ENVIRONMENTAL ECONOMICS

Money Talks!

EconomicsThe study of the

production, distribution, and consumption of goods and services.

Economic Needs vs. Wants

• Needs: must have to stay alive and healthy– Examples?

• Wants: everything else– Examples?

Law of Diminishing Returns

• Each additional unit of input yields less and less additional output.

• Example:– If you put too many seeds (or too

much fertilizer) in the ground, eventually each additional increment pays off less than previous ones.

• More Examples?example

Opportunity Cost• Every time you do something, the

opportunity cost is the best other thing you could have done instead (with the time, money, etc.).

• When you make a decision, the most valuable alternative you give up is your opportunity cost.

• Example: If a city decides to build a landfill on vacant land that it owns, the opportunity cost is some other thing that might have been done with the land and construction funds instead (e.g., build a school, park, sell it, etc.)

Internal Costs

• Costs paid directly by the consumer

• Examples?

External Costs

• Costs not included in the price of the product, but that are ultimately paid by someone (e.g., the whole society).

• Examples?

True Cost

• = Internal Costs + External Costs• Includes both short-term and long-

term costs, and costs to the buyer and society.

Internalizing External Costs

• Most of the time, impacts on the environment are not taken into account when determining the costs and benefits of doing business.

• By internalizing external costs the market system can be used to optimize resource use in the long term.

True Cost Example: Gasoline

• Internal Costs = $?• External Costs = $14.14/gallon ($559

billion - $1.69 trillion/year in US– $1.01: tax subsidies, new roads,

pollution cleanup– $1.05: Military & other protection– $12.08: Environmental, health, and

social costs• True Cost: = over $15/gallon!

Source: Sierra. March/April 2002: p. 15

True Cost Example: Gasoline

• Internal Costs = $?• External Costs = $6-15/gallon ($559 billion -

$1.69 trillion/year in US– 1) Tax Subsidization of the Oil Industry– 2) Government Program Subsidies– 3) Protection Costs Involved in Oil

Shipment and Motor Vehicle Services– 4) Environmental, Health, and Social

Costs of Gasoline Usage– 5) Other Important Externalities of Motor

Vehicle Use.– True Cost: = over $15/gallon!

Source: http://www.progress.org/2003/energy22.htm

Pollution Example

• A factory is emitting pollution out of its smokestack.

• Using evermore sophisticated (and expensive) technology we can reduce the amount of pollution coming out of the smokestack all the way to the point that no pollution is emitted.

Pollution Example• How much pollution should we allow to

come out of the factory’s smokestack?– 100%: all of it– 75%: reduce it by ¼– 50%: reduce it by half– 25%: reduce it by ¾– 0%: force the company to emit no

pollution.

Pollution Example• How much pollution should we allow to

come out of the factory’s smokestack?• Answer? You need to weigh both the

internal and external costs to minimize the total costs, thus saving the opportunity costs to apply elsewhere.

Pollution Example:How much pollution should

we allow to be emitted?

Internalizing External Costs

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% of Pollution Emitted

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Cost of PollutionControl

Cost to HumanHealth/Welfare

True Cost

Pollution Example Answer

• In this case, cutting emissions by about 50% (optimum pollution level) minimizes total societal costs (optimum true cost).

Pollution Example Answer

• So, how do we internalize the external costs?– Add up the human health &

welfare costs and add them to the costs of the product (internal costs) that the factory produces.

– Use those added costs to cover the health/welfare costs.

Pollution Example Answer

• Had you forced the company to reduce emissions to 0%, then the true cost would have risen from only $25 million to $100 million!

• You would have lost $75 million in opportunity cost.

Review• What are the internal costs?• What are the external costs?• What are the true costs?• How does the law of diminishing returns apply?• How does opportunity cost apply?• What are the pros/cons of internalizing external

costs? Internalizing External Costs

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% of Pollution EmittedC

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True Cost

Is the optimum pollution level always 50%?