool that aids in evaluating different options that a natural resource man-ager might face. Because our ecological resources and services are so varied in their composition, itisoftendifficulttoexaminethemonthesamelevel.However,aftertheyareassignedavalue,anenvironmental resource or service can then be compared to any other item with a respective value. Ecosystem valuation is the process by which policymakers assign a value – monetary or otherwise – to environmental resources or to the outputs and/or services provided by those resources. For example,amountainforestmayprovideenvironmentalservicesbypreventingdownstreamflood-ing. Environmental resources and/or services are particularly hard to quantify due to their intangible benefitsandmultiplevalueoptions.Itisalmostimpossibletoattachaspecificvaluetosomeoftheexperiences we have in nature, such as viewing a beautiful sunset. Problems also exist when a re-source can be used for multiple purposes, such as a tree – the wood is valued differently if it is used forfloodcontrolversusifitisusedforbuildingahouse.Thequantityofaresourcemustalsobetaken into consideration because value can change depending how much of a resource is available. Anexampleofthismightbeinpreventingthefirst“unit”ofpollutionifwehaveapristineairenvi-ronment.Preventingthefirstunitofpollutionisnotvaluedveryhighlybecausetheenvironmentcaneasily recover. However, if the pollution continues until the air is becoming toxic to its surroundings; the value of preserving clean air by preventing additional pollution is going to be increasingly valued. Withineconomics,valueisgenerallydefinedastheamountofalternategoodsapersoniswillingtogive up in order to get one “additional unit” of the good in question. An individual’s preference for

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certain goods may either be stated or revealed. In the case of stated preferences, the amount of money a person is willing to pay for a good determines the value because that money could otherwise be used to purchase other goods. However, value may also be determined by simply rankingthealternativesaccordingtotheamountofbenefiteachwillproduce.Revealedprefer-ences can be measured by examining a person’s behavior when it is not possible to use market pricing. There are typically two ways to assign value to environmental resources and services – useandnon-use–andthereareapproachestomeasuringenvironmentalbenefitsbasedonthesedefinedvalues.Whenenvironmentalresourcesorservicesarebeingused,itiseasiertoobservethe price consumers are willing to pay for the conservation or preservation of those resources. Market or opportunity cost pricing can be used when there are tangible products to measure, such astheamountoffishcaughtinalake.Replacementcostcanalsobeused,calculatedbasedonany expenses incurred to reverse environmental damage. Hedonic pricing will measure the effect that negative environmental qualities have on the price of related market goods. When evaluat-ing non-use value, contingent valuation is employed through the use of surveys that attempt to assessanindividual’swillingnesstopayforaresourcethattheydonotconsume.Acost-benefitanalysisrequiresthequantificationofpossibleimpactsofaproposedproject.Theimpactscouldbephysicalormonetary,butbothmustbecalculatedandincludedsinceafinancialanalysisthatrequires assigning dollar values to every resource evaluated is also performed. The process of environmental resource or service valuation provides a way to compare alternative proposals, but itisnotwithoutproblems.Allvaluationtechniquesencompassagreatdealofuncertainty:flawscan exist in the methods of assigning value accurately due to a wide number of variables and it is difficulttocompartmentalizeandmeasureenvironmentalandnaturalresourcesand/orserviceswithin an ecosystem that functions as an interconnected web.

In summary, ecosystem valuation is a complex process by which economists attempt to assign a value to natural resources or to the ecological outputs and/or services provided by those resourc-es.Althoughchallenging,itallowspolicymakerstomakedecisionsbasedonspecificcomparisons,typically monetary, rather than some other arbitrary basis. In recent years, the government has placed increasing emphasis on cost-effective laws and projects. Therefore, establishing a common measure by which to evaluate alternatives is essential.

4.6 TRADE-OFFS

As we make everyday choices – how much time to spend working or studying, what to spend our money on – we are experiencing what in economics are called trade-offs and opportunity costs. A trade-off is when we choose one option in favor of another and the opportunity cost is what is sacri-ficedinordertogetsomething.Whetherwerealizeitornot,weareconstantlyevaluatingthecostsandbenefitsofeachdecisionwemake;therefore,itcanalsobesaidthatweareperformingourowncost-benefitanalysiseachtimewemakeachoice.Asdecisionsaremade–eitherindividuallyoras a society – we constantly make trade-offs in order to get more of one thing by giving up another. The saying “time is money” illustrates this point. If we ‘consume’ more free time, we are left with

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less money due to the fact that we are not earning money from using the time to work. The opposite is true as well; if we want more money, we must put in more work hours to get it; therefore there is less free time available. When we consider time and money, and graph the combinations for where one has no preference of one over the other, we come up with an indifference curve, such as the one below.

