Environmental Economics Course

Market failure and decision making

19/10/2011

Cristina Marta-Pedroso

cristina.pedroso@ipb.ptcristina.marta@ist.utl.pt

• Externalities

• Public Goods

• Ecosystem services

• Economic Valuation of Ecosystem Services

• Highlighting the inclusion of Economic Valuation in

decision making:

• Governmental intervention (e.g Agri-environmental

policies)

• Castro Verde

• Private sector (TEEB for Business /WBCSD )

• EVI – Cascata da Serra da Estrela

• In market equilibrium the marginal benefit is equal to marginal cost. • This is the general (and necessary) condition for optimization. • In this case, market equilibrium illustrates the quantity of seedlings that maximize

the sum of consumer and producer surpluses. For example, the net benefit for consumers (forest owners) and producers (owners of nursery firms).

If the market is perfectly competitive, the market equilibrium is also socially optimal.

X = Consumer Surplus

Y = Consumer Surplus

Externalities (Negative or Positive)

An external effect, or an externality, is said to occur when the production or

consumption decisions of one agent have an impact on the utility or profit of

another agent in an unintended way, and when no compensation/payment is

made by the generator of the impact to the affected party.

Positive Externality: Bread smell

Analysis of Positive Externalities

Underproduction

Negative Externality: Pollution

Analysis of an negative externality

Overproduction

Public Goods (extreme cases of Positive Externalities)

 Characteristics

 

 Public Goods

 Private Goods

  

[Non]Excludability

Goods cannot be confined to those who have paid for it. In this sense, non-payers can take a free ride and enjoy the benefits of consumption.

Consumers can be excluded from consuming the product if they are not willing to pay for it.

  

[Non]Rivalry 

Consumption by one person does not reduce the availability of a good to others.

One person's consumption of a product reduces the amount available for other people to consume

 Why is there a problem?  When markets are unable to capture some attributes of a given good is there a market failure, e.g. the private (cost) benefit does not equal the social benefit (cost).

Inequalities among the private and social cost and benefit are called externalities, negative positive or externalities.

What is called the free rider problem gives light on why the firms, e.g. farmers, do not have an incentive, in a competitive market, to provide public goods too consumers. The absence of a full internalization of these benefits in the market price of agricultural products is the main underlying cause for natural resources depletion.

 

The "free rider" principle says that you cannot charge an individual a price for the provision of a non-excludable good because somebody else would gain the benefit from consumption without paying anything

Purely Private

Rivarly

Excludability

Purely Public

Mixed Goods

o consumo de um individuo desse bem não diminui a possibilidade de consumo por outro

uma vez produzido esse bem é impossível (ou muito difícil) evitar que outro tenha acesso a ele

Intervenção Governamental

Mercado

Benefícios que os ecossistemas providenciam ao Homem

Millennium Ecosystem Assessment

The value of a forest is often measured only by the timber and fuel provided by its trees.

In these countries, however, that is generally less than one third of the total economic value.

The higher figure includes services such as control of the climate through absorption (sequestration) of carbon dioxide, protection of freshwater sources (watersheds), and recreation.

Because many of these services are not bought and sold in markets, they are frequently lost or degraded even though their value to human societies is high.

(Source: MEA)

Madeira e lenha correspondem a menos de

1/3 do valor económico das florestas

mediterrânicas

Environmental Economics Course

Market failure and decision making

20/10/2011

Cristina Marta-Pedroso

cristina.pedroso@ipb.ptcristina.marta@ist.utl.pt

• Externalities

• Public Goods

• Ecosystem services

• Economic Valuation of Ecosystem Services

• Wrap up

• Highlighting the inclusion of Economic Valuation in

decision making:

• Governmental intervention (e.g Agri-environmental

policies)

• Castro Verde

• Private sector (TEEB for Business /WBCSD )

• EVI – Cascata da Serra da Estrela

1. Which of the following statements is true regarding externalities?

A. Both negative and positive externalities lead to inefficient outcomes in

markets.

B. Negative externalities lead to inefficiencies in markets, but positive

externalities do not.

C. Negative externalities occur when the good harms those who consume it.

D. Positive externalities occur when the good benefits those who consume it.

2. The two main characteristics of a public good are:

A. production at constant marginal cost and rising demand.

B. non-excludability and production at rising marginal cost.

C. non-rivalry and non-excludability.

D. non-rivalry and large negative externalities.

3. Unlike a private good, a public good:

A. has no opportunity costs.

B. has benefits available to all, including nonpayers.

C. produces no positive or negative externalities.

D. is characterized by rivalry and excludability.

4. Which of the following is an example of a public good?

A. a weather warning system

B. a television set

C. a sofa

D. a bottle of soda

5. The market system does not produce public goods because:

A. there is no need or demand for such goods.

B. private firms cannot stop consumers who are unwilling to pay for such goods

from benefiting from them.

