Chapter 27: Dollars and Environmental Sense: Economics of

Environmental Issues

The Economic Importance of the Environment

• In the mid-1990’s US spent ~$115 billion/ year to deal w/ pollution.– About 2% of GNP– Many more cost of pollution are hidden– The EPA has a budget of $6 billion/ year

The Economic Importance of the Environment

• Effects of pollutants:– Lower average life expectancies and higher

incidences of certain diseases.– Particulate air pollution in U.S. cities

contributes to 60,000 deaths annually.

• The value of the benefits from Clean Air Act amendments is estimated to be $110 billion in 2010, while the costs are estimated to be $27 billion.

The Economic Importance of the Environment

• Health damage in tangible factor– Measurable.

• Other factors such as landscape beauty are also important– Hard to quantify

• Environmental decision making often involves analysis of tangible and intangible factors.– One task of environmental economics is to develop

methods for evaluating intangible.

The Environment as a Commons

• Often people who use a natural resource do not act in a way that maintains that resource and its environment in a renewable state.– They do not seek sustainability.– Profit motive w/not always lead a person to

act in the best interest of the environment.

The Environment as a Commons

• “The tragedy of the commons.”– When a resource is shared, an individual’s personal

share of profit from exploitation of the resource is usually greater than that individual’s share of the resulting loss.

• A commons is any resource owned publicly with public access for private uses.– Each user tries to maximize personal gain and must

periodically consider whether to add more cattle to the herd on the commons.

The Environment as a Commons– The addition of one cow has both a positive and a

negative value.– The positive value is the benefit when the herder sells

that cow. – The negative value is the additional grazing by the

cow.– The benefit to an individual of selling a cow for

personal profit is greater than that individual’s share of the loss in the degradation of the commons.

– The short-term successful game plan, therefore, is always to add another cow.

The Environment as a Commons• Eventually the common grazing land is so

crowded with cattle that none can get adequate food and the pasture is destroyed. – In the short run, everyone seems to gain, but in the

long run, everyone loses.

• Complete freedom of action in a commons inevitably brings ruin to all.

• The implication seems clear: – Without some management or control, all natural

resources treated like a commons will inevitably be destroyed.

The Environment as a Commons• There are many examples of commons;

– US forest, 38% are on publicly owned lands. – Ocean fisheries away from coastlines – Deep-ocean seabed, where valuable mineral

deposits lie– Antarctica – The atmosphere– Great Chagos Bank in the Indian Ocean

The Environment as a Commons• In the 19th century burning wood in fireplaces

was a major source of heating in the US.– As population increased.– Air quality in some local areas declined.

• As a result some communities restrict or prohibit the use of fireplaces and wood-stoves.

• The local air is a commons and its overuse required a societal change.

The Environment as a Commons• Recreation is a problem of the commons

– Overcrowding of national parks, wilderness areas, and other nature-recreation areas.

– E.g. Voyageurs National Park in MN• Some environmentalists argue it should be a

wilderness area because it is ecologically fragile.

• Other group argue that near by Boundary Waters provide ample wilderness.

Low Growth Rate and Therefore Low Profit as a Factor in Exploitation

• The second reason individuals tend to overexploit natural resources held in common is the low growth rate of the resource.– E.g., whales and whale oil.– How can whalers get the best return on their

capital? – We will examine two approaches:

• resource sustainability and maximum profit.

Low Growth Rate and Therefore Low Profit as a Factor in Exploitation

• Whalers adopt a simple, one-factor resource sustainability policy– Only harvest the net biological productivity each

year and thus maintain the total abundance of whales at its current level.

– They will stay in the whaling business indefinitely.

• In contrast, if they adopt a simple approach to maximizing immediate profit– They will harvest all the whales now, sell the oil,

get out of the whaling business, and invest the profits.

Low Growth Rate and Therefore Low Profit as a Factor in Exploitation

• Economically speaking the second scenario is more profitable.

• Whaling on the open seas can be also viewed as a problem of a commons, complicated by low growth rate.

Externalities• Also called an indirect cost,

– An effect not normally accounted for in the cost–revenue analysis of producers.

– Not recognized by them as part of their costs and benefits.

– Costs or benefits that don’t show up in the price tag.

• Consumers must compared true costs or the price will be wrong.

Externalities• Air and water pollution provide good

example of externalities.• Production of nickel.

– Direct costs include purchasing ore, energy to run the smelter, building the plant, and paying employees.

– Externalities include degradation of the environment from plant emissions.

Externalities• How do we get the value of clean air and

water and other environmental benefits to be recognized socially as greater than zero?