On the graph, X is the point where we have an even balance of time and money; yet an indif-ferencecurve issuchthatone isequallysatisfiedatanypointalongthecurve.Therefore,wecould move to point A, where we would have a lot more time but less money, or we could move topointB,withalotmoremoneybutlesstime,andwewouldbeequallysatisfied.Theslopeofthe indifference curve is based on the marginal utility of each decision; each successive move to-wards an axis comes at a higher price. For example, at point B we require more money for each unit of time than we do at point X because our time is more valuable since we have less of it. Therefore, we will begin to experience diminishing marginal utility. The economy and the environ-ment are inextricably linked. Whether one is looking at daily life or natural resources and other environmental issues, because resources are scarce, choices have to be made about how to use them. The basic fact is that resources used to meet one choice or alternative cannot be used to meet another. Just like how we value regular goods, the valuation of natural resources and the environment is based on how we value their services and, for services that are consumed directly, that value is based on our utility and willingness to pay for a certain amount of the services.

The decision about how to allocate resources relating to the environment has an impact on all sectors of our economy, primarily because of the complex relationship between utilizing natural resources and economic output. Many times, the cost of utilizing these resources and/or services include direct costs as well as opportunity costs and external costs, which are not traded in mar-kets or assessed directly in monetary terms. For example, when trees are cut for such uses as housing and furniture, some of the direct costs will include the cost of machinery and labor dur-ing cutting, processing, and manufacturing. The opportunity costs relating to this use would be the opportunities foregone by the machinery and labor that could not be used elsewhere, since it wasoccupiedcuttingtrees.Theexternalcostsarethelossofenvironmentalbenefitsthatarenolonger realized which may include a loss in watershed management services, species protection, and CO2 reduction. Many agree that in most cases the market is the best way to determine the allocation of resources. The demand for various products and the availability of natural resources – along with a number of other factors, including preferences, the number of buyers and sellers,

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pricing,alternativechoices,etc–isexpectedtoleadtoanefficientresultofactualsupplyandde-mand. However, markets can fail to account for the full cost of a natural resource and/or services, whichwillpreventitfromachievinganefficientallocationoftheresource,leadingtoexternalities.To reduce the potential for market failures and their resulting externalities, planners and policymakers attempt to identify a course of action that generates the greatest soci-etal benefits. Much of this is done by using amix of policy and strategies, including regula-tion, taxes, permits, access restrictions, etc. It is finding the appropriate balance betweenutilizing our natural resources and meeting the demands of society that will allow us to con-tinue to expand our economy while sustaining our natural resources and the environment.

4.7 MARGINAL COSTS AND BENEFITS

Marginalcostsandbenefitsareessential informationforeconomists,businesses,andconsum-ers. Even if we do not realize it, we all make decisions based on our marginal evaluations of the alternatives.Inotherwords,“whatdoesitcosttoproduceonemoreunit?”or“whatwillbethebenefitofacquiringonemoreunit?”Whennecessary,individualandsocialmarginalcostandben-efitcurvescanbedrawnseparatelyinordertounderstanddifferenteffectsthatagivenactionorpolicy might have. In the case of pollution, the social cost is generally higher than the individual costduetoexternalities.However,asawhole,aneconomicsystemisconsideredefficientatthepointwheremarginalbenefitandmarginalcostintersect,orareequal.Similartotheproductionof goods and services, we can utilize the same information in order to analyze pollution abatement – in terms of the production or reduction of pollution – within the market. In order to assess en-vironmental improvement, we must take cost into consideration. The cost of these improvements is often thought of as the direct cost of any action taken in order to improve the environment.

Marginal cost measures the change in cost over the change in quantity. For example, if a company is producing 10 units at $100 total cost, and steps up production to 11 units at $120 total cost, the marginal cost is $20 since only the last unit of production is measured in order to calculate marginal cost. Mathematically speaking, it is the derivative of the total cost. Marginal cost is an important measurement because it accounts for increasing or decreasing costs of production, which allows a company to evaluate how much they actually pay to ‘produce’ one more unit.

