environmental economics summary ch 1-4

8/6/2019 Environmental Economics Summary Ch 1-4

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ENVIRONMENTAL ECONOMICS

Second Edition An Introduction

By Barry C. Field


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CHAPTER NO. 1

WHAT IS ENVIRONMNTAL ECONOMICS?

INTRODUCTION

Economics is the study that how and why individuals make decisions about the use

and distribution of human and nonhuman resources. The scope of thissubject isvery

broadening which can provide a set of analytical tools at vast level. On the other hand

we can see that Environmental Economics is the application of principles of

economics to study that how environmental resources are developed and managed.

Environmental economics discuss the problems from the both perspectives like at

micro and macro level.

ECONOMIC ANALYSIS

Economics is the study that is related to the decision making at individual and group

basis that how they manage their resourcesin order to increase wealth. Environmental

economics focuses on the societys natural environment and the way that how people

make decisions for improvement and destruction of environment. At firm level as

well individual level there is problem of wastage. We can also see that how

incentives can change the behavior of peolple.

There is another important point is to see the difference between positive andnormative economics. For example how a housing society reacts to changesin interest

rate is positive economics but on the otherhand what kind of regulationsshould adopt

for a particular environmental problem is a case of normative economics.

Basically pollution is the result of profit motive. In almost all the firms their motive is

profit maximization, so they dont care about the pollution side. So, it is important

that if we want to save environment we have to weaken the strength ofprofit motive.

Individuals also involve in this type of guilty like no maintainenance of car. There is

another approach called moral approach. Basically environmental pollution is also

the result of unethical behavior. So ifit is true it is also very important to increase the

general level of mortality among people.

INCENTIVES- A SIMPLE HOUSEHOLD EXAMPLE


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An incentive issomething that attracts people to modify or change their behavior.For

example in economics there are monetary incentives which can help to change the

consumers behavior but there are non monetary incentives also like self esteem, the

desire to preserve a beautiful environment.

Ther is one simple household example of New Jersey where the developed econmies

manage the trash disposal. Every household has to pay annually or monthly basis for

trash management. This is common practise in these communities. The govt want to

reduce the amount of trash, so they design and offer the incentives for the families

that they have to pay for the each bag of trash like family have to pay according to the

number of bags. So, they announce they will give incentives to the families who will

have less number of trash bag. Now due to this offer families started to recycle of

avoid to use excessive packing. This is a simple example of incentives at the

household level.

INCENTIVES IN INDUSTRY

Incentives are also important in reducing the pollution in industries. Forindustriesit is

very important to charge from the firms as they have emissions during production

process. For example there is incentive based approach like CO2 taxes in developed

countries.

INCENTIVES IN TRANSPORTATION

The transportaion system also is an important source of pollution as the numbers of

vehicles are increasing day by day. When individulas buy a vehicle they compare the

benefits and cost which they have to bear. There is external cost that is the pollution

which is produced by that vehicle. So the most important thing that usershould not

only consider their private costs but they should also think about the external cost.

THE DESIGN OF ENVIRONMENTAL POLICY

Environmental economics has a vital role in the design of public policies for

improvement of environmental quality. Because well designed environmental policies

are very important. Many policy makerssuggest the policies which might not work.

Issues related to design of environmental policies are the major part of environmental

economics.


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MACRO ECONOMICS QUESTIONS: ENVIRONMENT AND GROWTH

The macro economics refer the economy structure as a whole, where we can see the

GDP, inflation and unemployment rate.

COST EFFECTIVENESS ANALYSIS

There are several types of environmental analysis, one is called cost effective analysis.

This is a very simple analysis where we can see for the least expensive way of

achieving a given environmental quality target or put in some different but equivalent

terms. For example, reduce the output of CO2, effective policy to lower down the

amount of CO2.

BENEFIT COST ANALYSIS

In cost effective analysis the economists have only one concern about the costs of

achieving some environmental goal. But in benefit cost analysis, both benefits and

costs of a policy or programme are measured or expressed in comparable terms.

Benefit cost analysis is the main analytical tool used by economists to evaluate

environmental decisions. Today it is throughout used in public sector. It is alos used

as an aid in selectinf efficient policies, sometimes an agency uses it to justify what it

wants to do.

INTERNATIONAL ISSUES

There is lot of problems at the global level like the hot debate is global warming.

