Economics 350Economics 350Economics 350Economics 350

Environmental EconomicsEnvironmental Economics

Air pollution

Hazardous wastes

Cost-benefit analysis

Abatement costsWater pollution

Optimal pollution

Global warming

Endangered species

EPA

Solid municipal waste

Tradable discharge permits

Command and control

Emission taxes

Households: “pay as you throw” garbage systems

Firms: CO2 taxes and tradable SO2 permits

Appeals to moral behavior

Recognizes that people respond to incentives

Moral ApproachMoral Approach Economic ApproachEconomic Approach

Households: “give a hoot, don’t pollute”

Firms: emission standards

Why do people behave in ways that harm the environment?

Economic Way of Thinking

Rationality Scarcity Marginal analysis Equilibrium Positive vs. normative analysis

Environmental Policy

ObjectivesEnvironmental qualitySustainable developmentBiodiversity

Types of PoliciesCommand and ControlMarket Approaches

EffectivenessCost/Benefit Analysis

Environmental Policy

PoliticsSpecial interestsFairness issues

OutlookPessimists

Thomas Malthus

Bootleggers & Baptists ?

Malthusian Model

time

Food production

Population

Thomas Malthus

Environmental Policy

PoliticsSpecial interestsFairness issues

OutlookPessimists

Neo-Malthusians“Limits to Growth”

Optimists“cornucopians”Technology and markets

Julian Simon

Economy and Environment

Economy

Nature

Natural Resource Economics Environmental Economics

resources residuals

PPC shows all combinations of two goods that can be produced from given resources and technology

Illustrates tradeoff between the two goods

PPC shows all combinations of two goods that can be produced from given resources and technology

Illustrates tradeoff between the two goods

Economy and Environment: PPC

Market Goods

Environmental Quality

PPC

A

B

ΔG

ΔEQ

Note: Environmental degradation may shift PPC inward over time.Note: Environmental degradation may shift PPC inward over time.

Production Possibilities Curve

Assume a concave production possibility curve. Suppose that society decides to increase the production of market goods by 10,000 units, and that as a result environmental quality falls by 10 units. If a further increase of 10,000 units of market goods is sought, we can expect that environmental quality will:

1 2 3 4 5

a) b) c) d)

0% 0%0%0%

a) fall by 10 units. b) fall by less than 10 units. c) fall by more than 10 units.d) increase by less than 10 units.

Producers

Consumers

Residuals: Rp Discharged: dRp

Residuals: Rc Discharged: dRc

Recycled: rRc

Goods: G

Recycled: rRp

Raw Materials

M

M = dRp + dRc M = G + Rp – (rRp + rRc)

Fundamental Balance

3 Ways of Reducing MReduce G

Reduce “consumerism”Zero population growth?

Reduce Rp

Reduce residual intensity of productionSectoral shift

Increase (rRp + rRc)Mandatory content requirements

Fundamental Balance

M = G + Rp – (rRp + rRc)

Types of Pollutants Cumulative Noncumulative

Local Regional Global

Point Source Non-Point Source

Stationary Source Mobile Source

Continuous Emissions

Episodic Emissions

Radioactive waste, plastics, many chemicals

Noise

Noise, visual

SO2

CO2, CFCs

Smoke stacks, waste treatment plants

Agricultural runoff

Factories

Cars, planes, boats

Power plants, factories, waste treatment plants

Oil and chemical spills

US Pollution Control Expenditures: 2005

Abatement Expenditures (billions $)

Capital Operating Total % of Total

Air $3.88 $ 8.63 $12.51 47

Water $1.35 $ 6.73 $8.08 30

Solid Waste $0.68 $ 5.32 $6.00 23

Total $5.91 $20.68 $26.59U.S. Census Bureau, Pollution Abatement Costs and Expenditures: 2005, MA200(05), U.S. Government Printing Office, Washington, DC, 2008. Online: http://www.census.gov/prod/2008pubs/ma200-05.pdf

Review of Microeconomic Theory

Rational man modelAn individual seeks to maximize his or her utility.

For social optimality the rule is:

Taking action until the marginal private cost of further action equals the marginal private benefit of that action.

Taking action until the marginal social cost of further action equals the marginal social benefit of that action

Market Model

What Q is produced? What Q should be produced?

What Q is produced? What Q should be produced?