Marginal cost will normally initially decrease through a short range, but increase as more is pro-duced. Therefore the marginal cost curve is typically thought of as upward sloping. The mar-ginal cost curve can represent a wide range of activities that can reduce the effects of environ-mental externalities, like pollution. The key point is that most environmental improvements are not free; resources must be expended in order for improvement to occur. For example, take an environment that has been polluted – while the initial unit of cleanup may be cheap, it be-comes more and more expensive as additional cleanup is done. If cleanup is undertaken to point “Q”, the total cost of the cleanup is P*Q the white and light gray areas on the graph below.

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Marginalbenefit is similar tomarginal cost in that it is ameasurementof the change inben-efitsoverthechangeinquantity.Whilemarginalcostismeasuredontheproducer’send,mar-ginalbenefitislookedatfromtheconsumer’sperspective–inthissenseitcanbethoughtofasthe demand curve for environmental improvement. Themarginal benefit curve represents thetradeoff between environmental improvement and other things we could do with the resources needed togain the improvement.Again takeanenvironment thathasbeenpolluted, thefirstunitof thispollution that iscleaneduphasaveryhighbenefitvalue toconsumersof theen-vironment. Each additional unit that is cleaned up is valued at a somewhat lower level than each previous one because the overall pollution level continues to decrease. Once the pollu-tion is reducedbelowacertainpoint, themarginalbenefitofadditionalpollutioncontrolmea-sures will be negligible because the environment itself is able to absorb a low level of pollution.

Takingalookatthegraphabove,thetotalconsumerbenefitthatisrepresentedasthedarkgreyarea,thenetbenefitisgreatestwhenthequantity–“Q”–reachesthemarginalbenefitcurve.WecouldincreasetotalbenefitbyaddingpollutioncontrolsbeyondQ,butonlywithmarginalcosts(MC)greaterthanmarginalbenefits(MB),soitisnolongerefficienttofurtherincreasetheben-efits.Oftentimes,benefitsaremoredifficulttomeasurebecausetheyarenotalwaysmonetary.In cases such as these the measurement may involve utilizing revealed preferences, through a survey or another mechanism, in order to discover the maximum price consumers are willing to payforaparticularquantityofagood.Anaveragebenefitisusedwhenconsideringsocietyasawholebecauseeachindividual’swillingnesstopayisdifferent.Marginalcostsandbenefitsareavital part of economics because they help to provide the relevant measurement of costs and ben-efitsatacertainlevelofproductionandconsumption.Ifmeasuredmarginalcostsandbenefitsareprovided, it is much easier to calculate the ideal price and quantity. It is where the two intersect thatwillalwaysbethemosteconomicallyefficientpointofproductionandconsumption.Whenconsideringenvironmentalissues,theefficientpointatwhichmarginalcostsandmarginalbenefitsare equal is an important economic concept because it captures the essence of tradeoffs. Often, environmental improvement Concerns often revolve around whether we are above or below this point–whetheranyadditionalenvironmentalimprovementcanprovidemorebenefitthanitwillcost;thisbecomesanessentialcomponentincost-benefitanalysis.

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4.8 COST BENEFIT ANALYSIS

Cost-benefitanalysis(CBA)isananalyticalwayforsocietytomakedecisionsaboutcomplicatedissues such as education, health care, transportation, or the environment. Like most personal decisions, it involves a comparison of the costs of an action compared with considerations of thebenefitsof thataction.However, forpublicpolicy it is formalizedandquantitative.For in-stance, a public policy can be evaluated by calculating andweighing the benefits against thecosts, once all factors have been given a common unit of measurement. When policymakers have to choose among various alternatives, they require a tool that will allow them to distin-guish between the options. Decision makers can then choose the policy with the largest surplus, oroverallnetbenefits.Inrecentyears,forexample,theU.S.government is increasinglyseek-ing more cost-effective policies in order to balance the budgets. While the overall concept of CBAissimple,thestepstakentoevaluateeachbenefitandcostcanbecomequitecomplicated.

The most important component of a CBA is the base situation – or what would happen if no changesweremade.Allotherdecisionsarecomparedtothisbasesituation.Thefirststepistoidentifytherelevanttimeperiod:whenwouldthecostsandbenefitsberealized?Oncethebaseandrelevant timeperiodareestablished,benefitsandcostscanbecalculated in termsofhu-manwellbeing.Inthiscase,abenefitisdefinedasanythingthatincreaseshumanwell-being,andacostisanythingthatdecreasesit.Thesedefinitionsandtheirrespectivecalculationstendto provoke controversy due to the use of valuation and discounting, which involves applying a mathematicalformulatodeterminethepresentvalueoffuturebenefitsandcosts.Forexample,a dollar today will not be worth the same amount in 50 years, its value will have decreased due toinflation.Also,today’sdollarcouldbeputtootheruses(foregoneopportunities)whichcande-creaseitsnetfuturevalueinthechosenuse.Discountingtakesthevaluesofcostsandbenefitsin the future and “discounts” them by the value of the foregone opportunities, or makes them smaller, toaccount for their inevitablechange invalue.Measuringthebenefitsofapolicycaninvolve anything from additional income, to an increased quality of life, or even to a cleaner envi-ronment; costs may consist of forgone opportunities, internal and external costs, and externalities.

