Introduction to Environmental and Natural Resource Economics

7/27/2019 Introduction to Environmental and Natural Resource Economics

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Introduction to Environmental and Natural Resource Economics

1. What is Environmental Economics? Economics - is the study of choice under conditions of scarcity

o Economics can be applied to a variety of fields, not just traditional commoditieso Economics is not about profits or money

Money is used to help allocate the resourceso Economists study how incentives impact people's behavior

Due to scarce resources, individual behavior is constrained Humans cannot satisfy all their wants and needs

Environmental and natural resource economics- the application of economicsto the study ofhow environmental and natural resources are developed andmanaged.

2. ResourceA resource is something which is valuable and useful in that condition in which wefind it. Resources used as inputs to production of goods and services. Like uraniumis an input to produce electricity.Two forms

Row or unprocessed form Final product consumed directly

The resource which are unknown or the utility of the things are not found are notresources as they have no value. Thus the resource must be scarce and should havevalue attached.

Resource is dynamic concept because the possibility is always exists the changes in

Relative scarcity Information Technological change:- that may force to be resource materials that were not

earlier consider as resources.3. Dimension of the resourcesResources has multiple dimension quality, quantity, time and space dimension

Examples

Air is available in most places in such vast quantities relatives to demand that it mayseems more like a free goods then a resource but in many places the like hospital theoxygen cylinder are available in scarce amount and hence have high value. In spacecapsule the flow of the oxygen is limited. Similarly the quality of the air also have


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positive value that is individuals and society are willing to spend money to obtain theair of high quality.

4. Type of the resourcesMajor resources used in agriculture are land, labor, capital and management.Generally there is imperfection in categorization of the natural resources. Oneresource can be categorized into more than one group. Certain resources may not befit well into any group.

Examples forest as a whole is environmental resources but timber individual isrenewable resources.

According to purpose there are 3 groups of the resources

A)Natural resourcesThe goods and services provided by the living and nonliving environment to meetthe human needs and desire are natural resources.

i. Two types1. Renewable - the resource can be replenished

a. Fish, cattle, fruits, etc.2.Nonrenewable - one the resource used, it is gone forever

a. Petroleum - diesel fuel, gasoline, plasticsB)Environmentalresources - resources provided by nature that are not utilized orconsumed by humankind directly but services can be valued.

Parks and wild life Usually impacted by pollution

C)Flow resourcesThese are provided in some predetermined quantity and quality beyond the humancontrol and must be used when provided or otherwise wasted. There is no chance ofstock and storage examples labor, building, radiation from the sun.

D)Fund resourcesStorage changes the flow resources into the fund resources. It is more and moremanipulated by people. Examples are solar energy, electricity, water and soilnutrients.


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On the basis of the divisibility

1. Divisible resourceFor e.g. seeds, fertilizer, pesticides etc. these are variable resources which can beeasily divisible.

2. Lumpy resourcesThere is no chances of the dividing and only one part of if used cannot produceoutputs ex tractor, pumping sets etc these are fixed.

Why Study Environmental Economics?

Market economies - prices reflect the relative scarcity of goods.o High price - good is relatively scarce relative to demand

Market and prices do not usually exist in environmental economicso Environmental and natural resource economics is unique?1. Market failures is common in the natural resource economy- government

intervention may be necessary Monopolies, public goods, externalities, absence of well-defined property

right etc.2. Long time horizons - choices today can impact mankind centuries down the

road Nuclear waste Polluting water in a lake Mining for metals

3. Study environmental economics to bring harmony to the economic system andthe environment

4.NR requires multi-disciplinary approach it is master of allBiological process growth all need to be known for optimum harvesteconomics model only does not fit it.


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5. Questions for Environmental Economics1. What is the market failure?a) Monopolies - one firm controls a market

Usually the reduce production to cause the market price to increase Can earn substantial profits Examples

Natural monopolies - telephone, water, natural gas, and electricity Microsoft DeBeers Corporation - control the raw diamonds market

b) Externalities- buyers and sellers in a market impact third parties Person plays (consumes) loud music impacts the neighbors A firm emitting air pollution impacts people living nearby Positive - public immunizations

Gov. inoculates its people, preventing the spread of diseasesc) Asymmetric information - one party in the market has more information

Used car salesman has more info. than the buyer A person with a heart problem gets medical insurance

d) Public goods - private markets have trouble supplying public goods Usually police, military, inoculations, clean air, etc. Expanded to include education, highways, libraries, mail delivery, etc.

Markets may not supply enough of them, so gov. supplies thembecause they benefit society

e) Open resource - property that is owned by everyone or absence of ownership People tend to over exploit the resource Tragedy of the Commons Over fish in public lakes Dump trash and litter on a public land

2. How to correct market failure?o Markets do not exist for environmental resources.

Government can regulate the resource Traditional method

Government creates a market for the resource More governments are using this option

3.

How to evaluate environmental programs?o Cost-Benefits Analysis - compare the costs and benefits of protecting a

resource Economists find the level of protection where marginal costs equals

marginal benefits. This is calculus - max. benefits and min. costs


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Environment resources should be viewed in terms of positive economicso Could environmental resources provide us with benefits?o Could government change the incentives for environmental protection?o Policy makers and society's view points can impact the type of

environmental policies

6. Models of Scarcity:

Malthus - population is growing geometrically but food production is growingarithmetically

o Malthus was a priest and economisto Wrote -Essay on the Principle of Population as It Affects the Future

Improvement of Society (1798)o Land is a fixed, scarce resource and food production is limitedo If the population exceeded its food production, then some people would "die

off." Why economics is called the abysmal science

o Problem - Malthus ignored the impact of technology Technology increases the production from scarce resources

Paul Ehrlich, a biologist in 1971 statedo Environmental Impact = (Population)*(Affluence)*(Technology)

Growing population puts increased pressure on the environment\ Technology helps reduce the impact on the environment Affluence - a wealthier society has more alternatives

Citizens can afford to pay higher prices for pollutionabatement, etc.

Malthusian ideas keep coming backo Population Time Bombo Global warming will destroy mankindo Doomsday Models - computer models that predicted severe shortages of

resources Usually future prices are missing from these models As resources become scarcer, the prices rise.

Higher price has four impacts

Consumers reduce their demand for products Sellers want to increase production of product Development of new technologies Exploration for new resources

Example - Petroleum - scientists predicted in the 1970s that theworld would run out of petroleum by 2000


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As oil became more expensive, companies explored anddrilled for more oil

High cost oil extraction - Northern Slope of Alaska Deep drilling in the Gulf of Mexico???

New technologies Satellite imaging Drilling Oil from shale???

Malthusian ideas have not happened!o The price of most resources has actually fallen over time!o Food prices have fallen by 50% since 1960, and 90% since 1800.o Be careful!

We have not accounted for environmental damage. Why do pessimistic predictions get more attention than reality?

1. Funding for scientific research goes to areas with many problems Researchers have to substantiate the problem to receive more

funding i.e. Global warming

2. Environmental groups need to be noticed by both the mass media andby potential donors.

3. Attitude of the media Bad news is more interesting than good news. Humans focus on bad experiences more than good experiences

Lecture #2 - Growing Population and Economic Growth

The Economic System

Starting with Physics

First Law of Thermodynamics - "The change in the internal energy of a closedthermodynamic system is equal to the sum of the amount of heat energysupplied to or removed from the system and the work done on or by thesystem."o Energy is neither created or destroyed

Second Law of Thermodynamics - "The total entropy of any isolatedthermodynamic system always increases over time, approaching a maximumvalue."o To do work, there has to be an energy difference.o Entropy means energy differences equalize over time.


