ENVIRONMENTAL ECONOMICS Second Edition An IntroductionBy Barry C. Field 1 Individuals also involve in this type of guilty like no maintainenance of car. For example how a housing society reacts to changes in interest rate is positive economics but on the otherhand what kind of regulations should adopt for a particular environmental problem is a case of normative economics.A SIMPLE HOUSEHOLD EXAMPLE 2 . We can also see that how incentives can change the behavior of peolple. There is another approach called moral approach. 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. Environmental economics discuss the problems from the both perspectives like at micro and macro level. The scope of this subject is very broadening which can provide a set of analytical tools at vast level. so they don¶t care about the pollution side. Environmental economics focuses on the society¶s natural environment and the way that how people make decisions for improvement and destruction of environment. There is another important point is to see the difference between positive and normative economics. At firm level as well individual level there is problem of wastage. INCENTIVES.CHAPTER NO. 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. So. Basically pollution is the result of profit motive. So if it is true it is also very important to increase the general level of mortality among people. Basically environmental pollution is also the result of unethical behavior. it is important that if we want to save environment we have to weaken the strength of profit motive. ECONOMIC ANALYSIS Economics is the study that is related to the decision making at individual and group basis that how they manage their resources in order to increase wealth. In almost all the firms their motive is profit maximization. This is common practise in these communities. Because well designed environmental policies are very important. So. the desire to preserve a beautiful environment. This is a simple example of incentives at the household level.An incentive is something that attracts people to modify or change their behavior. Issues related to design of environmental policies are the major part of environmental economics. For industries it is very important to charge from the firms as they have emissions during production process. 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 the most important thing that user should not only consider their private costs but they should also think about the external cost. Ther is one simple household example of New Jersey where the developed econmies manage the trash disposal. There is external cost that is the pollution which is produced by that vehicle. Many policy makers suggest the policies which might not work. When individulas buy a vehicle they compare the benefits and cost which they have to bear.For example in economics there are monetary incentives which can help to change the consumer¶s behavior but there are non monetary incentives also like self esteem. INCENTIVES IN INDUSTRY Incentives are also important in reducing the pollution in industries. The govt want to reduce the amount of trash. Now due to this offer families started to recycle of avoid to use excessive packing. INCENTIVES IN TRANSPORTATION The transportaion system also is an important source of pollution as the numbers of vehicles are increasing day by day. 3 . they announce they will give incentives to the families who will have less number of trash bag. THE DESIGN OF ENVIRONMENTAL POLICY Environmental economics has a vital role in the design of public policies for improvement of environmental quality. For example there is incentive based approach like CO2 taxes in developed countries. Every household has to pay annually or monthly basis for trash management. INTERNATIONAL ISSUES There is lot of problems at the global level like the hot debate is global warming. we need to discuss that how to achieve effective environmental policy in a highly political policy environment. reduce the output of CO2. But in benefit cost analysis.MACRO ECONOMICS QUESTIONS: ENVIRONMENT AND GROWTH The macro economics refer the economy structure as a whole. It is alos used as an aid in selectinf efficient policies. Like how environment affects different people and groups in an economy or society. BENEFIT COST ANALYSIS In cost effective analysis the economists have only one concern about the costs of achieving some environmental goal. effective policy to lower down the amount of CO2. There is one most important thing is that how the burden of current progress might be distributed among different countries of the world. Benefit cost analysis is the main analytical tool used by economists to evaluate environmental decisions. 4 . where we can see the GDP. New pollution control initiatives incorporating economic incentive principals are being adopted at the federal and as well as at state level. ECONOMICS AND POLICIES Further more. For example. COST EFFECTIVENESS ANALYSIS There are several types of environmental analysis. Environmental policy not only affects the natural environment it also affects the people. inflation and unemployment rate. sometimes an agency uses it to justify what it wants to do. Today it is throughout used in public sector. 