However, in measuring costs, it is important not to confuse externalities with secondary effects: externalities result in real output changes whereas secondary effects do not. An example of this would be electricity generation – the externality would be pollution while the secondary effect would be the increased cost of doing business when the price of electricity rises. The pollution actually generates new costs, such as the need to scrub sulfur dioxide from smokestacks. The increased businesscostsaresimplyareflectionofthefluctuationinthepriceofelectricitywhichisalreadycalculated as a cost. In order to avoid double-counting, only true externalities can be included inaCBA.Afterallbenefitsandcostshavebeengivenacommonunitofmeasurement,optionscan be evaluated. The ideal situation will result in Pareto improvement: some are made better-off while no one is made less well off. But, since the ideal outcome is rare, CBA is based on a ‘poten-tial’Paretoimprovementandeconomicefficiency.ApotentialParetoimprovementiswherethe

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possibility exists for compensation to those who are less well off, whether or not it actually happens.A final result of a CBA should be wheremarginal benefits andmarginal costs of a proposedproject are equal. In the graph below, this is at point Q. The surplus is illustrated by the shaded area in the graph. At the equilibrium, the surplus is greatest, making it the best possible so-lution. If the quantity were to increase to point 1, the marginal costs would exceed the mar-ginalbenefits,meaning itwouldnoteconomicallyefficient. If thequantityweretodecreasetopoint-1,someofthesurpluswouldbelost,whichwouldalsoindicateinefficiency.CBAaimstoachievepointQ,wheremarginalbenefitandmarginalcostareequalinordertomaximizeeco-nomicefficiency.Theuncertaintyoftheseforecastscancreateafundamentalproblemwhenpoli-cymakersrelyentirelyonCBAtomakeadecision.Criticsarguethatcost-benefitsanalysisdoesnot include equity considerations. Ecological valuation and discounting are other controversial aspects of CBA because there are many different values that certain natural resources could as-sume, and thediscount rate chosenwill have significant implications for the resulting analysis

4.9 REGULATORY POLICY VS ECONOMIC INCENTIVES

Command-and-control is comforting to politicians and people: governments know what they are asking for, people know what they are getting, companies know what they are supposed to deliver; the only people who do not like it are economists.~ The Economist, September 2, 1989

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Environmental regulation in the United States has traditionally relied on command-and-control policies in which regulators – typically the government – set standards or limits and apply them uniformly to a broad category of sources. There are three types of command-and-control mecha-nisms that regulators can choose to implement: ambient, emissions, or technology standards.

Anambientstandardsetstheamountofapollutantthatcanbepresentwithinaspecificenviron-ment. An example of this would be when a regulator sets a limit on ground level ozone [parts per million or “ppm”] allowable within a city’s limits. This is also an example of an indirect regulation because although emissions from individual sources are being restricted, the ambient level is what the standard is attempting to control. Emissions standards are much more common as they seek tolimittheamountofemissionsreleasedbyafirm,industry,orarea.Itdiffersfromanambientstandard because its use does not determine the ambient level of a pollutant in the environment; rather,itattemptstoreducetheoverallamountofapollutantreleasedonafirm-by-firmbasis.Finally, regulators can choose to implement a technology-based standard which would force pollut-ers to use a particular pollution control technology that they deem reasonably cost-effective, such as installing scrubbers on smokestacks. It is believed by many that the primary advantage of using command-and control mechanisms is that they provide a clear outcome. It is also comparatively simple to monitor compliance since regulators only have to make sure that the standard has been met. Therefore, it is possible that an emissions reduction goal can be reached; if not, the viola-torswillpayafine.However,command-and-controlmechanismshaveseveraldrawbacks.Onekey element is information uncertainty. It is not only very costly for regulators to gather necessary information; they often have to collect it from the sources that they are regulating, creating the possibilityforinaccurateordishonestreporting.Anothersignificantconcernisthatpollutershavevery little choice about how to meet the standard since some standards are strictly dictated by the regulators. Therefore, there is no incentive for the sources to research new and creative ways to further reduce their own pollution emissions. However, in the case of emission standards, sources are often able to decide how they can best meet the standard. Finally, since command-and-control mechanisms are uniformly applied across broad categories of sources, it is unlikely that it can be the most cost-effective way to decrease pollution levels or emissions. Because the marginal costs for limiting pollution will vary among the sources, it also essentially guarantees that equity will not be achieved. Under this scenario, polluters are not charged for the marginal cost of pollution that theycontinuetoemit;only for thepollutiontheyabate,which iseconomically inefficient.