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The Sulfur dioxide turns into acid rain, which damages forests andlakes.

Acid rain depletes minerals from the soil and raises the phof water, killing the fish

Environment does have a sink capacityo Sink capacity - the environment can handle a level of pollution or waste

with minimal impact. Once the pollution or waste exceeds the sink capacity, then it

damages the environment.

What factors drives this model?1. Population growth - more people consume goods and services

Demands for resources and energy increases More wastes and waste energy is produced

2. Economic growth - society produces more goods and services Each person consumes more goods and services More wastes and waste energy is produced

Be carefulo Technology and institutional arrangement impact the amount of

resources, energy, and waste that humans produceo Last 10 years, people in the United States recycle more

Glass bottles, aluminum, paper, plastics, etc are recycledo New institutions and arrangements had to be developed

Bins and collection centers where people can dispose of theirwastes

Recycling centers that separates the types of waste Industries adjusting their production processes to include recycled

materials New transportation vehicles for recycled wastes

o Traditionally, metals have always been recycled like copper Nobody throws away silver and gold

o Market prices exist for recycled materialso

Be careful! Recycled materials do not mean it is cheaper Costs money for recycling centers, sorting, machines, equipment,

and transportation Some claim recycling makes products and services more

expensive


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You have to compare the cost of recycling the material toextracting the material from the environment.

High-income countries like United States and Europe are bigrecyclers

More is said later in the Environmental Kuznet's CurvePopulation Growth

More people put more pressure on the environmento Primary energy consumption increased globally by 4.3% in 2004o As much as 60% of the global population depends on the waters of

international fresh water systems Rivers and lakes of which basins are shared by more than two

countries Predicting fresh water shortages Could have more wars and conflicts over fresh water

Graph below shows how fast the world's population is growing

The developed world is 75% urbano The rate is accelerating in the developing worldo By 2030 urban population is expected to rise to five billion or 60% of the

worlds population Sources - U.N. Population Division report World Urbanization Prospects: 2003

Revision; BP Statistical Review of World Energy June 2005; GEO Year

Book 2006; WRI 2005 The prediction has a problem


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Population growth rate has been slowing and is shown below

Why is population slowing?o Children are expensive in both money and time

Developed countries have close to a zero population growth rate People delay having children Complete an education Accumulate assets like a house, car, etc.

Much of the population growth is in developing countries HIV is impacting population growth rates in some African

countries


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Market has many assumptionso Lectures 3 and 4 we will discuss market failures

Why do some markets have a perpetually shortage or surplus?o Government is intervening with the market price

Why is demand and supply important?o Higher population means more people, and thus, more consumerso Demand shifts to the righto Market price and quantity both increaseo Producers increase their quantity supplied

Humans have market prices for their goods and services High market prices cause

1. Industries expand to the higher demand and price More suppliers enter the market Supply shifts right Market price falls The price drop depends on industry and its long-run cost

2. More products are supplied to market More resources are located and extracted More waste are generated

3. Spurs technological progress If many industries are expanding within a country, then we have economic

growth

Economic Growth

Macroeconomics


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o Gross Domestic Product (GDP) - the traditional measure ofmacroeconomic performance

GDP is the sum of the money values of all final goods andservices produced in a country during a year.

Does not include sales of intermediate goods and services Only includes products and services produced within a

country Does not include voluntary work Does not include degradation to the environment Does not include depletion of resources

Depleting a stock of natural resources (e.g. oil,minerals, forests) increases GDP

Used in production of goods and services Future generations could be hurt

Less petroleum or no forests if they are cutdown

Economic growth -increases in GDPo Usually GDP per-capita output

Per capita is per person A higher GDP per capita means each citizen has more goods and

services Thus, population is important.

o Picture below shows GDP percent-growth rate in 2007 Before the 2008 Financial Crisis


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Derivation of a Growth Modelo Total production of goods and services in a country are treated as one

large production function for whole economyo Common in growth theory

GDPt = f(A, Kt , Lt , Rt , Et)

Variables areo GDP at time to A is autonomous growth

Reflects technology, usually the intercept in a regression equationo K is capitalo L is laboro E is for energyo R is for natural resourceso Usually equation has E or R, but not both

Petroleum or coal are resources that society derives energy from

Is economic growth good or bad for the environment?o More growth means GDP is increasingo Requires more resources and energyo Technology can change A too, creating an offset!

If government imposes restrictions on natural resources or energy use, thenregulations put restrictions on natural resources, R, or energy, E.


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o Society goes through transitions from agricultural to heavy industrial,which increase pollution.

o Over time, heavy industrial is replaced with services and light industrial,which generates less pollution.

o Environmental regulations can strengthen over time as country develops.o Higher income allows more investment in pollution equipment.o Country goes through deforestation and then afforestation.

Criticismo Some pollution levels increase at a decreasing rate.

Carbon dioxide emissions Technology reduces a car engine's CO2 emissions Higher incomes means more people buy cars

o One possible reason for the problems of finding the Kuznet curve is theprocess of learning.

As developed countries develop pollution abatement technologies,developing countries can implement these technologies at a fasterrate, which give different estimates of the Kuznet curve.

Latecomers had the advantage of learning from other nations'environmental policies.

They learn what works and does not work This is a technological leader-follower model.

Japan's History of Environmental Policy

Early concerns about damage from copper mining arose in 1868 Government did not pay serious attention to the environment until after World

War II.o United States helped re-develop their country

National economic development was the central governments top priority.o Pollution was viewed as a local government problem.

Rapid growth in the 1950s led to increases in pollution. 1958

o Japan had disease outbreaks from water pollutiono The National Diet passed two water quality laws in 1958

The first laws at the national level.

Before hosting the Tokyo Olympics in 1964o International pressure to improve water quality in the Sumida River in

Tokyo.o Japanese government created the Pollution Control Division of the

Ministry of Health and Welfare (1964) and the Basic Law forEnvironmental Pollution Control (1967).


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Humans extract resources and energy from the environment Humans use resources and energy to produce goods and services Then humans consume these products Each human activity generates wastes and energy that is returned

to the environment Human activities could do the following: Resource depletion - humans extract more resources than can be

replenished Example Humans extract water and supply it to cities Many cities are extracting more water than the amount being

replenished by rainfall Pollution - human activities that degrade the environment or

resource base Example Humans emit sulfur dioxide from burning of coal. The Sulfur dioxide turns into acid rain, which damages forests and

lakes. Acid rain depletes minerals from the soil and raises the ph of

water, killing the fish Environment does have a sink capacity Sink capacity - the environment can handle a level of pollution or

waste with minimal impact.


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Once the pollution or waste exceeds the sink capacity, then itdamages the environment.