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. both benefits and costs of a policy or programme are measured or expressed in comparable terms. legal. y 5 . What goes in must come out. Linkage Between Economy and Environment y y This box diagram shows linkages between Nature and economy.CHAPTER 2 THE ECONOMY AND THE ENVIRONMENT INTRODUCTION The economy is the collection of technological.´Residuals´. Thus. y Environmental economics is the study of the flow of residuals (see the box diagram) and its impact in the natural world. matters only change in shape. Nature provides raw materials and energy to the economy. Basically production and consumption also produce leftover waste products called. residuals are emitted to Nature. According to the First Law of Thermodynamics (also known as the Law of conservation of matters). During both production and consumption processes. the total weight is conserved. and social arrangements through which individuals in society seek to increase their material and spiritual wellbeing. size. Economy uses the resources to produce goods which are then consumed. the total weight of raw material and energy inputs to economy must be balanced by the total amount of residuals flowing to the environment. The two elements in an economy are production and consumption. or phases. THE FUNDAMENTAL BALANCE It is important point that in society the producers and consumers actually are the same people in different capacities. or phases. size. y According to the First Law of Thermodynamics (also known as the Law of conservation of matters). Production and consumption creates residuals. It is these connections that focus of what has called sustainability. Biological and ecological processes create connections between the rates of resouces used in present and quantity and quality present in future generations. Many resource extraction processes such as timber cutting has direct repercussions on environmental quality. There are subdivisions in this area like y y y y y y Mineral economics Marine Economics Land Economics Energy Economics Water Economics Agriculture Economics In natural resource economics there is renewable and nonrenewable resources.NATURAL RESOURCE ECONOMICS Natural Resource economics is the application of economic principles to study the extraction and utilization of natural resources. Fishiries and timber are example of renewable resources while the petroleum reserves are the example of nonrenewable resources. 6 . matters only change in shape. It both of them we must have to see the present and the future. Thus. the total weight is conserved. the total weight of raw material and energy inputs to economy must be balanced by the total amount of residuals flowing to the environment. What goes in must come out. MATERIAL BALANCE CONCEPT The "materials balance" concept tells us that there are only three ways of reducing residuals in the environment. whereas environmental quality includes visual and aesthetic quality of the environment. therefore. FEW TERMINOLOGIES y Distinguish between ambient quality and environmental quality. biological. Such sources are called point sources. It may as well change the composition of outputs to reduce inputs (for example: a change from manufacturing sector to information or service sector). 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. power plants as sources of SO2 emissions. Materials balance concept also tells us that emissions in one medium are reduced by increasing emissions in another media. such as a factory. chemical. 7 . We can see that Land. Effect of emissions on ambient quality depends upon physical. for example." y Improve productivity of inputs Improvement of technology or productivity leads to requirement of fewer inputs for the same amount of output. y Increase recycling of residuals Increased recycling of residuals also reduces the amount of virgin inputs. o Ambient quality is the quality of surrounding air and water. y Source would mean the location where emissions occur. y Reduce output Reduction of output reduces amount of inputs. o o Besides depending on the different processes of the natural system. which may change from day to day. water. an automobile. and meteorological processes of the natural system. some people advocate "zero population growth. and air are the three different environmental medium that receive residuals. o Some sources can easily be identified. or a leaking landfill. y Depending on whether a pollutant accumulates over time. o When emissions from two sources mix up and cannot be separated. the conversion of land to housing or commercial purposes. but oil spills and Chernobyl nuclear disaster are episodic emissions.o Sources that are difficult to identify are called nonpoint sources. Overall this chapter throws light on the short run and longrun environmental policy also. examples are agriculture runoff polluting streams and rivers. etc. design and implementation of environmental policy may be problematic. y Fig: Production Possibility Curves for Current and Future Generations 8 . it is categorized as a cumulative or non-cumulative pollutant. are cumulative pollutants. they may bring inter-temporal problems. y Noise is a local pollution. such as radioactive wastes and plastics. Assigning reduction in emissions among sources would be difficult. Certain environmental