Economic incentives which have been debated by economists for decades – have only recently begun to play a larger role in both national and international environmental policy. As regulators seek to meet increasingly costly environmental quality goals, they have begun to look at incentives asamoreflexible,lowercostalternative.Itisexpectedthattheregulatorysystemcanbemademoreeffectivebypromotingenvironmentallyefficientchoiceswithlessgovernmentinterference.Incentive-basedpoliciesaimtoencouragepolluterstofindinnovative, low-costwaystoreducetheir environmental emissions by offering rewards or by doling out punishments in the form of taxes or fees, marketable permits, or liability.

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Taxes or fees charge the polluter a certain amount per unit of pollution, the value of which is determined by the regulator. Marketable permits allow companies to pollute at a level that is marginally cost-effective. It allows them to buy additional permits as needed if they fail to meet their targets internally, and to sell excess permits if they exceed their internal pollution reduction targets. Liability involves establishing a precautionary level that allows for the great-estbenefittosociety,andholdingfirmstothatstandardifaproblemarises.Whilemoreflexiblethantrueestablishedstandards,itputstheburdenonthefirmtotakecertainlevelsofprecau-tion with respect to environmental issues or to be held accountable for any negative results.Incentives have several advantages, including allowing the source to play a role in determining the most cost-effective way to reduce their emissions and, thereby, in meeting their marginal costs. All three types of incentives attempt to maintain the “equi-marginal principle,” or when the marginal control costsareequalacrossallsources.Thiscreatesanefficientor“leastcost”overallsolution.Also,whencompared to command and control mechanisms, the regulator requires less information under an in-centive program since there is greater motivation for polluters to devise their own innovative solutions.

Therefore, the regulator does not need to know how cost-effective various control options will be, or what the cost is at any particular installation, because the source will be held accountable for all of their actions and will pay both pollution control costs and damage costs. Although many may be in favor of using economic instruments – when it comes to taxes – the affected sources are often in opposition. These affected groups begin to perceive economic policy instruments as imposing higher costs than command-and-control regulations. Taxes also present political obstacles since no industry likes to see increased taxes, and politicians do not want to lose support by passing legislation that includes more taxes. Of additional concern is the view of added complexity as regulators attempt to address pollution issues across diverse areas and/or industries. However, pollution taxes are some-times desired by companies if they are applied to all since the equal taxation is viewed to be ‘fair.’In the case of environmental policy, politicians are primarily concerned that something be done and lessinterestedinthespecificchoiceordesignofthepolicies.Oftentimes,economicincentiveshaveto be approved by a political system where the bargaining processes become important, and the issuestobesortedoutbetweenofficials,experts,andtheaffectedpartiesbecomemoretechnicaland legal in nature. However, while command-and-control regulation is still common, more and more legislation is beginning to use market mechanisms, or a combination of command-and-control along with market mechanisms, in order to best meet the demands of the environmental issues at hand.

4.10 SUMAARY

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4.10 BIBLIUOGRAPHY

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UNIT FIVEENVIRONMENTAL

VALUATION: PRINCIPLES, TECHNIQUES AND APPLICATIONS5.0 INTRODUCTION

From scenic beauty and recreational opportunities to direct inputs into the production process, en-vironmentalresourcesprovideacomplexsetofvaluestoindividualsandbenefitstosociety.Coastalareas, for example, offer scenic panoramas and radiant sunsets. Fish and other edible sea life caught in coastal areas provide a rich and nutritious source of food to consumers. Beaches are also excellent recreationareas,usedforrelaxation,exercise,orbirdwatching.Theseareonlythedirectbenefits.There are also values that are not directly tied to use, such as climate modulation, physical protection, andstewardshipforfuturegenerations.Allofthesebenefitsarerelevantinenvironmentalvaluation.