What factors drives this model? Population growth - more people consume goods and services Demands for resources and energy increases More wastes and waste energy is produced Economic growth - society produces more goods and services Each person consumes more goods and services More wastes and waste energy is produced Be careful Technology and institutional arrangement impact the amount of

resources, energy, and waste that humans produce Last 10 years, people in the United States recycle more Glass bottles, aluminum, paper, plastics, etc are recycled New institutions and arrangements had to be developed Bins and collection centers where people can dispose of their

wastes Recycling centers that separates the types of waste Industries adjusting their production processes to include recycled

materials New transportation vehicles for recycled wastes Traditionally, metals have always been recycled like copper Nobody throws away silver and gold

Market prices exist for recycled materials Be careful! Recycled materials do not mean it is cheaper Costs money for recycling centers, sorting, machines, equipment,

and transportation Some claim recycling makes products and services more

expensive You have to compare the cost of recycling the material to

extracting the material from the environment. High-income countries like United States and Europe are big

recyclers More is said later in the Environmental Kuznet's Curve Population Growth More people put more pressure on the environment Primary energy consumption increased globally by 4.3% in 2004 As much as 60% of the global population depends on the waters

of international fresh water systems


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Why is population slowing? Children are expensive in both money and time Developed countries have close to a zero population growth rate People delay having children Complete an education Accumulate assets like a house, car, etc. Much of the population growth is in developing countries HIV is impacting population growth rates in some African

countries

Now we see why Mathusian ideas keep coming back


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Market is stable If price is higher than market price of $2 Market has a surplus Producers are supplying more than what consumers want Producers lower the price until the price is $2 again If price is lower than market price of $2, Market has a shortage Consumers want more than what producers are supplying Producers raise the price until it is $2 Market has many assumptions Lectures 3 and 4 we will discuss market failures

Why do some markets have a perpetually shortage or surplus? Government is intervening with the market price Why is demand and supply important? Higher population means more people, and thus, more consumers Demand shifts to the right Market price and quantity both increase Producers increase their quantity supplied


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Humans have market prices for their goods and services High market prices cause Industries expand to the higher demand and price More suppliers enter the market Supply shifts right Market price falls The price drop depends on industry and its long-run cost More products are supplied to market More resources are located and extracted More waste are generated Spurs technological progress

If many industries are expanding within a country, then we haveeconomic growth

Economic Growth Macroeconomics Gross Domestic Product (GDP) - the traditional measure of

macroeconomic performance GDP is the sum of the money values of all final goods and

services produced in a country during a year. Does not include sales of intermediate goods and services Only includes products and services produced within a country Does not include voluntary work Does not include degradation to the environment Does not include depletion of resources Depleting a stock of natural resources (e.g. oil, minerals, forests)

increases GDP Used in production of goods and services Future generations could be hurt


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Less petroleum or no forests if they are cut down Economic growth -increases in GDP Usually GDP per-capita output Per capita is per person A higher GDP per capita means each citizen has more goods and

services Thus, population is important. Picture below shows GDP percent-growth rate in 2007 Before the 2008 Financial Crisis

Derivation of a Growth Model Total production of goods and services in a country are treated as

one large production function for whole economy Common in growth theory GDPt = f(A, Kt , Lt , Rt , Et) Variables are GDP at time t A is autonomous growth Reflects technology, usually the intercept in a regression equation K is capital L is labor E is for energy R is for natural resources Usually equation has E or R, but not both Petroleum or coal are resources that society derives energy from


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Is economic growth good or bad for the environment? More growth means GDP is increasing Requires more resources and energy Technology can change A too, creating an offset! If government imposes restrictions on natural resources or energy

use, then regulations put restrictions on natural resources, R, orenergy, E.

Companies could adjust capital, K, or labor, L, but restrictionswould most likely lower GDP growth

Technological progress could increase A also It is difficult to measure impacts of regulations on resources,

environment, and GDP Example Government imposes a regulations to reduce air pollution in a city Causes higher costs People may be healthier Live longer, work harder, pay less money for medical problems,

etc Thus, regulations slow GDP down initially, but healthier people

make GDP grow faster. The Environmental Kuznet's Curve Kuznet's curve is a hypothesized relationship between

environmental degradation and income per capita. The shape of the relationship is an upside down U-shape.

The shape is estimated as a quadratic, Et=f(GDP, GDP

2

), where Eis pollution emissions at time t per capita and GDP per capita. When income per capita is low, a country does not invest in

pollution abatement. As income per capita increases, a country invests in more

pollution abatement.


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Examples: Society goes through transitions from agricultural to heavy

industrial, which increase pollution. Over time, heavy industrial is replaced with services and light

industrial, which generates less pollution. Environmental regulations can strengthen over time as country

develops. Higher income allows more investment in pollution equipment. Country goes through deforestation and then afforestation. Criticism Some pollution levels increase at a decreasing rate.

Carbon dioxide emissions Technology reduces a car engine's CO2 emissions Higher incomes means more people buy cars One possible reason for the problems of finding the Kuznet curve

is the process of learning. As developed countries develop pollution abatement technologies,

developing countries can implement these technologies at a fasterrate, which give different estimates of the Kuznet curve.

Latecomers had the advantage of learning from other nations'environmental policies.

They learn what works and does not work This is a technological leader-follower model. Japan's History of Environmental Policy Early concerns about damage from copper mining arose in 1868 Government did not pay serious attention to the environment until

after World War II. United States helped re-develop their country


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National economic development was the central governmentstop priority.

Pollution was viewed as a local government problem. Rapid growth in the 1950s led to increases in pollution. 1958 Japan had disease outbreaks from water pollution The National Diet passed two water quality laws in 1958 The first laws at the national level. Before hosting the Tokyo Olympics in 1964 International pressure to improve water quality in the Sumida

River in Tokyo. Japanese government created the Pollution Control Division of the

Ministry of Health and Welfare (1964) and the Basic Law forEnvironmental Pollution Control (1967).

Recently, Japan has focus policy focus shifted to global issues. Kyoto Protocol - reduce greenhouse gas emission to slow down

global warming Japan is now focusing on quality of life issues. Not mentioned Since the early 1990s, the Japanese economy entered into two

decades of sluggish growth Real estate prices are still dropping and economy has weak

growth China's History of Environmental Policy

Mao Zedong declared in 1949 that pollution was a capitalistproblem that did not exist in socialist countries. In 1972, water pollutionbegan to attract the governments

attention Environmental Protection Law passed in 1979. The Constitution stated that protecting the environment was the

responsibility of the state. Polluters should be held responsible for pollution treatment,

including a polluter pays fee system. Government has lack of resources Local governments focus on growth More factories, more jobs, more income, and more taxes Local governments opened illegal coal mines and built electric

power plants without the national government's approval The Olympics were held in China in 2008 China was embarrassed about the green water off of Shanghai


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Some Olympiads wore gas mask in Beijing because of the high airpollution levels

Maybe the Chinese government will add more environmental laws The Developing World The developing world Have higher population growth rates Moving from agrarian societies to industrialized societies, which

results in more pollution. Increasing urbanization People are moving to the cites, because that is where the jobs are Same thing in the United States and Kazakhstan Potential Problems Urbanization - environmental problems become problems when

people are close together, so that their actions affect othersnearby.

The infrastructure to support increased populations is lacking inmany cities.

Fresh water, collecting and treating waste water, solid wastedisposal, etc.

Weak governance Not only are regulations often weaker, but the government may

not enforcement compliance. Corruption and lack of democracy are also problems. Lack of information/education

Educated people (in the United States) are pro-environment Encourage environmental regulations Developing countries have wide spread poverty Leaders emphasize economic growth Place less weight on future considerations like environmental

damage or resource depletion Developing countries may use less efficient technologies They could buy the old equipment and machines used in

developed countries Less efficient machines use more energy and resources Benefits If they become high-income societies, then they may invest in

green technologies or replenish renewable resources Population growth rate slows down However, high-income societies use more resources and produce

more pollution such as carbon dioxide. Leakages - not in many introductory courses


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United States - environmental laws became too harsh Compliance costs were too high Some industries relocated to countries like Mexico and China Weak environmental laws Cheaper labor These industries pollute even more shipping their products to the

United States High U.S. incomes are indirectly creating large amounts of

pollution I think this happened to Japan too Japan started to outsource the production of goods and services to

other Asian countries. Japan was big investors in other countries like China, South

Korea, etc. Some countries activity seek out companies, trying to get them to

invest in their economies Creates jobs, incomes, economic growth, and more tax revenue This Page is an outdated, user-generated website brought to you

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3. Open access property - property owned by society or the absence ofownership.