There is one most important thing is that how the burden of current progress might be

distributed among different countries of the world.

ECONOMICS AND POLICIES

Further more, we need to discuss that how to achieve effective environmental policy

in a highly political policy environment. Environmental policy not only affects the

natural environment it also affects the people. Like how environment affects different

people and groups in an economy or society. New pollution control initiatives

incorporating economic incentive principals are being adopted at the federal and as

well as at state level.


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CHAPTER 2

THE ECONOMY AND THE ENVIRONMENT

INTRODUCTION

The economy is the collection of technological, legal, and social arrangements

through which individuals in society seek to increase their material and spiritual

wellbeing. The two elements in an economy are production and consumption.

Basically production and consumption also produce leftover waste products

called,Residuals.

Linkage Between Economy and Environment

y This box diagram shows linkages between Nature and economy.y Nature provides raw materials and energy to the economy. Economy uses the

resources to produce goods which are then consumed. During both production

and consumption processes, residuals are emitted to Nature.

y Environmental economicsis the study of the flow of residuals (see the boxdiagram) and itsimpact in the natural world.

y According to the First Law of Thermodynamics (also known as the Law ofconservation of matters), matters only change in shape, size, or phases, thetotal weight is conserved. What goesin must come out. Thus, the total weight

of raw material and energy inputs to economy must be balanced by the total

amount of residuals flowing to the environment.


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NATURAL RESOURCE ECONOMICS

Natural Resource economics is the application of economic principles to study the

extraction and utilization of natural resources. There are subdivisionsin this area like

y Mineral economicsy Marine Economicsy Land Economicsy Energy Economicsy Water Economicsy Agriculture EconomicsIn natural resource economics there is renewable and nonrenewable resources.

Fishiries and timber are example of renewable resources while the petroleumreserves are the example of nonrenewable resources. It both of them we must have

to see the present and the future. Biological and ecological processes create

connections between the rates of resouces used in present and quantity and quality

present in future generations. It is these connections that focus of what has called

sustainability. Many resource extraction processes such as timber cutting has

direct repercussions on environmental quality.

THE FUNDAMENTAL BALANCE

It is important point that in society the producers and consumers actually are the

same people in different capacities. Production and consumption creates residuals.

y According to the First Law of Thermodynamics (also known as the Law ofconservation of matters), matters only change in shape, size, or phases, the

total weight is conserved. What goesin must come out. Thus, the total weight

of raw material and energy inputs to economy must be balanced by the total

amount of residuals flowing to the environment.


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MATERIAL BALANCE CONCEPT

The "materials balance" concept tells us that there are only three ways of reducingresidualsin the environment.

y Reduce outputReduction of output reduces amount ofinputs; therefore, some people advocate"zero population growth."

y Improve productivity of inputsImprovement of technology or productivity leads to requirement of fewerinputsfor the same amount of output. It may as well change the composition of outputsto reduce inputs (for example: a change from manufacturing sector to informationorservice sector).

y Increase recycling of residualsIncreased recycling of residuals also reduces the amount ofvirgin inputs.

We can see that Land, water, and air are the three different environmental mediumthat receive residuals. Materials balance concept also tells us that emissionsin onemedium are reduced by increasing emissionsin another media.

FEW TERMINOLOGIES

y Distinguish between ambient quality and environmental quality.o Ambient quality is the quality of surrounding air and water, whereas

environmental quality includes visual and aesthetic quality of the

environment.

o Effect of emissions on ambient quality depends upon physical,chemical, biological, and meteorological processes of the natural

system, which may change from day to day.

o Besides depending on the different processes of the natural system,damages resulting from degradation of environmental quality also

depend on human choices of where and how to live and on

susceptibility of living and nonliving systems.

y Source would mean the location where emissions occur, such as a factory, anautomobile, or a leaking landfill.

o Some sources can easily be identified; for example, power plants assources of SO2 emissions. Such sources are called point sources.