damages are not related to emissions. but acid rain is a regional pollution. noise is a non-cumulative pollution. whereas greenhouse effect is a global pollution. Emissions from power plants are continuous. Nondegradable wastes. logging or strip mining. urban storm water runoff. o o For example. e.g. Different persons may have different demand curves. Marginal benefit from a good decrease with increasing consumption of the good. y y y y y y y y y y Demand curve is also a representation of marginal willingness to pay. A person's demand may change over time with changes in knowledge (experience or information) about the good or with changes in income. Curve y The higher the price. either because of different preferences or income levels. say. Area under the d-curve measures the total willingness to pay for a given quantity. people are willing to pay larger quantities only at lower prices. The value you place on a good depends on how much you have already consumed. It is also a marginal benefit curve. improvement in environmental quality). Higher income people are likely to have higher d-curve for environmental quality. Area also measures the benefits (of. The same individual can place more value on the same good when income increases. or Marginal Willingness to Pay. Therefore. o An implication is that the same improvement in environmental quality is tagged a lower value if implemented in an area inhabited by poor. and environmental assets are generally considered normal goods. compared to the value when implemented in an area inhabited by rich.CHAPTER 3 BENEFITS AND COSTS . SUPPLY AND DEMAND Demand. We can see downwardsloping demand curve to show this negative relationship. Implicit in the demand curve is the law of decreasing marginal returns. Demand for normal goods increases with income. 9 . Height of the d-curve measures the marginal willingness to pay. o This difference in value arises from the lower ability to pay of poor people. The more apples you eat. the lower the quantity demanded. the less tastier is the next apple. reflecting different values placed by them on the same good. Curve y The higher the price. or Marginal Cost. this return is considered a part of profit by accountants). o Note that marginal cost includes a normal return on equity capital (a return that could have been earned if invested elsewhere. Implicit in the supply curve is the law of increasing marginal costs. For each price add quantity demanded of all consumers to obtain the market demand. Fig: The concept of Marginal Cost y y y The supply curve is also a representation of marginal cost of production. Supply. the greater the quantity supplied.. For a producer to supply a given quantity.e. but there are cases of decreasing MC (for at least up to a certain level of 10 .y Market demand (demand of all individuals in a market aggregated together) is the horizontal summation of individual demands. i. o Increase in MC with increase in production is a general case.We can see an upwardsloping supply curve. the producer must be offered a price at least equal to the marginal cost at that level of quantity. marginal cost increases as more and more of a good is produced. o Consider supply of clean water as an example. If further cleanliness is desired to get rid of dissolved substances in water. Height of the supply curve is a measure of marginal cost (the opportunity cost of production). it may need still more expensive chemical processes. Fig: Derivation of Aggregate (Market) Supply from Individual Firm Supply Curves 11 . Area of the supply curve is the total cost of supply. or shifts the s-curve to the right. the greater the marginal cost of supply. Firms may differ in their marginal costs (s-curves) because of different technologies they use. the total cost of providing the same improvement in environmental quality may be different for different firms. In some cases. Example: new and old firms.y y y production. The cleaner the water supplied. primarily due to economy of scale). Accordingly. If still more cleanliness is sought to get rid of chemicals in the water. Market supply curve is the horizontal summation of firms' supply curves (just as in case of market demand). water may have to be boiled or distilled (a relatively more expensive procedure). Improvement in technology lowers marginal cost. Cleaning costs increase progressively. The cost of a firm may also go down with improvement in technology of the firm. MC may remain constant with production. The marginal cost of supplying water depends on degree of cleanliness sought. Water can be easily cleaned of solid residues and suspended particles by filtering it through a filter or strain (a physical process). gets most of net benefits available to the society. government intervention in market for the purpose of increasing the share of poor reduces the size of the pie. That is the society is now left with a lower amount of net benefits (because net benefit is not maximized). economic efficiency does not guarantee equitable distribution of net benefits among members of the society. In other words. Issue of Equity y y y y y y Economic efficiency guarantees maximum possible net benefits to the society. market allocation is generally efficient. 