Also called Tragedy of the Commons (Hardin 1968) Property rights are not well defined

o Open access is nonexcludable but rivalrouso Outsiders cannot be excluded from using the propertyo Outsiders can consume the resource, leaving nothing behind

People have less incentive to develop, improve, or maintain land, if otherscannot be excluded from consuming it.

Exampleso Fishermen over fish in public waters.o Fishermen catch too many fish, causing fish populations to decrease to

such a level that hurts future fish catching.o Companies dump wastes onto public lands or waters.o Air can be an open access resource. Some firms pollute and send

pollution into the air Correcting this market failure

o Allow one firm to control the resource The firm acts like a monopoly and develops the best plan to utilize

that resource Monopoly may abuse that resource too Example - monopolist - owns rights to common land with a

forest Monopolist cuts down all the trees if lumber prices

are higho Government create a permit system

Anyone harvesting or extracting the resource needs a permit Common property becomes private property Permit holders will monitor the resource against invaders and

poachers Government has to monitor the permit holders to ensure they

comply with the terms of the license

4. Externalities - The consumption or production of one individual orfirm affects another persons utility or production without theirconsent.

The externality influences profits and utility, but does not impact marketprices.

Key - choice is not incorporated into the market price Therefore, an externality is not efficient (Arrow 1969).


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(i) Positive externality - an individual's or firm's actions generatebenefits for nonparticipating parties

The private market may not supply enough Supply function understates the true value of output

o S is regular supply function and D is for demando Society would desire a higher supply

Social Marginal Costs (SMC) - the marginal cost function that isbeneficial for the whole society

Example 1 - Inoculation for diseaseso Each person who gets an inoculation can prevent spread of a disease

Example 2 - scientific knowledge or technological know-how Fixing positive externality

1. Subsidies - government provides subsidies so producers will supply more Example - government grants subsidies to producers of vaccines Note - government could subsidize the consumer to take

advantage of the externality2. Government provides the good

Health departments give vaccines to the poor and elderly3. Government provides legal protection

Patent - grants inventors exclusive right to producer theirinvention for 17 years in the United States

Some countries may not honor patents(ii) Negative externality - an individual's or firm's choice or actionnegatively harms others without their consent


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o Creates job losses as industry shuts down.o If industry that generates pollution has a strong demand, then black

markets could develop.o Government spends money to monitor, arrest, and incarcerate violatorso Industry relocates to another country and exports it back to the original

country

2. Lawsuits - U.S. has a variety of laws that allow people to sue toaddress externalities

If firms know that they are creating negative externalities, they reduce negativeexternalities to reduce likelihood of being sued

Firms compare marginal abatement cost to the marginal damageo By avoiding damage, the firm lowers its liabilityo Damage to the environment is very hard to estimate.

Note that the government does not need to know the marginal costs of the firmin order to achieve the desired level of pollution.

Problemso The burden of proof may be difficult in court.o Litigation is costly

Large legal fees and damage awardso Need to know both who causes the harm and what the damages are.o Courts are slowo Renting seeking behavior encourage attorneys to sue for large legal

fees and damage awardso Leakages manufacturing firms may flee to developing countries with

weak environmental lawso Courts usually do not come up with comprehensive plans

Rules are developed from a case-to-case basis3. Command-and-control regulations (CAC) - government uses laws andregulations that dictate the standards and/or technology used to reducepollution.

Government fines and penalizes companies that violate the rules. Government could permanently shut down a company for excessive violations U.S. has historically used command and control (CAC) policies

o Why, when market-based environmental policies are more efficient?o Reasons

1. Environmental groups - firms shouldn't be able to buy the right topollute

Immoral to hurt the environment


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o Does not depend which party holds the property right.o Example - a firm dumps pollution into a lake that kills the fish.

1. If the right to use the lake is given to the fishermen, then thepolluting firm has to negotiate and compensate fisherman in orderto pollute the lake

2. If the right is given to the polluting firm, then the fishermen willpay the firm not to pollute the lake.

Benefitso Could work for small group of peopleo Private parties solve a pollution problem without the governments

help Assumptions and Problems

o Property rights are well defined Someone owns the resource

o Need to be able to clearly establish who causes the harm. Some victims aren't well defined (e.g. endangered species)

o Zero transaction costs Search and information Bargaining and decision Monitoring and enforcing

o Perfect informationo A court system enforces contracts without any costs.o Two parties (it is more difficult for large groups of people to agree about

something).o

No wealth effects. If ownership of the resource makes one party wealthier, then that

party may be more resistant to bargaining.o More people will come to the problem if they are likely to be

compensated.

5. Market incentives - government uses price or quantity mechanisms tointernalize the externalities.

Price incentiveso

Pollution taxes - government puts a price on pollutiono Subsidies - government helps firms pay for pollution equipment

Quantity rationingo Market permits - government requires firms to have a permit in order to

pollute Government creates permits Firms may purchase or sell permits in a market


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(i) Pigouvian Taxes - government places a tax directly on pollution.

Government imposes a tax for each unit of pollution that is emittedo Firms are supply too many units to the market

Creating pollutiono Government places a tax on pollution

Taxes increase a firm's costs and reduces profits The Pigouvian tax works by internalizing the cost of the

externality. Polluter incorporates the social cost of pollution.

o Firms also have an incentive to develop new pollution controltechnology in order to avoid paying taxes

o Government implements a tax on pollution, which puts a price onpollution

Equilibrium price increases while quantity supplied decreases This is efficient because firm pays all costs including pollution Firms still pollute, but less Firms can pay the tax on pollution or avoid the tax by reducing

pollution

Welfare effectso Usually taxes cause a deadweight loss on societyo However, firms are polluting, which is harming the environmento It is like the environment is subsidizing the productiono Shown in graph below

Red triangle - shows up as consumer and producer surpluses, butrepresents damage to the environment

Price is too low and quantity is too high


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Yellow triangle - damage to environment; nobody benefits fromthis

Quantity should be less than Q* It is not the price that damages the environment, but the

quantity

Alternative method to show taxo Be careful of the scaleo MB - as firms invest in more abatement equipment, the marginal benefits

to the environment decreaseso MC - as firms invest in more abatement equipment, its marginal costs

increaseo Gov. places a tax on pollution

If there were no tax, firms would not invest in abatementequipment


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o Taxes distort markets, because market prices are higher and marketquantities are lower.

o Empirical research indicates Pigovian taxes may also be distortionary(ii) Government can implement a subsidy

The opportunity cost of polluting is losing the subsidy. Government grants a subsidy to help a firm pay for a specific abatement

technology.o The technology helps reduce pollution.

Problems with subsidieso The polluter receives money from the government, rather than payingo New firms may enter market, so that total pollution increaseso Need to raise taxes to pay for subsidies

Taxes create distortions in the market Market price is higher and market quantity is lower.

o Ethics - should we have to pay to avoid pollution?o Subsidies are often politically motivated, and can be difficult to remove

when no longer needed.

(iii) Market Permits - A transferable discharge permit places themaximum limit of pollution or concentration level that any firm isallowed to discharge into the environment.