Supply

Demand

quantity

Price

Q*

P*

Normative

Positive

Consumer Surplus = ∑(WTP – Price) Total Expenditure = P*Q

Consumer Surplus = ∑(WTP – Price) Total Expenditure = P*Q

Market Model: Demand Side

Demand

quantity5

$50

Buyer’s Marginal Benefit or WTPPrice

$25

1

Consumer Surplus

Total Expenditure

Market price

Producer Surplus = ∑(Price – Marginal Cost) Producer Surplus = ∑(Price – Marginal Cost)

Market Model: Supply Side

Supply

quantity

Price

3

$25

Total Cost

Producer SurplusSeller’s Marginal Cost

$10

Market price

CS

Market Model

Free Market Outcome: P*, Q* Maximizes social welfare: SW = CS + PS

Free Market Outcome: P*, Q* Maximizes social welfare: SW = CS + PS

Supply

Demand

quantity

Price

Q*

P*

PS

Deadweight Loss

Q

Market Model

Problem Set 1, #8 Problem Set 1, #9

Equimarginal PrincipleTotal Costs of Production

Output Plant A Plant B Plant C

0 20 5 15

1 25 13 22

2 37 30 32

3 50 60 47

4 80 105 77

5 115 155 117

ΔTCMC=

ΔQ

Suppose you wanted to produce Q = 11. How would you allocate output among the three plants if you wanted to minimize the costs of production?

Suppose you wanted to produce Q = 11. How would you allocate output among the three plants if you wanted to minimize the costs of production?

Allocate output such that MCA = MCB = MCCAllocate output such that MCA = MCB = MCC

Define:

__________________

Plant A: Q = 4Plant B: Q = 3Plant C: Q = 4

MC = $30 in all plants

TC = 80 + 60 + 77 = $217

Imperfect competition Imperfect information Externalities Public goods/Common Resources

Imperfect competition Imperfect information Externalities Public goods/Common Resources

Market Failures

Occur when decision makers do not consider all costs (or benefits) of their actions

Two views

A. C. Pigou Ronald Coase

Externalities

Cashmere Externalities

Externalities: Pigou

Social Cost = Private Cost + External Cost

cashmere

$

D1

Sprivate

Q1

P1

P2

Q2

Ssocial

Marginal external cost

How can society achieve social optimum?

Impose tax = marginal external cost Internalize the externality!

Free Market: P1, Q1

Optimal Outcome: P2, Q2

Free Market: P1, Q1

Optimal Outcome: P2, Q2

Free market overproduces goodsthat generate a negative externality

TEC

M&M Experiment

Public Goods & Common Resources

Rival in consumption

Non-rival in consumption

Excludable

Non-Excludable

Private GoodsArtificially Scarce

Goods

Common Resources

Public Goods

Excludability: can you be excluded from consuming the good?

Rivalry: does my consumption hinder your consumption?

Excludability: can you be excluded from consuming the good?

Rivalry: does my consumption hinder your consumption?

Tragedy of the Commons

Commonly-owned resources tend to be over-exploited Conflict between self-interest and the

common good Examples

Garrett Hardin

Am I in danger of

being over-harvested?

Sample Problems

Problem Set 1: #20 (Externality) Problem Set 1: #18 (Public Goods)

0

20

40

60

80

100

120

140

0 200 400 600 800 1000 1200 1400 1600

SO2/m3

$

ΣMB

MBH MBA MBS

MC

Social Optimum occurs where ΣMB = MC

SO2 (μg/m3) Dirtier air

$

0

10

20

30

40

50

60

70

0 500 1000 1500 2000 2500 3000 3500 4000 4500

Orange Juice

D = Σd

dA dSdH

There are essentially three ways of reducing M (raw material usage) and, therefore, residuals discharged into the natural environment. These include all of the following except

0% 0%0%0%

a) reducing G (output of goods) b) increasing Rp (production

residuals) c) increasing rRp + rRc (recycled

production and consumption residuals)

d) all of the above.

1 2 3 4 5

All of the following are examples of point-source pollutants except one. Which one is not an example of a point-source pollutant?

0% 0%0%0%

a) municipal waste treatment plants

b) agricultural chemical runoff

c) electric power plants d) Eramet Metals

manufacturing plant

1 2 3 4 5

Public goods are distinguished by two primary characteristics. These are:

0% 0%0%0%

a) market failure; high prices b) government intervention;

high prices c) nonrivalry; nonexclusivity d) rivalry; exclusivity

1 2 3 4 5

The efficient output will be less than the free market output when:

1 2 3 4 5

a) b) c) d)

0% 0%0%0%

a) Marginal social cost and marginal private cost are equal

b) Marginal social cost is greater than marginal private cost

c) Marginal social benefit and marginal private benefit are equal

d) Marginal social benefit is greater than marginal private benefit

a) Marginal social cost and marginal private cost are equal

b) Marginal social cost is greater than marginal private cost

c) Marginal social benefit and marginal private benefit are equal

d) Marginal social benefit is greater than marginal private benefit

The table below shows the marginal benefit from water quality for the only two citizens of a town. Water quality is a public good. If the marginal cost of water quality is $75 per quality unit, what is the efficient quantity of water quality?

Fanting Gary

Marginal benefit of water quality

WaterQuality

Marginal benefit of water quality

80 1 100

70 2 85

60 3 60

45 4 35

25 5 15

0 6 0

1 2 3 4 5

1 2 3 4 5 6

0% 0% 0%0%0%0%

a) 1b) 2c) 3d) 4e) 5f) 6