12 . many times governments interfere in a market place through price floors and price ceilings to affect distribution of market outputs. There are two such cases of interest in environmental economics. But in the process. When demand curve measures both the private MB and the social MB and when supply curve measures both the private MC and social MC. But. one who has the ability to pay gets most of the goods and services and. We can see graphically the socially efficient rate of output. the government intervention makes the market outcome inefficient.CHAPTER 4 ECONOMIC EFFICIENCY AND MARKETS Competitive Market Generally Achieves Economic Efficiency y y y Competitive market generally achieves economic efficiency. Equity is a normative issue. o Production of goods associated with environmental externalities o Production of public goods (many environmental services are public goods) Firms in their production decision consider only private costs and ignore external costs (those costs that are not borne by the firm but are true costs to the society). costs are higher and therefore fewer amount of such goods should be produced. whereas the social MC would be higher because it includes external costs. therefore. On the other hand. In a market system. Efficiency guarantees the largest possible pie. This is the reason. market equilibrium coincides with the efficient allocation. Market output exceeds the efficient level of output. Market S-curve only represents private MC. but poor are likely to get a smaller share of the pie. To the society. but not necessarily equitable. Performance of Market in the Presence of Negative Environmental Externalities y y y y y A competitive market fails to achieve economic efficiency in certain cases. 000 a year on treatment. treatment costs of each firm would go up to $60. o With the new firm. The true social MB is higher than what such a market-revealed demand curve shows. instead of the current expenditure of $40. For each quantity of public good.000 per year. because of free riding. o A new firm is contemplating to begin operations on the lake. It will ignore the fact that each of the other four firms will now have to spend $60. Market demand of a public good is the vertical summation of individual demands. clean air. there is an incentive to free ride (consume without making full payment. national defenses.000 a year. You can be excluded from consuming a hamburger if you are not willing to pay for hamburger. But. etc. Since market outcome would not be efficient. $80. A possible method may be to impose a tax of $80. o Each firm uses water of the lake as an input to production and discharges emissions back into the lake. a nonpayer cannot be excluded from consuming a public good. o Treatment costs of each firm depend on the ambient quality of water in the lake. o Four similar firms are situated on a lake (an open-access resource). ecological benefits of forests. the government may intervene in this case.000 of treatment costs to its other costs to determine its operating cost.y y y This presents a rational for the government to intervene to correct the market failure to produce efficient quantity.therefore a demand curve estimated from such contributions understates the true benefits of the public good. o What is the cost of operating a new firm on the lake? The new firm adds $60.000 a year.000 per year for each firm. if made available to one person. radio signal. automatically becomes available to other persons.000 a year on the new firm. add prices or marginal willingness 13 . For example. Public Goods y y y y y y A public good. This tax internalizes the external cost.000 is the external cost imposed by a new firm on existing firms. Let us consider an example of open-access externalities presented in the textbook. Since no one can be excluded from consuming a public good. or making payment below the level of benefits). o We will discuss many types of government interventions related to pollution (a negative externality) control. Market is therefore likely to supply less than efficient quantity of public goods. which amounts to $80. Show graphically. clean rivers. o One such intervention can be a pollution tax. The amount of payments (contributions) received to supply a public good in a market place . o Let the treatment costs be $40. But a social planner includes the increase in treatment costs of existing firms. Very few people pay the full price of a public good. Mostly voters are uninformed. what is the probability that the person or the issue preferred by the voter 14 . and voters are engaged in the process of public policy formulation and each of these may be influenced by their private interests in this process. consequently. Consider from the perspective of a voter. or true marginal willingness to pay of the society. yes. Therefore. their effectiveness is dependent on contributions they can raise for the cause. There are some systematic tendencies and incentives within legislatures and enforcement agencies that work against the attainment of efficient and equitable public policy. Whenever an activist organization supply environmental goods of public nature (e. o How do we then expect that the same individual. bureaucrats. o Lobbyists. A voter finds that the cost of being informed is substantial whereas the benefit of being informed for voting is generally