Exampleso Some electric generation plants use coal to generate electricity

Some coal has sulfur that turns into sulfur dioxide when burned Sulfur dioxide leads to acid rain They have to buy sulfur dioxide permits

o Proposing a permit system for mercury emission and greenhouse gases Government places the maximum amount of pollution that can be emitted

o Also called cap and trade systemo Each polluter has to buy a permit

One permit allows firm to emit 10 metric tonnes of sulfur dioxideinto atmosphere

o Government creates enough permits, where Sum pollution levels in permits = maximum pollution level Quantity rationing

Pigouvian tax - is price rationing The permit creates a market price of pollution.

o Firms with high marginal abatement costs buy permits, so that theycould pollute more


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How much say does the future get.2. Cost-Benefit Analysis - Government should use cost-benefit analysis to evaluate public projects,

environmental laws, or resource depletion.

Marginal benefit (MB) - the additional amount society benefits, if government supplies onemore unit of a resource.

o Public goods - This is the total demando Negative slopeo Usually I drop MB and use D for demand for public goods

Marginal cost (MC) - the increase in cost to society, if government supplies one more unit of aresource

o Positive slopeo This is the supply for a public goodo Usually government assesses taxes on society to finance projects

Government maximizes society's return to a public good when MB = MCo If MB > MC, government should increase one more unit of a public goodo If MB < MC, government should decrease a public good by one unit

Examples Government builds a new highway

o Benefits Businesses and people benefit from the highway if people use it. Relieves congestion from surrounding roads and highways Creates construction jobs

o Costs Government pays construction companies to build highway Government has to assess taxes Opportunity costs

Land could be used for another activity


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Has probability of not getting caught, then pays nopenalty

o Firm's marginal abatement costs become marginal abatement costs = penalty for cheating * probability caught + MC of

compliance

o Government can force compliance by Increasing probability of getting caught Increasing the penalty if caught

Uncertainty for environmental problems is highly non-linearo Damages may be barely noticeable for low levels, but become severe above some

uncertain threshold, or tipping point.

o Man should not go beyond the tipping point.o Our world is too complex, we do not know where the tipping points are.

4. Irreversibility - a process or choice that is not reversible

Goes with the Precautionary Principal Two types

1. Mankind's impact on the environment A species goes extinct. Pollution kills all living organism in a lake Note - some environmental damage is reversible

A country cuts down its forests This country could replant its forests

Note - Global warming Theoretically - it is possible to remove greenhouse gases out of

atmosphere

Plant more trees, use biofuels, etc.2. Sunk Costs - historical costs that are not recoverable


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o Environmentalists and alarmist choose low discount rates Future generations probably would choose a low discount rate too, but their

decisions are not known

o Note - Environmental damage is viewed like a cash flow I have environmental damage appearing out of no where and causing problems

in exactly 200 years

Complications of Pollution

1. Pollution sources are defined as two types

Point source pollution - the pollution has an identifiable sourceo Examples - Smoke stacks to factories and electric power plantso Policies for reducing pollution from Lectures 3 and 4 work well with type

Command and control regulations Pigouvian taxes Subsidies Market permits Lawsuits

Nonpoint source pollution - pollution is emitted from many sources and it is extremely difficultto identify and monitor.

o Example Soil erosion - farmers till the soil. The soil is loose, so rain may erode it. Fertilizer and other chemical runoffs - farmers use fertilizers and chemicals like

pesticides

Rain dissolves the chemicals and they build up in lakes and rivers Pollution emissions like CO2 from automobiles

United States has millions and millions of cars Usually large

o Causes asymmetric information


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Burning sulfur creates SOx emissions The SOx emissions drift north from the United States to Canada Sunlight converts the SOx into sulfuric acid Rain pours down taking the acid with it The acid dissolves and leeches minerals from the soil, killing the trees The Ph decreases in lakes and ponds, killing the fish and other life forms.

o Global warming - nonpoint source emissions Burning fossil fuels release carbon dioxide into the atmosphere, allowing the

earth to trap more heat.

It makes no difference where the carbon dioxide was emitted. Countries enter into agreements with each other to fix pollution problems

o Montreal Protocol in CFC productiono Kyoto Protocol to fix greenhouse gase emissions at the 1991 level.

Problemso Free rider problem - Game theory is extensively used in transboundary pollution

problems.

o Prisoners dilemmao Two countries: United States and Canada

Enter agrees to reduce a mutual transboundary pollutiono If both countries choose tough environmental laws, their GDPs grow at 1%o If one country has soft environmental laws and the other has tough, then industries with

the weak laws have a cost advantage.

They can produce more output, increasing GDP They grow at 6%

o If both countries have soft environmental laws, then their GDPs growth at 5% They are producing too much pollution


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United States choice is to choose between tough or soft environmental laws.o The choices are the green ellipseso The dominant strategy is to choose the soft environmental laws, given Canada has a

choice.

The reason is GDP is larger

Canadas choice is to choose between tough or soft environmental laws.o The choices are the red ellipses


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o Firms choose to locate in areas with lower control costs.o These are likely to be areas with low initial levels of pollution.o Firms in the United States

Moved from the North to the South From the snow belt to the sun belt

Then moved to Mexico and then China Now, they are moving to Bangladesh

Industry may ask the federal government to take the leado Example - Automobile industry

U.S. automobile industry opposed federal emission standards for cars in 1960s States started to push for emission standards Then car industry pushed for federal standards, because it is easier to have one

set of regulations from the federal government than 50 separate, but different

regulations from the 50 states.

California has passed tougher emission regulations for cars California standard and the 49 state standard

o State only has to meet the minimum standard of the federal government States can choose to set tougher limits

5. The Porter Hypothesis - environmental regulations can increase a firm's competitiveness through

innovation and new technology

Environmental regulations - causes technological progress that lowers costs and increasesquality.

o Benefits of innovation can exceed the cost burden of regulation.o Example

Robbins Company - EPA was going to shut down this company because it wasdischarging contaminated water

Used water to electroplate jewelry


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Company engineers found a way to recycle the water The recycled water was cleaner than buying the water from the city

government

Company produced higher quality jewelry Less jewelry were rejected

Company's water bill was greatly reduced Does not mention how cost increased for purifying the water

o Environmental Regulations:1. Provide signals to companies about resource inefficiencies and areas for potential technologicalimprovements.

2. Companies gather information on pollution, increasing corporate awareness.3. Reduces uncertainty about investments to reduce pollution

Gov. is tells them to reduce the pollution4. Imposes costs and burdens on businesses that encourages innovation and progress.5. Levels the playing field

All companies are subjected to the same regulations.o Criticism

0. Regulations are costly, because of compliance costs.1. Theoretically, innovation offsets are possible, but there are many counter examples.2. Competitive businesses actively search for profitable innovations and will not overlookprofitable opportunities.

3. Have to examine the costs and benefits of environmental regulationsSpecific Pollution Types

1. Sulfur Dioxide (SO2)

Acid rain - caused by sulfur dioxide (SO2) and nitrogen oxides (NOx).o Comes from burning of fossil fuels

Coal contains sulfur


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Ozone is highly reactiveo Ozone will oxidize metals, except gold, platinum, and iridium

Ozone is not formed directly from car and truck exhausto Ozone forms as sunlight hits air containing hydrocarbons and nitrogen oxides

Government policieso A combination of nonpoint and point sourceo Point source - reducing NOx emissions from power plants and industrial combustion

sources

1. Introducing low-emission cars and trucks Reduce NOx emissions from exhaust

2. Use "cleaner" fuels Cities with ozone problems have to use reformulated gasoline Some components easily evaporate, especially during the summer Source of hydrocarbons Reformulated gasoline evaporates less easily, but it is more expensive.

