Environmental economics2

2 different approaches

• Ecological paradigm: concerned with the health and survival of ecosystems

• Economic paradigm: concerned with maximizing human welfare– BUT: does that mean current welfare (short-

term) or future welfare (long-term)??

Ecological paradigm

• Ecologists think of maximizing long-term welfare

• What do we call that?– Sustainability

Economic paradigm

• Economists often concerned with how the environment affects human well-being– Environment has no value by itself (intrinsic

value)

Environmental economics

• Maximizing human welfare MUST INCLUDE properly valuing ecosystems and the costs of environmental degradation

Environmental economics

• To an economist, environmental issues fall into two areas:– Generation of wastes and pollutants as

unwanted byproducts of human activities– The management of renewable and

nonrenewable natural resources

How much is too much?

• How much pollution should be permitted?• Current levels too high? . . . Or too low?• Shouldn’t pollution be zero?

– Why or why not?

Market economy

• For many goods, supply and demand determine a market equilibrium.

• Examples: iPads, Modern Warfare II, bananas

• BUT: for natural resources or environmental quality– Not true market goods– Hard to price

Externalities

• Key concept• Whenever an economic activity creates

``spillovers’’ on people not directly involved in the activity, there is an externality.

= unintentional side effects• Usually negative

Externalities are social costs• When externalities occur, a

company’s private production cost is NOT the same as the social cost of production.

• Social costs might include costs of pollution cleanup or added healthcare costs

• When external costs are ADDED to the costs of production, the supply curve shifts left (for a given price, suppliers will supply less)

supply

Supply + social cost

What happens to the price ofa product if externalities areIncluded?

KEY

Slide

Externalities

• A factory that pollutes a river creates involuntary costs (negative externalities) for anyone using the river– Fishermen –can’t fish or can’t eat catch– Boaters –unable to boat or increased maintenance– Swimmers – lose swimming spot; increased illness– Water suppliers – costs of making water safe

Externalities

• There can be positive externalities• Examples?

– Your neighbor paints her house and improves her yard with new landscaping. She bears all the cost. She reaps some benefit.

– YOU and other neighbors also benefit

How deal with externalities?

• Several ways– Command-and-control (government regulation)– Tax– Subsidy Economic– cap-and-trade incentives

Command-and-control

• The traditional way of dealing with environmental regulation in the U.S. (and elsewhere).

• Regulators – usually the federal or state government – sets standards or limits on some activity, such as pollution emitted.

Command-and-control

• Ambient standard– Regulator sets the amount of a pollutant that

can be present in a specific environment.– E.g.: government sets limit on ground-level

ozone (say, 100 ppm) in an area– Indirect: the limit is on the level in the

atmosphere, not on specific polluters.

Command-and-control

• Emission standards– Limit the amount of emissions from a specific

firm, industry, or region– Doesn’t set allowed level in environment, but

tries to reduce pollution company by company.

Command-and-control

• Technology-based standard– Require polluters to use particular technology

to control pollution.– E.g.: power plants that are required to install

scrubbers on their smokestacks.

Command-and-control

• Why use c-and-c?– Clear outcome– Easy to monitor compliance

• Drawbacks– Information can be hard to come by

• The regulated industry has incentive for dishonesty• Gathering information can be expensive

– Regulated industries may have no incentive to find innovative ways to meet standards

Command-and-control

• Drawbacks (continued)– Not always cost effective– Marginal cost for limiting pollution likely to

vary among sources• Means: some companies may be able to reduce

pollution much more cheaply than others

Command-and-control

• 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

Tax

• Fee charged to polluter • Value determined by the regulator• Goals:

– Discourage environmentally damaging activity– Raise revenue (often to be used for

environmental projects)– Internalize the externality

Tax• A tax may be imposed on a product that causes environmental harm, such as a pollutant.• The tax is a way to INTERNALIZE the externality—that is, to REVEAL the true cost of

the product (including the social costs such as environmental degradation or health impacts).

• What is the effect?

• Environmental economists LIKE pollution taxes!

Tax

• Example:– Gasoline tax– Much higher in Europe than the US

• Environmental taxes were about 3.5% of total tax revenue in the US in 2003– About 7% in Europe

Tax

• Advantages– The source (regulated industry) can determine

most cost effective way to reduce emissions– Economically efficient: polluter will reduce

emissions as long as that’s cheaper than paying the tax.

– The regulator (government) doesn’t need as much information (such as on control techniques) so less expensive to implement

Tax

• Disadvantages– Taxes are politically unpopular– Fairness: gas tax, for example, may be

perceived as harming the poor the most

Subsidy

• A reverse tax• Payments—by governments—for desirable

activities– ‘A result of a government action that confers an advantage on consumers or producers, in

order to supplement their income or lower their costs’

• For example: there have been subsidies for purchasing fuel-efficient cars—money back or a tax break.

Subsidy

• Disadvantages– May make it seem like environmentally

friendly behavior must be paid for, rather than is a responsibility.

– Subsidies have a cost—government is paying for them

– Subsidies may require government to pick winners

Subsidies & taxes

• Possible negative effect of both:– May decrease people’s environmental ethic,

because they may feel that if they pay the tax or forego the subsidy, they have a right to pollute and no further responsibility.

– DISCUSS