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o Sources that are difficult to identify are called nonpoint sources;examples are agriculture runoff polluting streams and rivers, urban

storm water runoff, etc.

o When emissions from two sources mix up and cannot be separated,design and implementation of environmental policy may be

problematic. Assigning reduction in emissions among sources would

be difficult.

y Depending on whether a pollutant accumulates over time, it is categorized as acumulative or non-cumulative pollutant.

o For example, noise is a non-cumulative pollution.o Nondegradable wastes, such as radioactive wastes and plastics, are

cumulative pollutants; they may bring inter-temporal problems.

y Noise is a local pollution, but acid rain is a regional pollution, whereasgreenhouse effect is a global pollution.

y Emissions from power plants are continuous, but oil spills and Chernobylnuclear disaster are episodic emissions. Certain environmental damages are

not related to emissions, e.g. logging orstrip mining, the conversion of land to

housing or commercial purposes.

Overall this chapter throws light on the short run and longrun environmental

policy also.

Fig: Production Possibility Curves for Current and Future Generations


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CHAPTER 3

BENEFITS AND COSTS , SUPPLY AND DEMAND

Demand, or Marginal Willingness to Pay, Curve

y The higher the price, the lower the quantity demanded. We can see downward-sloping demand curve to show this negative relationship.

y Demand curve is also a representation of marginal willingness to pay. It is alsoa marginal benefit curve.

y Implicit in the demand curve is the law of decreasing marginal returns. Themore apples you eat, the less tastieris the next apple.

y Marginal benefit from a good decrease with increasing consumption of thegood. Therefore, people are willing to pay larger quantities only at lower

prices.y The value you place on a good depends on how much you have already

consumed.y Height of the d-curve measures the marginal willingness to pay.y Area under the d-curve measures the total willingness to pay for a given

quantity. Area also measures the benefits (of, say, improvement inenvironmental quality).

y Different persons may have different demand curves, reflecting differentvalues placed by them on the same good, either because of different

preferences orincome levels.y A person's demand may change over time with changesin knowledge

(experience orinformation) about the good or with changesin income. Thesame individual can place more value on the same good when incomeincreases.

y Demand for normal goodsincreases with income, and environmental assetsare generally considered normal goods.

y Higherincome people are likely to have higher d-curve for environmentalquality.

o An implication is that the same improvement in environmental qualityis tagged a lowervalue ifimplemented in an area inhabited by poor,compared to the value when implemented in an area inhabited by rich.

o This difference in value arises from the lower ability to pay of poorpeople.


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y Market demand (demand of all individualsin a market aggregated together) isthe horizontal summation ofindividual demands. For each price add quantity

demanded of all consumers to obtain the market demand.

Supply, or Marginal Cost, Curve

y The higher the price, the greater the quantity supplied.We can see an upward-sloping supply curve.

Fig: The concept of Marginal Cost

y The supply curve is also a representation of marginal cost of production.y For a producer to supply a given quantity, the producer must be offered a price

at least equal to the marginal cost at that level of quantity.o Note that marginal cost includes a normal return on equity capital (a

return that could have been earned ifinvested elsewhere; this return isconsidered a part of profit by accountants).

y Implicit in the supply curve is the law ofincreasing marginal costs, i.e.,marginal cost increases as more and more of a good is produced.

o Increase in MC with increase in production is a general case, but thereare cases of decreasing MC (for at least up to a certain level of


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production, primarily due to economy ofscale). In some cases, MCmay remain constant with production.

o Considersupply of clean water as an example. The marginal cost ofsupplying water depends on degree of cleanlinesssought. The cleaner

the watersupplied, the greater the marginal cost ofsupply. Cleaningcostsincrease progressively. Water can be easily cleaned ofsolid

residues and suspended particles by filtering it through a filter orstrain(a physical process). If further cleanlinessis desired to get rid ofdissolved substancesin water, water may have to be boiled or distilled(a relatively more expensive procedure). Ifstill more cleanlinessissought to get rid of chemicalsin the water, it may need still moreexpensive chemical processes.

y Height of the supply curve is a measure of marginal cost (the opportunity costof production). Improvement in technology lowers marginal cost, orshifts thes-curve to the right.

y Area of the supply curve is the total cost ofsupply.y Firms may differin their marginal costs (s-curves) because of different

technologies they use. Example: new and old firms. Accordingly, the total cost

of providing the same improvement in environmental quality may be differentfor different firms. The cost of a firm may also go down with improvement in

technology of the firm.

Market supply curve is the horizontalsummation of firms' supply curves (just as

in case of market demand).