3. Improving vehicle inspection programs. Many states passed vehicle inspection programs for large cities Vehicle owners have their car emissions checked each year If it passes, then they get an inspection sticker on window If cars do not have inspection stickers, then police can pull them over

and issue citations

Inspection stickers change color and appearance each year3. The Montreal Protocol

Example of a successful international agreement.o Signed in 1987o Phase-out the use, production, and exports of chlorofluorocarbons (CFCs)


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Used as a coolant in refrigerators and air conditioners CFCs destroy the ozone layer in upper atmosphere

o Contains chlorine that destroys the ozone by turning it back into O2o Publicity surrounding the ozone hole over Antarctica provided public pressure.o India and China did not sign until1990

A $260 million fund was established to help finance the transition to HCFC Wanted to reduce leakages - countries that did not sign would start producing

CFCs

Why the Montreal Protocol was successful?o Most international agreements are not successful

Leakages Cheating

o Only six main companies produce CFCs, so monitoring simple.o Clean technological substitutes have developed quickly.

This helped keep the costs of compliance low. One substitute, hydrochlorofluorocarbons (HCFC) also depletes the ozone layer,

but at a slower rate.

It will be phased out by 2030o Note - both CFCs and HCFCs are greenhouse gases

The United States passed a tax on CFCso Producers paid $1.37 per pound for CFCs in 1990

$5.35 per pound in 1995o The power to tax is the power to destroy

HCFC became relatively cheaper $10 per can

Additional Pollution Economics


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Approximately 8,000-10,000 died within 72 hours 25,000 have since died from gas-related diseases.

All chemical companies became part of program2. Tax codes could perpetuate environmental problems

Taxes can correct externalities, but can also exacerbate problems. United States

o Percent depletion allowance - Oil and gas producers can deduct a fixed percentage ofgross income each year.

This was established in 1909 to stimulate domestic production. Is it still needed? Repealing would save $900 million over five years.

o Oil and gas companies can treat exploration and development as an expense, ratherthan depreciating over a number of years.

Repealing would save $17 billion over five years. Encourages greater extraction of virgin materials, discourages recycling.

o Sport utility vehicle deduction Businesses can deduct $25,000 of purchase of large vehicles (> 6,000 lbs or

2,727 kg) in the first year

No expensing allowed for light vehicles. Originally intended for large equipment (e.g. construction) Repealing would save $700 million over five years.

The former Soviet Union and Eastern European countries implemented environmental taxes inthe late 1970s and early 1980s.

o Create incentives for state owned enterprises to reduce emissions.o Used complicated engineering formulas, not market based policieso Could lead to odd results.o Before 1999, Lithuania charged several million dollars per ton of SO2.


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Not surprisingly, non-payment was an issue.3. Two Firm Carbon Cap Model

One firm is an old plant with out-dated equipment and technology Therefore, firm has high marginal abatement costs. Trick - reverse the marginal cost function so it looks like a demand function Gov. is going to setup a permit system

o This firm will buy permits

The other firm invests in new technology, and therefore has lower has lower abatement costs. The new plants low marginal abatement cost curve that goes left to right with

abatement.

o The firm supplies pollution permits


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Firms engage in tradeo The vertical axis become the market priceo The quantity axis becomes the permits

Firms have an incentive to adopt new technology to reduce their marginal abatement costs.

4. Environmental Damage and Free Trade

Countries engage in free tradeo Free trade may lead to more environmental damage

Modify supply and demand for a product that is importedo No free trade - market price and quantity are PD and QD


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Importing a producto The world price is PW, QT is total amount consumed, and QD is amount produced

domestically

o Small country case, where country does not influence the world priceo Yellow triangle is the gain from free trade

Unfortunately the product causes environmental damage.o If producing the product causes environmental damage

Marginal Social Cost (MSC)o Free trade causes less environmental damage to importing countryo Environmental damage is shifted to exporting countryo The green trapezoid is the reduced environmental damage from importing

Benefit to importing country


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Unfortunately, consuming the product causes environmental damage within the importingcountry

o Country has a true marginal benefits function, D' Equivalent to the MSC

o The red trapezoid is the increased environmental damage from importing good Cost-Benefit Analysis - Engage in free trade if the marginal benefits of free trade equal or exceed

its marginal costs

Do not worry about the case for exports Do not memorize all the trade agreements!


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The drought in Africa puts

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If we donate, then

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millions of people

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we can help

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o Thawing of permafrost Permafrost - in cold climates, the ground is always frozen through out the whole

year

Earth is experiencing a warming trend Are greenhouse gases causing the world to be warmer or is this one of the earth's natural

cycles?

o Global warming is a theoryo Sun is having a lot of activity

Spike in sun spot activity 17th century very few sun spot activity, which is called the mini-ice age

o 1960s the public was worried about an impending ice age Slight cooling trend between 1930s and 1960s

Carbon dioxide is main greenhouse gaso Concentration level was 270-290 ppm for thousands of years before the Industrial

Revolution

o By 1998, concentrations were at 365 PPM. Parts per million (PPM)

o The human activities may be increasing the growth CO2 concentration from Mauna Loa Observatory, Hawaii


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What percentage of (dry) air is composed of carbon dioxide?o Dry air is: 78.08% nitrogeno 20.95% oxygeno 0.93% argono 0.038% carbon dioxide

Global Warming is probably a combination of sun and human activities Below is connection between temperature and CO2 concentration

o Predicting a 2.50 C increase in global temperatureo A difference of 30 C determines whether we go into an ice age or not.


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Greenhouse Gases

1. Global Warming Potential (GWP) - 1 metric ton of carbon dioxide in the atmosphere traps a specific

amount of the suns radiation

Carbon dioxide is always defined as a GWP of 1o Other greenhouse gases are compared to carbon dioxide

Noteo Many compounds break down over timeo Example methane has an initially high warming potential but drops over time as

methane breaks down in atmosphere

Carbon dioxide is stable and persists for centurieso GWP is defined over a period of time, usually 100 years

Greenhouse Gases Global Warming Potential (GWP)

Carbon dioxide (CO2) 1

Methane (CH4) 23


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o Water (steam) is used in electric power plants to drive steam turbines GWP is not calculated because water vapor is sensitive to temperature changes

o Cold temperatures causes vapor to condenseCost Benefit Analysis of Global Warming and Climate Change

1. World is too complicated

Feedback loops - global warming causes earth to be warmer but something changes thatstrengthens or weakens warming effect

o Water vapor Positive feedback - water vapor is a greenhouse gas that increases greenhouse

effect

Negative feedback - water absorbs energy to become vapor Some of the sun's energy is used to change water's state

o Clouds Positive feedback - clouds absorb and re-radiates infrared light, increasing the

greenhouse effect.

Negative feedback - clouds prevent less sunlight from hitting the earth,reflecting sunrays back into outer space

o Oceans Positive feedback - warmer water releases its stored carbon dioxide, increasing

greenhouse gases.

Negative feedback - oceans can absorb heat, thus slow down global warmingo Which effects dominate?