• Quantitative evaluation of the tangible natural resources– Such as air, water, forests, and minerals– Prior to development or management of a

particular area is now standard procedure.

Externalities• Some suggest that environmental and

ecological costs should be included in costs of production through taxation or fees.– Expense borne by the corporation that benefits

directly or would be passed on to consumers.– Others suggest that these costs should be shared

by the entire society and paid for by general taxation

– Economists generally agree that the “polluter pays” approach provides much stronger incentives for cost-effective pollution reduction.

Public Service Functions of Nature

• It is estimated that bees pollinate $20 billion worth of crops in the US.– Cost of pollinating these crops by hand would

be exorbitant.– A pollutant that eliminated bees would have

large indirect economic consequences.– Recently, outbreak of bee parasites in the US

reduced the abundance of bees, bringing this once-intangible factor to public attention

Public Service Functions of Nature

• Only when our environment loses a public service function do we usually begin to recognize its economic benefits.

• What had been accepted as an economic externality (indirect cost) suddenly may become a direct cost.

• Public service functions have been estimated to provide between $3 trillion and $33 trillion per year.– Natural capital

Valuing the Beauty of Nature• Often referred to as landscape aesthetics• One of the perplexing problems associated

with aesthetic evaluation is personal preference.

• Philosophers differ on what key elements are important to aesthetic quality– Coherence, complexity, and mystery– Unity, vividness, and variety

How is the Future Valued• Because we know we are mortal we tend

to value personal wealth and goods more if they are available now than if they are promised in the future.– But many people still argue we have a debt

to future generations

• Can we place an economic value on future existence of anything?

How is the Future Valued• Economists observe that it is an open

question whether something promised in the future will have more value then it does today

• So in terms of the future, the basic issues are: – (1) We are so much richer and better off than our

ancestors that their sacrificing for us might have been inappropriate.

– (2) Even if they had wanted to sacrifice, how would they have known what sacrifices would be important to us?

Risk-Benefit Analysis

• The riskiness of a present action in terms of its possible outcomes is weighed against the benefit, or value, of the action.

Acceptability of Risks and Costs• Some behaviors are far riskier than others.

– Ultimate fate for everyone is death

Acceptability of Risks and Costs

• Looking at Table 27.1 we can make a couple of conclusions. – Value of lowering air pollution is an

improvement in the quality of our lives, rather than an increase in the time we are alive.

– Natural indoor air pollution is much more deadly than most outdoor air pollution.

Acceptability of Risks and Costs

• Generalizations about the acceptability of various risks:– Number of people affected. – Novel risks appear to be less acceptable than

long-established or natural risks.– People’s willingness to pay for reducing a

risk also varies with how essential and desirable the activity associated with the risk is.

Acceptability of Risks and Costs• On the basis of direct effects on human

health, it costs more to increase longevity through a reduction in air pollution than to directly reduce deaths through the addition of a coronary ambulance system.

• The issue boils down to whether we should improve the quality of life for the living or extend life expectancy regardless of the quality of life.

Acceptability of Risks and Costs• US Toxic Substances Control Act

– No one may manufacture a new chemical substance w/o obtaining a clearance from the EPA.

– Act establishes procedures to estimate the hazard to the environment and to human health.

• The EPA examines the data and judges the degree of risk associated w/ all aspects of production;– Extraction of raw materials, manufacturing,

distribution, processing, use, and disposal. – Can be banned or restricted if it will pose an

unreasonable risk.

Global Issue: Who Bears the Cost?

• The less developed countries did not share in the economic benefits of the burning of fossil fuels during the first two centuries of the Industrial Revolution, but they are sharing in the disadvantages of this activity.

How do we Achieve a Goal?• Means to implement a society’s policies are

known among economists as policy instruments. – Moral suasion - i.e., persuading people by talk,

publicity, and social pressure)– Direct controls, which include regulations– Market processes, which affect the price of goods

and include taxation of various kinds, subsidies, licenses, and deposits

– Government investments, which include research and education.

Control of Pollutants

• In controlling pollutants, marginal cost is the cost to reduce one additional unit of pollutant.– Often increases rapidly as the percentage

of reduction increases.

Control of Pollutants• Three common methods of direct

control of pollution: – (1) setting maximum levels of pollution

emission– (2) requiring specific procedures and

processes that reduce pollution– (3) charging fees for pollution emission

Control of Pollutants• The problem with the first approach is that

careful monitoring is required indefinitely to make certain the allowable levels are not exceeded.

• The disadvantages of the second approach;– Severe financial burden on the producer of the

pollutant– Restrict the kinds of production methods open to an

industry– Become technologically obsolete.

• Sale of licenses or permits has been found to be among the more successful recourses.