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5.3 ENVIRONMENTAL VALUES

Usevalues,suchasfishingandhiking,arethemoredirectandquantifiablecategoryofenvironmentalvalues, but they capture only a portion of the total economic value of an environmental asset. Indirect-use values, non-use values, and intrinsic values are also associated with preserving environmental resources.

Total economic value is represented by the following equation:Total economic value = direct-use value + indirect-use value + non-use value + intrinsic valueIndirect-use values associated with coastal areas include biological support, physical protection, climatemodulationandgloballifesupport.Non-usevaluesarelessdirect,lesstangiblebenefitstosociety and include option and existence values.

The option value is the value an individual places on the potential future use of the re-source, for example, benefits a beachwouldoffer during future trips to the coastal area. Ex-istence values include bequest, stewardship, and benevolence motives. Bequest value is the satisfaction gained through the ability to endow a natural resource on future generations.

The stewardship motive is derived from an altruistic sense of responsibility toward the preservation of the environment and a desire to reduce environmental degradation. The benevolence motive reflectsthedesiretoconserveanenvironmentalresourceforpotentialusebyothers.Finally,theintrinsicvalueofnaturereflectsthebeliefthatalllivingorganismsarevaluableregardlessofthemonetary value placed on them by society. Table 1 presents a typology of environmental values.

Figure 1: Environmen-tal valuation topics cov-ered on this Web page.

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Table 1. Categories of Environmental Values (adapted from Spurgeon 1998) ________________________________________(a) Direct-use values: goods and services directly consumed by users- Products (e.g., edible, ornamental, medicinal, inputs into production process)- Recreation- Waste assimilation- Research- Education (b)Indirect-usevalues:indirectbenefitsarisingfromecologicalsystems -Biological support – links to other species and habitats-Physical protection – coastal defense function-Climate regulation-Global life support – functions that aid in supporting life on Earth (c) Non-use values -Option value-Existence value Bequest motiveStewardship motiveBenevolence motive (d) Intrinsic value: organisms have a worth of their own regardless of usefulness to humans________________________________________

It is important to note that there are certain environmental assets that are absolutely essential tothesupportofanimallife,andthatthetotalvalueoftheseassetsisnotdefinable.Marginalchanges, however, in the productivity and security of even irreplaceable environmental assets (e.g., the degradation of part of a large ecosystem or environmental resources essential to human life) can be captured in terms of total economic value. For example, the total economic value of air and water quality are immeasurably large because extreme degradation of either would result in irreversible and catastrophic damage to the capacity of this planet to support human and other life.However,wecanobservethefinitevaluethatsocietyplacesonsmalllossesofeventhoseassets that are absolutely essential for sustaining life. For instance, society has proven willing to acceptsomedegradationofairqualitytoimprovetheefficiencyandconvenienceoftransporta-tion. In this particular example, individual choices are not a good indicator of the value of air quality since most of the costs of reduced air quality are externalized or passed on to others.

5.4 METHODS FOR VALUING THE ENVIRONMENT

Environmental valuation is largely based on the assumption that individuals are willing to pay for environmental gains and, conversely, are willing to accept compensation for some environmental

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losses. The individual demonstrates preferences, which, in turn, place values on environmental resources. That society values environmental resources is certain; monetizing the value placed on changes in environmental assets such as coastal areas and water quality is far more complex. En-vironmental economists have developed a number of market and non-market-based techniques to valuetheenvironment.Figure2presentssomeofthesetechniquesandclassifiesthemaccordingtothe basis of the monetary valuation, either market-based, surrogate market, or non-market-based.

Figure 2: Environmental Valuation Methods

Market-Based Methods. Economists generally prefer to rely on direct, observable market interac-tions to place monetary values on goods and services. Markets enable economists to measure an individual’s willingness to pay to acquire or preserve environmental services. In turn, consumers reveal their preferences through the choices they make in allocating scarce resources among competing alternatives. There are a number of market-based methods of environmental valuation. Thisarticle identifiesanddiscussesthreemarket-basedtechniques:a)factorofproductionap-proach, b) change in producer/consumer surplus, and c) examination of defensive expenditures.

The value of a natural resource can be monetized based on its value as a factor of production. An EconomicViewoftheEnvironmentnotesthattheoutputofanyfirmisafunctionofseveralimportantinputs (e.g., land, capital, natural resources), which are collectively known as “factors of production.” In their role as factors of production, raw materials and environmental inputs are used in the pro-duction of other goods. When a natural resource has direct value as a factor of production and the impact of environmental degradation on future output of that resource can be accurately measured, the resultant monetary value of the decline in production or higher cost of production can be mea-sured. For example, a decline in water quality could have a direct and detrimental impact on the pro-ductivityandhealthofshellfishbeds.Thistechniqueismethodologicallystraightforward;however,it is limited to those resources that are used in the production process of goods and services sold in markets. Because many goods and services produced by the environment are not sold in markets, the factor of production method generally fails to capture the total value of the resource to society.