Fig: Derivation of Aggregate (Market) Supply from Individual Firm Supply Curves


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CHAPTER 4

ECONOMIC EFFICIENCY AND MARKETS

Competitive Market Generally Achieves Economic Efficiency

y Competitive market generally achieves economic efficiency.y When demand curve measures both the private MB and the social MB and

when supply curve measures both the private MC and social MC, marketequilibrium coincides with the efficient allocation.

y We can see graphically the socially efficient rate of output.

Issue of Equity

y Economic efficiency guarantees maximum possible net benefits to the society.y But, economic efficiency does not guarantee equitable distribution of net

benefits among members of the society.y In a market system, one who has the ability to pay gets most of the goods and

services and, therefore, gets most of net benefits available to the society. Inother words, market allocation is generally efficient, but not necessarilyequitable.

y Thisis the reason, many times governmentsinterfere in a market placethrough price floors and price ceilings to affect distribution of market outputs.But in the process, the government intervention makes the market outcomeinefficient. That is the society is now left with a lower amount of net benefits(because net benefit is not maximized).

y Efficiency guarantees the largest possible pie, but poor are likely to get asmallershare of the pie. On the other hand, government intervention in market

for the purpose ofincreasing the share of poor reduces the size of the pie.y Equity is a normative issue.

Performance of Market in the Presence of Negative Environmental Externalities

y A competitive market fails to achieve economic efficiency in certain cases.There are two such cases ofinterest in environmental economics.

o Production of goods associated with environmental externalitieso Production of public goods (many environmental services are public

goods)

y Firmsin their production decision consider only private costs and ignoreexternal costs (those costs that are not borne by the firm but are true costs tothe society).

y Market S-curve only represents private MC, whereas the social MC would behigher because it includes external costs.

y To the society, costs are higher and therefore fewer amount ofsuch goodsshould be produced.

y Market output exceeds the efficient level of output.


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y This presents a rational for the government to intervene to correct the marketfailure to produce efficient quantity.

o We will discuss many types of government interventions related topollution (a negative externality) control.

o One such intervention can be a pollution tax.y Let us consider an example of open-access externalities presented in the

textbook.o Foursimilar firms are situated on a lake (an open-access resource).o Each firm uses water of the lake as an input to production and

discharges emissions backinto the lake.o Treatment costs of each firm depend on the ambient quality of waterin

the lake.o Let the treatment costs be $40,000 per year for each firm.o A new firm is contemplating to begin operations on the lake.o With the new firm, treatment costs of each firm would go up to

$60,000 per year.

o What is the cost of operating a new firm on the lake? The new firm adds $60,000 of treatment costs to its other costs

to determine its operating cost. It will ignore the fact that eachof the other four firms will now have to spend $60,000 a year

on treatment, instead of the current expenditure of $40,000 ayear.

But a social plannerincludes the increase in treatment costs ofexisting firms, which amounts to $80,000 a year. $80,000 is the

external cost imposed by a new firm on existing firms.y Since market outcome would not be efficient, the government may intervene

in this case. A possible method may be to impose a tax of $80,000 a year onthe new firm. This tax internalizes the external cost.

Public Goods

y A public good, if made available to one person, automatically becomesavailable to other persons. For example, national defenses, radio signal, cleanair, clean rivers, ecological benefits of forests, etc.

y You can be excluded from consuming a hamburgerif you are not willing topay for hamburger. But, a nonpayer cannot be excluded from consuming apublic good.

y Since no one can be excluded from consuming a public good, there is anincentive to free ride (consume without making full payment, or making

payment below the level of benefits). Very few people pay the full price of a

public good.y The amount of payments (contributions) received to supply a public good in a

market place - therefore a demand curve estimated from such contributions -understates the true benefits of the public good, because of free riding.

y The true social MB is higher than what such a market-revealed demand curveshows. Market is therefore likely to supply less than efficient quantity of

public goods. Show graphically.y Market demand of a public good is the vertical summation ofindividual

demands. For each quantity of public good, add prices or marginal willingness


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to pay of all individuals to obtain the market demand, or true marginalwillingness to pay of the society.

y It isvery likely that a private entrepreneuris unwilling to supply public goodsbecause the entrepreneur cannot exclude nonpayers from consuming the goods.

Therefore, public goods are provided by either the government or activistsnonprofit organizations.

y Whenever an activist organization supply environmental goods of publicnature (e.g. protecting forests), their effectivenessis dependent oncontributions they can raise for the cause.You can expect that the amount ofcontributions would be lower than the true value ofsuch environmental goods,

because of free riding.