2. Estimating the Damages from Climate Change

How do you put a value on these events? How do separate the damage from global warming and earth's nature weather cycles Costs

o Rising sea level increases loss of land area, including beaches and wetlands


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o Loss of species and forest area, including coral reefso Disruption of water supplies to cities and agriculture

Ground water becomes contaminated with salt watero Health damage and deaths from heat waves and spread of tropical diseaseso Increased costs of air conditioningo Loss of agricultural output due to drought

Benefitso Increased agricultural production in cold climateso Lower heating costso Less deaths from exposure to cold

Less predictable but possibly more damaging effects, including:o Increase frequency of hurricanes and other extreme weather events

Hurricanes come in cycleso A possible rapid collapse of the Greenland and West Antarctic Ice Sheets, which would

raise sea levels by 12 meters or more, drowning major coastal cities

o Sudden major climate changes, such as a shift in the Atlantic Gulf Stream, which couldchange the climate of Europe to that of Alaska

"The Day after Tomorrow" Preventive measures:

o Mitigation - reducing emissions of greenhouse gases Use less fossil fuels. Install pollution control devices. More energy efficient technology

o Sequester - something absorbs carbon dioxide and stores it Forests, crops, and plants convert CO2 into oxygen Carbon is stored in the wood, roots, and plant structures


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Even if wood is made into lumber, the carbon is still thereo Re-Cycle - absorb carbon dioxide from atmosphere and re-lease it for energy

Biofuels Liquid fuels - ethanol, butanol substitute for gasoline and biodiesel for

diesel

Biomass - burn wood and plants to generate bio-electricity Manure - burn manure to generate electricity

Manure releases methane as it decayso Adaptive measures include:

Construction of dikes and seawalls to protection against rising sea level andextreme weather events such as floods and hurricanes.

Shifting cultivation patterns in agriculture to adapt to changed weatherconditions in different areas, and relocating people away from low-lying coastal

areas

o Note - much more complicated in practice Have to look at life-cycle emissions

Solar cells do not release greenhouse gas emissions when in operation Releases a lot of greenhouse gases during manufacturing

Constructing a power plant, etc. with concrete Concrete uses limestone, which releases a lot of carbon dioxide

into the atmosphere

Policy Options

1. Greenhouse gases are a stock pollutant

If humans stop generating greenhouse gases, then the amount we put up there is still there.o Economics - many policies just have firms and people pay for generating externalityo Internalizing the cost of the externalityo Thus, they would still producing greenhouse gases.


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o All policies that reduce greenhouse gases would increase market prices and lowermarket quantities

o Thus, policies may not slow down global warming Developing countries argue that they should not have to limit their emissions

o Limited emissions may limit growtho Should developed countries compensate the undeveloped ones to reduce greenhouse

gas emissions

o Developed countries already used fossil fuels to develop a rich society Environmental Kuznet's Curve

United Stateso Has 5% of world's populationo Emits 25% of world's CO2 emissionso USA is world's biggest emitter

China is currently the second largest emittero Expected to over take the United Stateo Dutch Scientists already said it happened.

Decreasing greenhouse gas emissions depend on future technologieso Especially in technologies where carbon dioxide is abated, sequestered, or recycled

2. Appeal to peoples civic duty

Green energy costs more than standard fossil fuels People invest in green technologies even though they are more expensive Example

o Homeowner invests in solar panels for homeo Supplements 500 watts of power during the day timeo Electricity from the grid costs $0.08 per KWHo Electricity from solar panels costs $0.20 per KWH


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4. Command-and-control regulations - government uses laws and regulations that dictate the standards

and technology used to reduce greenhouse gases

Government imposes the technology and machines that an industry uses Government fines and penalizes companies that violate the rules Benefits

o Government easily enforces the ruleso Lower greenhouse gas emissions

Problemso Regulations limit a firms flexibility and freezes technologyo Firms may not produce at minimum costso Bureaucrats have a tendency to perpetually change the ruleso May encourage violatorso Gov. could have a large cost to monitor, prosecute, and punish violatorso Encourages leakages

5. Market incentives - government uses price and quantity mechanisms to internalize the externalities

Price incentives Greenhouse gas tax - puts a price on greenhouse gas emissions

o A firm emitting greenhouse gases pays the tax or abates by using technology to reduceemissions

Subsidieso Firms planting trees (sequestering carbon)o Public uses biofuels to recycle carbon from atmosphere

Global warming potential (GWP) is used as an exchange rate If the tax is $100 per metric ton of carbon dioxide emissions, then firms pay $2.220 million to

emit 1 metric ton of sulfur hexafluoride

o Sulfur hexafluoride has a GWP of 22,200


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Quantity incentives Cap and trade system gov. places the maximum limit on amount of greenhouse gases that

can be emitted

Gov. creates tradable permitso Quantities specified within the permits add up to the limit of greenhouse gaseso Gov. auctions or gives permits to greenhouse gas emitters

Use global warming potential (GWP) as an exchange rate for different gaseso Allow producers to create permits if they abate / sequester / recycle greenhouse gases

Create a market for tradable permits Market incentives give firms more flexibility

o Some firms will invest in technology to reduce greenhouse gaseso These firms could sell their permits to other emitterso Some firms will choose to emit and buy the permitso Firms may meet pollution objectives with the lowest costs

Benefitso Gov. dictates level of greenhouse emission, firms are given the flexibility in how to meet

objectives

o Emitting greenhouse gases becomes a property righto Permits and taxes put a price on emissionso Possibly a subsidy on abatement, sequestration, and carbon recyclingo Gov. collects revenue

Problemso Imposes higher enforcement costs on governmento Greenhouse gases have many sourceso Will gov. allow some sources to be exempt?o Gov. may be more interested in tax revenue or revenue from auctioned permits


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Kyoto Protocol

1. Kyoto Protocol - an international agreement that attempts to stabilize greenhouse gas buildup in the

atmosphere

Kyoto was adopted on December 11, 1997 in Kyoto, Japan WhY? Transboundary pollution - all countries are producing greenhouse gases

o For people to reduce greenhouse gas emissions, then all countries have to organize anddevelop a uniform policy

o This prevents leakages Kyoto Protocol is the first attempt

o 183 Countries signed the agreemento Gives countries flexibility in how to meet emissions

Permits, command and control regulations, etc.o United States signed but did not ratify agreemento 13 countries did not sign, including China

China surpassed the United States as a major greenhouse gas emittero India did sign the Kyoto Protocol

India introduced the $2,000 car The developing countries want the Western living standard

The agreement only forces countries to reduce emissions 5.2% below a countrys 1990emission level

o Even if all countries signed the Kyoto Protocol, our net greenhouse gas emissions arestill increasing

o Kyoto Protocol does not prevent global warming Kyoto Protocol entered into full force on February 16, 2005

o European Union reduces emissions by 8%o United States reduces by 7%


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o Japan reduces 6%o Russia reduces by 0%o Australia can increase emissions by 8%o Iceland can increase emissions by 10%

United States signed, but did not ratify it.o Why?o Economic growth!o President Bush set a goal of reducing greenhouse gas intensity by 18%o Illusion

Greenhouse gases are still increasing Greenhouse gas intensity is the ratio between greenhouse gas emissions and

GDP

Using more efficient technology decreases greenhouse gas emissions relative toGDP

Although economy is bigger (i.e. GDP), greenhouse gas emissions are stillincreasing, but the ratio (i.e. intensity) is decreasing.

This was already happening without President Busho Countries are supposed to reduce emissions to below 1990 level

Some complained about former Soviet Union countrieso Many former Soviet Union countries are under their 1990 levels and have room to growo Russiao President Putin signed Kyoto in 2004

The following opposed Kyoto: Russian Academy of Sciences, Ministry forIndustry and Energy, and economic adviser, Andrey Illarionov

Politics - Europe supported Russia admission to the World Trade Organization(WTO)

Penalties


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o If a country does not comply, then they have to make up the difference plus anadditional 30%

o Kyoto has weak enforcement What if country does not comply?