The standard method used to measure the net economic benefit of a good or service in amarket involves an examination of consumer and producer surplus. As noted in An Eco-nomic View of the Environment, consumer surplus is the difference between what each cus-tomer is willing to pay and the price of the good or service and is represented by the area

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falling above the price line and below the demand curve. Consumer surplus in Figure 3 is repre-sented by Area abc. Producer surplus is the difference between what a producer is paid for a good orserviceandwhatitcoststosupply,andisrepresentedbyAreabcd.Thetotaleconomicbenefitof a sale is the sum of the consumer and producer surplus.

Figure 3: Producer and consumer surplus for striped bass.

Measuring the producer surplus often involves the use of complicated econometric (economic statistical) techniques. As noted in Lipton and others (1995), however, the careful measurement of a small number of variables sometimes can be used to estimate the impact of an action on producer surplus. This study presents a hypothetical scenario in which habitat degradation leads to reduced catches of striped bass in Chesapeake Bay. In this example, the catch falls from 8,000 to 5,000 pounds per day. The before-after portrait of the producer surplus in this scenario is presented in Table 2.

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Table 2. Impact of Habitat Degradation on Producer Surplus________________________________________BeforeCatch rate per day (pounds) = 8,000Ex-vessel price1 = $0.70 / poundVariable cost per pound = $0.40Totaldaysfishedinseason=16Total revenue = 16 * 8,000 * $0.70 = $89,600Total variable cost = 16 * $0.40 * 8,000 = $51,200Producer surplus, therefore, equals $89,600 - $51,200 = $38,400. AfterCatch rate per day = 5,000Ex-vessel price = $0.70 / poundVariable costs per pound = $0.50Totaldaysfishedinseason=16Total revenue = 16 * 5,000 * $0.70 = $56,000Total variable cost = 16 x $0.50 * 5,000 = $40,000

Producer surplus after the habitat degradation is $56,000 - $40,000 = $16,000

________________________________________

Table 2 shows that the decline in habitat has reduced the daily catch by 3,000 pounds. In turn, commercialfishermenareexpendingmoreresources(fuel,labor)perpoundoffishcaught.Thatis,asthefishpopulationdeclines,variablecostsrisebecausemoreeffortisrequiredtolandthesame catch. Finally, this analysis holds the price-per-pound constant, although the basic principles ofsupplyanddemandsuggestthatpriceswouldlikelyincreaseasthesupplyoffishdeclines.Inreality, the ex-vessel price would likely rise in response to the declining catch rate as consumers bid up the price for the dwindling supply of striped bass (a discussion on consumer surplus fol-lows).Basedonthisanalysis,theproducersurplusresultingfromthecommercialfishingofstripedbass has declined by $22,400 ($38,400 - $16,000) as a result of habitat degradation.Producer surplus is only half the total economic picture. To capture the entire economic impact of the decline in the striped bass catch, the analyst must also measure the change in consumer surplus. When measuring consumer surplus, a demand curve must be constructed to quantify the area of Figure 2 represented by Area abc. Measuring the consumer surplus, however, generally in-volves the use of econometric techniques and requires time series information on the market price of the good or service and the quantity consumed at each price level, along with other factors affecting the demand for the product. Provided all of this information is available, the analyst can construct a product demand curve to measure the expansion or contraction of consumer surplus in response to changing environmental conditions and corresponding shifts in the quantity

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suppliedandprice.Afinalmarket-basedvaluationmethodisthatofdefensiveexpenditures,whichare made on the part of industry and the public either to prevent or counteract the adverse effects of pollution (Feather 1995) or other environmental stressors. The defensive expenditures method, also known as the averting behavior approach, monetizes an environmental externality by measuring the resources expended to avoid its negative impacts on a surrounding community. Types of defensive expendituresincludewaterpurificationdevices,beachnourishment,andreplantingseagrasses.SurrogateMarketMethods.Intheabsenceofclearlydefinedmarkets,thevalueofenvironmentalresources can be derived from information acquired through surrogate markets. The most common markets used as surrogates when monetizing environmental resources are those for property and labor. The surrogate market methods discussed below are the hedonic price method and the travel cost method, with a brief look at the use of random utility models for environmental valuation.