very small. but polluting firms want least control and are willing to contribute a large amount of money for the forthcoming election campaign of the politicians involved in the issue of pollution control policies. they either do not vote or make uninformed choices during voting. o Public officials while making a decision in a market place weigh personal benefits and personal costs associated with an activity. public goods are provided by either the government or activists¶ nonprofit organizations.g. Possibility of Government Failure y y Implicit in a request to government to formulate. You can expect that the amount of contributions would be lower than the true value of such environmental goods. It is very likely that a private entrepreneur is unwilling to supply public goods because the entrepreneur cannot exclude nonpayers from consuming the goods. implement. in his or her capacity as a public official. politicians. because of free riding. however. essentially ignores personal benefits and personal costs and focuses only on public interest while formulating or implementing public policies? o It is possible that personal interests of a public official conflict with public interest while formulating a public policy. o Rational Voter Ignorance Voters vote for electing politicians and also vote at times on issues put to referendum. Public inter est requires appropriate control of pollution. One may.y y to pay of all individuals to obtain the market demand. and monitor environmental policies is the assumption that public officials pursue public interest. question this assumption. Is campaign contribution likely to affect pollution control policy? Perhaps. protecting forests). The assumption that public officials pursue public interest while making public policies contravenes our more general assumption that economic agents are self-centered. a special interest issue. Special Interest Issue Certain issues are of interest to special interest groups. On the other hand. sportscasters. The Broncos franchise and people associated with football (owners.) make up the special interest group who will benefit from sales tax financing of the proposed stadium. Taxpayers (who are also voters) tend to ignore the cost because it is minuscule. the voter needs to spend substantial amount of time and perhaps some money too to become informed. In other words. The pursuit of personal interest of improving electability for the next election makes politicians often short sighted. In their legislative agenda. Costs. For this reason. taxpayers or voters care less on this issue. Regulators often become captive of the regulated. An example is the proposed financing of Broncos' stadium from sales tax collected in six counties of Colorado. although it may be a bad economics. the politician is eager to show before the next election at least some policy achievements that are positive or beneficial to his or her constituents. This phenomenon is called "rational voter ignorance. Public officials depend on those regulated (polluters) for information on cost of abating pollution. Therefore. are shared by taxpayers of the six counties. politicians too do not see a threat of voters' backlash if they support the tax financing proposal . voters generally make a rational choice to remain ignorant. On the other hand. etc. 15 . the group which is likely to benefit would lobby and contribute to campaign funds of politicians. the benefit of being informed and voting is very small. So. Short-sightedness Effect A politician is generally concerned with his or her electability in the next election. On the other hand. To each individual taxpayer the cost would be minuscule. coaches. Most probably they also choose to remain uninformed on economic desirability of the financial proposal (rational voter ignorance effect). they tend to favor projects that generate immediate benefits even at the expense of large future costs. players. Since cost of informed voting far exceeds benefit. however. costs associated with these issues are often shared among a large number of people." This can lead to many economically sensible issues losing in referendum.o o o wins in an election or referendum just because of his or her vote? This probability is almost negligible. A limited number of people will benefit from such issues. To improve electability. politicians tend to give precedence to special interest issues in the legislative process. rendering many workers jobless. Public officials often do not dare political risks and they succumb to polluters' political pressure while setting emission standards and while sanctioning violators of existing regulations. convince you that government intervention is not necessarily the best answer always The government can as well fail in achieving efficiency. Polluters may attempt to convince public officials (and even coerce or threaten them. at least. 16 . The above problems should. depending upon how strong they are politically) that high pollution taxes or stiff regulation would force the polluting sources to close operations. Before proposing government intervention.o Polluters may have incentive to mislead or confuse officials to avoid stiffer regulations. we should pause and think about alternative market-oriented approaches to solve environmental problems.