Possibility of Government Failure

y Implicit in a request to government to formulate, implement, and monitorenvironmental policiesis the assumption that public officials pursue publicinterest. One may, however, question this assumption.

y The assumption that public officials pursue public interest while makingpublic policies contravenes our more general assumption that economic agentsare self-centered.

o Public officials while making a decision in a market place weighpersonal benefits and personal costs associated with an activity.

o How do we then expect that the same individual, in his or her capacityas a public official, essentially ignores personal benefits and personalcosts and focuses only on public interest while formulating orimplementing public policies?

o It is possible that personal interests of a public official conflict withpublic interest while formulating a public policy. Public interestrequires appropriate control of pollution, but polluting firms want leastcontrol and are willing to contribute a large amount of money for theforthcoming election campaign of the politiciansinvolved in the issueof pollution control policies. Is campaign contribution likely to affect

pollution control policy? Perhaps, yes.o Lobbyists, politicians, bureaucrats, and voters are engaged in the

process of public policy formulation and each of these may beinfluenced by their private interestsin this process. There are somesystematic tendencies and incentives within legislatures andenforcement agencies that work against the attainment of efficient andequitable public policy.

o Rational Voter Ignorance

Votersvote for electing politicians and also vote at times onissues put to referendum. Mostly voters are uninformed;consequently, they either do not vote or make uninformedchoices during voting.

A voter finds that the cost of being informed issubstantialwhereas the benefit of being informed forvoting is generally

very small. Consider from the perspective of a voter, what is the

probability that the person or the issue preferred by the voter


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winsin an election or referendum just because of his or hervote? This probability is almost negligible. In other words, the

benefit of being informed and voting isvery small. On the otherhand, the voter needs to spend substantial amount of time and

perhapssome money too to become informed. Since cost ofinformed voting far exceeds benefit, voters

generally make a rational choice to remain ignorant. Thisphenomenon is called "rational voterignorance." This can leadto many economically sensible issues losing in referendum.

o Short-sightedness Effect A politician is generally concerned with his or her electability

in the next election. To improve electability, the politician iseager to show before the next election at least some policyachievements that are positive or beneficial to his or herconstituents. The pursuit of personal interest ofimprovingelectability for the next election makes politicians often short

sighted. In their legislative agenda, they tend to favor projectsthat generate immediate benefits even at the expense of large

future costs.o Special Interest Issue

Certain issues are ofinterest to special interest groups. Alimited number of people will benefit from such issues. On the

other hand, costs associated with these issues are often sharedamong a large number of people.

An example is the proposed financing of Broncos' stadiumfrom sales tax collected in six counties of Colorado.

The Broncos franchise and people associated withfootball (owners, players, coaches, sportscasters, etc.)make up the special interest group who will benefitfrom sales tax financing of the proposed stadium.

Costs, however, are shared by taxpayers of the sixcounties. To each individual taxpayer the cost would beminuscule.

Taxpayers (who are also voters) tend to ignore the costbecause it is minuscule. Most probably they also chooseto remain uninformed on economic desirability of thefinancial proposal (rational voterignorance effect). So,taxpayers orvoters care less on thisissue. For thisreason, politicians too do not see a threat ofvoters'

backlash if they support the tax financing proposal - aspecial interest issue.

On the other hand, the group which is likely to benefitwould lobby and contribute to campaign funds of

politicians. Therefore, politicians tend to give precedence to special

interest issuesin the legislative process, although it maybe a bad economics.

o Regulators often become captive of the regulated. Public officials depend on those regulated (polluters) for

information on cost of abating pollution.


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Polluters may have incentive to mislead or confuse officials toavoid stiffer regulations.

Polluters may attempt to convince public officials (and evencoerce or threaten them, depending upon how strong they are

politically) that high pollution taxes orstiff regulation wouldforce the polluting sources to close operations, rendering many

workers jobless. Public officials often do not dare political risks and they

succumb to polluters' political pressure while setting emissionstandards and while sanctioning violators of existingregulations.

o The above problemsshould, at least, convince you that governmentintervention is not necessarily the best answer always

The government can as well fail in achieving efficiency. Before proposing government intervention, we should pause

and think about alternative market-oriented approaches to solve

environmental problems.

environmental economics summary ch 1-4

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