The hedonic price method of environmental valuation uses surrogate markets for placing a value on environmental quality. The real estate market is the most commonly used surrogate in hedonic pricing of environmental values. Air, water, and noise pollution have a direct impact on property values. By comparing properties with otherwise similar characteristics or by examining the price of a property over time as environmental conditions change and correcting for all non-environmental factors, information in the housing market can be used to estimate people’s willingness to pay for environmental quality.The travel cost method is employed to measure the value of a recreational site by surveying travel-ers on the economic costs they incur (e.g., time and out-of-pocket travel expenses) when visiting the site from some distance away. These expenditures are considered an indicator of society’s willingnesstopayforaccesstotherecreationalbenefitsprovidedbythesite.

To better understand the travel cost method, consider the case of coastal pollution resulting in clo-sureofarecreationalbeach.Toestimatetheassociatedlostvalueofrecreationalbenefits,thefirststep of a travel cost analysis would be to survey individuals about the number of trips and expenses incurred during each trip to the beach. The second step is to examine the relationship between the expense incurred and the total number of trips taken (Table 3). Thus, the travel cost method enables theanalysttodevelopanimplicitdemandcurvefortherecreationalbenefitsofferedbythesiteper person, which can then be multiplied by the number of people in each cost category (generally judged by estimating costs associated with various distances from the site). In turn, the demand curve can be used to measure consumer surplus and monetize the direct, use value of the site.

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TABLE 3: TRIP EXPENSE AND NUMBER OF TRIPS TO A RECREATION BEACH

Trip Expense Number of Trips <$20 100 $20-$40 45$40-$60 32$60-$80 17$80-$100 9>$100 4

The travel cost method can be used to measure not only the elimination of a site but also the im-pact of access restrictions and changes in environmental quality. The travel cost method, however, is limited inapplicationandcapturesonlydirectrecreationalbenefitsandonlywhentherearemeasurable travel costs to examine. Finally, the travel cost method does not measure non-use and intrinsic values or other sources of value, such as commercial values. Random utility models (RUMs) are econometric models that, among other uses, permit the estimation of preferences among dif-ferent recreational areas with varying characteristics. The RUM, with its ability to assess competing multiple sites with varying recreational characteristics, holds considerable appeal for economists.

Consider three beaches with characteristics that vary based on location, water qual-ity, landscape features, access, existence of lavatories, and other services. These charac-teristics can be transformed into discrete and continuous variables used to assess consum-er preference by examining location preference and the total cost of trips taken (Table 4).

Based on the data collected through surveys of various sites, the RUM estimates the probabil-ity that an individual will visit one site out of several sites based on site characteristics. Vary-ing the quality of those characteristics (e.g., water quality, landscape features) permits the ana-lyst to assess how recreational travelers value changes in environmental quality at particular sites. A RUM is not specific to surrogatemarket techniques. Rather, a RUM is an estimationprocedure that can be combined with surrogate and non-market techniques used in valuing, for example, recreational areas and wetland area restoration. Travel cost studies often use RUMs; however, they may also be applied in stated preference studies that use choice experiments.

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DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENTTable 4: Expenditures per Trip and Number of Trips Taken (Adapted from Lipton 1995)

Individual Travel Costs / Site I Site II Site III

Number of Trips

1 Travel Costs $20 $40 $50

Number of trips 4 3 2





Non-Market Methods. The Contingent Valuation Method (CVM) is a non-market-based tech-nique that elicits information concerning environmental preferences from individuals through the use of surveys, questionnaires, and interviews. When deploying the contingent valuation method, the examiner constructs a scenario or hypothetical market involving an improvement or decline in environmental quality. The scenario is then posed to a random sample of the pop-ulation to estimate their willingness to pay (e.g., through local property taxes or utility fees) for the improvement or their willingness to accept monetary compensation for the decline in environmental quality. The questionnaire may take the form of a simple open-ended question (e.g., how much would you be willing to pay) or may involve a bidding process (e.g., would you accept $10, would you accept $20) or take-it-or-leave-it propositions. Based on survey responses, examiners estimate the mean and median willingness to pay for an environmen-tal improvement or willingness to accept compensation for a decline in environmental quality.

5.5 SUMMARY

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5.6 BIBLIOGRAPHY

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1 environmental economics

Documents

environmental health

moduleiii unit onethe

better health care

unlimited wants human

overall module objectives

principle of economics

basic biological needs

minimum needs