C. public enterprises can produce such goods at lower cost than can private

enterprises.

D. their production seriously distorts the distribution of income.

6. Because of the free-rider problem:

A. the market demand for a public good is overstated.

B. the market demand for a public good is nonexistent or understated.

C. government has increasingly yielded to the private sector in producing public

goods.

D. public goods often create moral hazard and adverse selection problems.

(Under)Provision of Public Goods by farmers

Produção de Alimento e 

fibra

Protecção da biodiversidade

Oportunidades de Recreio,  Lazer e relaxamento

Manutenção da identidade e patrimonio cultural

Os preços de mercado não incorporam as consequências ambientais das decisões dos agricultores. Estas consequências nã dão assim origem a custos e ou benefícios privados para o agricultor, pelo que o óptimo privado não coincide com o óptimo social.

Falha de mercado e a intervenção pública agro-ambiental

Falha de mercado

Intervenção pública (e.g agri-enviornmental policy)

As políticas devem fornecer os instrumentos (taxas, subsídios) mais adequados e ter em conta a disposição a pagar da sociedade por aqueles benefícios.

Na ausência de outros incentivos o agricultor actua no sentido de maximizar o seu rendimento (o rendimento que consegue captar – no mercado).

A grande maioria destes benefícios não são transaccionados no mercado, portanto não têm preço.

A case study regarding the provision of Public Goods by Agricultural

Governmental InterventionEconomic Valuation: contingent valuation

The Cereal pseudo steppes of Castro Verde:

an human dominated ecosystem

Marginal economic system (low productivity; low revenue)

Main reasons for land use change

Afforestation Land abandonment

Bird’s populations decline and landscape scenery loss

A Contingent Valuation Approach

Metodological approach (2)

Individuals’ attitude towards rural landscapes preservation

WTP elicitation

Socio-economic profile of respondents

1) Questionnaire(s) structure

Non-market good description and valuation scenarios

Elicitation procedure

Open-ended questions in a two stage process

2. Valuation scenarios

Elicitation scenario

NGO intervention mainly supported by citizens donations

Current EU financial support to keep farmers income would be suspended and new forms of land use will be adopted

Government intervention supported by an environmental tax (additional one)

Metodological approach (3)

2. Valuation scenarios (cont.)

A set of pictures and maps have been used to illustrate landscape, its location and the assemblage of birds depending on it.

Support materials

Prior to stating their WTP, individuals were asked to have in mind:

their current net income

their current expenses

The existence of other typical rural landscapes in the country

Budget constraint reminder

Metodological approach (4)

Imagine that this financial support is to be suspended and other farming options, would take place leading to a strong change in landscape structure.

A) As part of a national strategy of rural landscapes preservation the Portuguese government will implement a program of financial incentives to which the farmers of the municipality of Castro Verde could apply.The objective of such financial support is to ensure the continuity of traditional agricultural practices, to achieve the goal of cereal steppe preservation, at least, in 2/3 of the area of the municipality of Castro VerdeThis investment will be partially supported by one TAX to be paid by all Portuguese. Suppose that tax, additional to your current taxes, will be managed honestly and will be totally destined to maintain the traditional agricultural practice that origins the cereal steppe.

What is the maximum that you will be willing to pay annually, as an environmental tax, to maintain the cereal steppe, at least in 2/3 of the area of the municipality of Castro Verde.

Visualization of the landscape pictures and location map

8

paym

ent v

ehic

le =

tax

Regarding this I would like to ask you to consider the following hypothesis:

What is the maximum that you will be willing to pay, as a one time payment, to maintain the Cereal steppe, at least in 1/3 of the area of the municipality of Castro Verde?

B) In order to maintain the current landscape, at least in 1/3 of its extension, a private and non-profit organization, will acquire that area Castro Verde being responsible for its management. This intervention will be essentially supported by citizen donations.

paym

ent

vehi

cle

= d

onat

ion

Pictures and information about of Birds species and habitat requirements

Yes Rectification of answer

8 A

Rectification of answer

8 B

No, I knew about it

No, I do not consider it important

No,

The landscape introduced to you before is from, an ecological perspective, an important refugium for a set of birds’ species threatened at national and international level. Eventual landscape transformations, arriving from a shift in agricultural practice, will lead to a reduction in this birds population and to contribute for the risk of their extinction at global scale.