2. The European Union Emissions Trading Scheme (EU-ETS)

Each country gets allowances based on its national cap in Kyoto.o Specific industries will participate in trading

electric utilities oil refineries coke ovens iron & steel cement kilns glass manufacturing ceramics manufacturing the pulp and paper industry

If a company is going to exceed its greenhouse gas emissionso It buy carbon credits from the marketo Or has to abate its emissionso Possible for international permits

One country that cannot meet emission levels can buy credits for countries whoare below their emission levels.

Theoretically possible - one country plants a forest. Trees sequester carbondioxide from atmosphere and earn carbon credits.

Credits can be sold to a factory in China that is emitting greenhouse gases. European Countries - to generous in passing out permits

o Countries have incentives to give more allowances to industries that trade goods, sothat they do not have a competitive disadvantage with firms from other countries


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o Has not been effective in reducing carbon dioxide 2005, permit's price was 30 per ton 2006, permit's price was under 10 per ton 2007 permit's price was under 1 per ton

3. Comparison of the U.S. SO2 program and the EU CO2 trading program (EU-ETS)

European Union program is largero Around 11,500 sources, compared to about 3,000 for U.S. SO2 market

E.U. program decentralizedo Individual countries have jurisdictiono Value of allowances highero Worth around $41 billion, compared to about $5 billion worth of SO2 permits.o However, required reductions much greater for U.S.

SO2 permits call for 50% reduction from baseline, compared to just a few percent reduction forE.U.

SO2 was a pollutant that had been controlled before, so there was experience with abatementcosts.

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...possible rude language detected. Read at your sole discretion.

Lecture #8 - Nonrenewable Resources

Hotelling's Rule

1. Non Renewable Resource - once the resource is used, it cannot be replenished; its gone forever.

Three classifications of exhaustible resources:


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1. Current reserves - known reserves that can be profitably extracted at currentprices.

2. Potential reserves - reserves that could be recovered at higher prices.3. Resource endowment - the entire geological supply of resources (including those not

yet discovered).

The problem is scientists and companies are not 100% certain how much reserves are in theground

Engineers define the following:1. Proven reserves - have at least 90% or 95% certainty of containing the amount specified.2. Probable reserves have an intended probability of 50%3. Possible reserves have an intended probability of 5% or 10%

Current technology is capable of extracting about 40% of the oil from most wells.o Some say future technology will make higher extraction possible, but this is already

included Proven and Probable reserve numbers.

Companies have incentives to overstate their proven reserveso Oil companies want to improve their financial statements and their potential net wortho Producing countries gain a stronger international stature.

Other countries will be nicer to them.o Governments of consumer countries give false security and stability to their citizens.o In 2004 Shell Corporation had a scandal, where 20% of its reserves evaporated

BP's estimate of a country's Proved Petroleum Reserves as of 2009

2009 Country

Non-OPEC

(Billions of barrels)

OPEC

(Billions of barrels)

1. Saudi Arabia 264.209

2. Iran 138.400


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3. Iraq 115.000

4. Kuwait 101.500

5. United Arab Emirates 97.800

6. Venezuela 87.035

7. Russia 79.432

8. Libya 41.464

9. Kazakhstan 39.828

10. Nigeria 36.220

11. United States 30.460

12. Canada 27.664

13. Qatar 27.436

14. China 15.493

15. Brazil 12.624

16. Algeria 12.270

17. Mexico 12.187

Resource depletiono Mathematical analysis is much more complicatedo Extraction involves dynamic decisionso As resource is extract, then less can be extracted in the future

The present and future are tied together Costs of Extraction

o Extraction cost - the cost to remove resource out of ground, process it, and transport itto the market

Producers extract when P >= Marginal Extraction Cost (MEC)


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If MEC = $60 to extract oil out of Alaska Producers shut down production when petroleum price drops below

$60

Producers extract oil when price equals or exceeds $60o User cost - the opportunity cost of not having the resource to sell in the future

The owner of a resource has two sources of money for next year: Sell all the oil now, and invest the profits at interest rate, i. Wait and sell the oil next year.

The price of the resource has to be greater than the MEC, because of user costo Proof

Called intertemporal arbitrage Case A: Expected price next year rises less than the rate of interest:

The owner of the resource is better off selling the oil now and investingit.

Leads to lower prices now (greater supply) and higher prices next year(lower supply).

Case B: Expected price next year rises faster than the rate of interest: The owner of the oil is better off waiting to sell the oil next year. Leads to higher prices now (lower supply) and lower prices next year

(higher supply)

o By using this arbitrage, the petroleum companies cause petroleum prices to increase atthe rate of interest

Profit maximizationo Farmer: Choose output where p = MR = MCo Miner: Choose output where p = MEC + user costs (i.e. rent)

Miner: rent = P - MEC Still assuming it is a competitive industry


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o Similar to a monopoly Market price is higher, and thus, market quantity is lower Miners could earn long run profits, called rent

Hotelling rent - profit created by a resource scarcity in a competitivemarket, because the resource is fixed in nature

Also called Ricardian rent, resource rent, and user costs2. Hotelling's Rule

In Year 0, the firm starts extracting a depletable resourceo The market price and quantity are P* and Q*

In Year 1, the firm extracts less resources, because some of it has been used upo The supply function decreaseso The market price is higher and market quantity is lower

In Year 2, the firm again extracts less resourceso Supply function decreaseso The market price becomes higher and market quantity is lower

Thus, market prices should continuously increase for a depletable resourceo The higher prices are not evidence of abuse of market power.o The higher prices represent economic rent due to scarcity.


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3. Marginal Extraction Costs (MEC) should increase over time as petroleum and ores are depleted

Producers will extract the highest-quality ores first. As the high quality ores are depleted, then producers start to mine the less pure ores The MEC should increase over time

o Energy cost to extract may increaseo Higher cost to process the metalo May create more toxic wasteo Example 1 - Petroleum

Heavy crude oil, oil sands, and oil shale are not included in oil reserves Producers can uses these petroleum sources

They contain more sulfur and heavy metals Higher costs to extract this crap out Produces more greenhouse gas emissions

May be as three times as much as regular petroleumo Example 2- Gold mining in Nevada

Produces 6 million ounces per year (82% of the supply within the United States) Uses open pit mining and cyanide heap leaching recovery


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Producers dig out large pits Then they form large mounds They spray it with cyanide that dissolves the gold Collect the leeched residue and recover the gold

Our present mining operations have left a legacy of scarred earth and polluted water how willwe deal with future higher-impact requirements?

Thus, market price for minerals have to increase for companies to extract lower quality ores.4. Problems with Hotelling's Rule

The empirical evidence is mixed for Hotelling's Rule Hotelling's Rule ignores three factors

1. Technological improvements cause marginal extraction costs to fall over time A competitive industry passes the lower costs to the consumers as a lower price

2. Hotellings prices depend on the petroleum reserves being known and fixed Then petroleum extraction is based on intertemporal arbitrage. Petroleum companies do not know the location of all reserves.

Petroleum companies have a strong incentive to explore and drill fornew petroleum reserves, when petroleum prices are high

High petroleum prices Companies are exploring where extraction is much more

expensive

Extremely deep wells Extreme downhole temperatures Environmentally sensitive areas Allow extraction from the deep waters of the Gulf of Mexico or

the cold Alaskan climate.

3. Demand for petroleum can change

7/27/2019 Introduction to Environmental and Natural Reso

Introduction to Environmental and Natural Resource Economics

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Transcript of Introduction to Environmental and Natural Resource Economics