Facing this information would you like to revise the amount stated before?

Other

9

Modo de Entrevista Rendimento mi E (WTP) 95% CI pi E (WTP)

0.49 24.54

0.49 30.39

0.49 38.29

0.49 60.29

0.49 37.68

0.49 46.72

0.49 58.86

0.49 92.68

Regressão

€ €

Modelo Spike

Web 3.001 48.13 [60.5 38.3]

Web 3.215 59.62 74.9]

Web 3.446 75.11 [94.4 59.8]

Web 3.900 118.27 [148.6 94.1]

Presencial 3.430 73.92 [92.9 58.8]

Presencial 3.645 91.65 [115.2 72.9]

Presencial 3.876 115.47 [145.1 91.9]

Presencial 4.330 181.82 [228.4 144.7]

-

-

-

-

-

-

-

< 500

500-1100

1100-1750

> 1750

< 500

500-1100

1100-1750

> 1750

-

[47.5

Idade > 30

Results

Portuguese active population (older than 21 years)

4 802 985 WTP (Combined Spike model); one time payment

30.4 €Agregated WTP – 18 966, 67 hectares of cereal steppes

146 M€ [121– 160]

Annuity - hectaret = 40 yearsr = 5%

446 €

[362 – 491]

Total Ecosystem Valuation of an hydropower system watershed in Serra da Estrela, Portugal

Enquadramento

20110826-Ecosystem Valuation Initiative - Total Economic Valuation of Serra de Estrela’s Hydropower System Watershed.pptx

Total Ecosystem Valuation of Cascata da Serra da Estrela, Portugal

TEEB for business

experiencePara preencher o rodapé:

1. Pressione a tecla F5

2. Prima o seguinte botão Definir Default

3. Seguidamente prima F5

4. Confirme premindo o botão

Serra da Estrela Natural Park

Study Area: located in the highest Mountain in Continental Portugal

Watershed:

7.2 m ha

Objectivos

Estimativa do Valor Económico Total dos Serviços de Ecossistema providenciados bacia da Cascata da Serra da Estrela

Análise Custo Benefício de Cenários de Gestão Alternativos

Participatory Workshop

Literature review

Ecological data

collection

TEV

Set System Boundaries

Identify Main Ecosystem

Services

Biophysical units

quantification

Apply economic valuation

techniques

Sensitivity Analysis

1

2

34

5

•Discount rate variation (2%

and 5%)•Time horizon

variation

Set time horizon (concession

period: 20 years)

Compare with a dismantlement

scenario

Private Benefits – Private Costs + Public Benefits – Public Costs

Stage 1 – Dismantlement as baseline

Documento Word – 1. Total Economic Value and Discount rate

2. Valuation Methods

Total Economic Value

Current scenario Dismantlement Benefits Value (€/ year) NPV 20 years (€) Value (€/ year) NPV 20 years (€) Power Generation 6.047.777 79.137.103 0 0 Emission avoided 2.745.704 35.928.421 0 0 Water Supply 869.146 11.373.054 0 0 Food 3.292 43.071 3.292 43.071 Wood 871.532 0 871.532 Fire Risk Avoidance 938 12.271 0 0 Water Recreation 357.111 4.672.907 357.111 4.672.907 Recreational Fishing 4.167 54.527 0 0

Sub- Total 132.092.886 5.587.510 Biodiversity1* 493.967 1.421.861 551.741 1.588.162 Biodiversity 2* 429.413 1.236.044 479.637 1.380.614 Biodiversity 3 429.412 5.935.502 429.412 5.935.502 Biodiversity 4 954.000 12.483.396 954.000 12.483.396 Total 1

133.514.747

7.175.672

Total 2 133.328.930 6.968.124

Total 2 138.028.388 11.523.012

Total 3 144.576.282 18.070.906

Costs Dismantlement Costs Lump sum (€) 112.227.500

Total NPV 20 years* * 137.362.087 -101.293.072 1 LIFE; 2 Matrizes CAOF; 3 Gantioler et al, 2010; 4 ITI Serra da Estrela; * €/5 years; * *Average Total 1-Total 4

FOREST MANAGEMENT

SCENARIO

Biophysical characterizati

on

3 National Authorities

Forest management

Scenarios

Ecological Modelling

Hydrological modelling

Wildfire risk analysis

Stage 2 – Agro-forestry Scenarios

59

1

2

3

4

Biodiversity valorisation

model