ECON 4910 Spring 2007 Environmental Economics Lecture 12 Summing up

1. ECON 4910 Spring 2007 Environmental Economics Lecture 12 Summing up Lecturer: Finn R. Førsund Summing up

2. Content of course • Background • Environmental policy • International issues • Dynamic issues • Valuation Summing up

3. Background • What is environmental economics? • Building blocs: • Production of man-made goods and generation of pollutants • Production of environmental services • Interaction economic activity and the environment • Evaluation of man-made and environmental goods Summing up

4. Tools for dealing with the building blocks • Production and generation of pollutants • Multi-output production theory • Production of environmental services and interaction pollutants – the environment • Knowledge about natural environments and effects of deposition of pollutants • Evaluation of environmental goods • Externalities • Public-good theory Summing up

5. The basic social-choice model • Social choice: how much environmental protection, trade-off marketed goods – environmental services • Benefit to the production sector from pollution and damage of pollution to consumers • B = benefit, e = pollution, D = damage Summing up

6. The basic social-choice model, cont. • The social optimisation problem • Necessary first order condition • Second order sufficient condition Summing up

7. Illustration of the social solution b’,d’ b’ d’ b’* = d’* e e* Summing up

8. Explaining the benefit function and the purification function of the basic model • Factorially determined multi-output production in the production sector • Marketed output: y • Pollutants: e • Production inputs: x1 (K,L,E,M) • Purification inputs: x2 Summing up

9. Factorially determined multi-output production, cont. • Profit maximisation with environmental constraint • Output price: p • Input prices: q1, q2 • Pollution constraint: eR Summing up

10. Profit maximisation, cont. • The Lagrangian • First-order conditions • Endogenous variables as function of exogenous variables Summing up

11. The benefit function • Environmental restriction is so lax that the constraint is not binding • e* < eR • No purification resources are used. x2 = 0 • The profit function with binding environmental constraint Summing up

12. The damage function • Utility of environmental services as public goods • Man-made goods: xi • Environmental services: M • Demand for the environmental services, vertical summation Summing up

13. The damage function • Willingness to pay • Marshall demand functions • Indirect utility function in money • Max utility for given income, environmental services Summing up

14. Willingness to pay, cont. • Hicks demand functions • Expenditure function • Min. expenditure for given income, environmental services E Summing up

15. Willingness to pay, cont. • Compensating surplus • Difference in expenditure keeping the old utility level Uo when the environment improves from Mo to M1 • Question to the consumer: what are you willing to pay for an environmental improvement Summing up

16. Willingness to pay, cont. • Using the indirect utility function • The consumer is willing to pay the compensating surplus and will remain on the old utility level • Equivalent surplus • Difference in expenditure keeping the new utility level when the environment improves Summing up

17. Willingness to pay, cont. • Question to the consumer: what will you accept in payment for forgoing an environmental improvement • Using the indirect utility function • To accept the old environmental service the consumer must have a compensation giving him the same utility level as the improved environment would have given Summing up

18. Methods to find willingness to pay • Revealed preferences • Utilising complementarity between environmental service and market goods • The travel cost method finding demand for visiting sites • Hedonic regressions; isolating environmental differences • Household production; household produce their own environmental services • Stated preferences • Asking people; constructed markets and contingent valuation Summing up

19. Environmental policy • Is public regulation necessary? • Property rights; the Coase theorem • Market failure: public bads and externalities • Regulating policy instruments for pollution • Command and control • Economic incentives • Pigouvian fees, emission fees • Marketable permits • Regulation with unknown control costs • Unobserved emissions, audits Summing up

20. The Coase theorem Polluter can pay Pollutee to accept more pollution b’,d’ Bargaining solution d’ b’ Pollutee can pay Polluter to cut back b’* = d’* Property right pollutee Property right polluter e eπ d(emin)=0 e* Summing up

21. Unknown costs: The Weitzman rule Social loss using e* if L and if H -E{c’(e)} D’(e) Social loss if H using t* t* -cH’ Social loss if L using t* -cL’ e eL e* eL(t*) eH eH(t*) Summing up

22. International issues • Transboundary pollution • Global warming • Stratospheric ozone depletion • Acid rain • Type of pollutants • Uniformly distributed: deposition • Non-uniformly distributed: deposition • Deposition depends on location Summing up

23. Policy models for economic efficiency • Minimising costs for given environmental deposition targets • The RAINS model • Future projection eio • Deposition target dj* Summing up

24. Policy models for economic efficiency, cont. • Ideal Kyoto protocol Summing up

25. Tradable emission permits • Trade in permits can be used when • The social solution is derived from setting environmental standards because the damage function is not known • Damage function known, but certainty of achieving the desired pollution level is preferred • Trade in permits to a common trading price can only be socially optimal if the pollutant is uniformly dispersed Summing up

26. Efficiency of tradable permits -c1’, -c2’ -c2’ -c1’ e1 e2 e1o e2o e2* e1* eR = a(e1o +e2o) Summing up

27. Stock pollution • Damage from accumulated waste • Cannot achieve an interior steady-state solution without decay of accumulated pollution • Decay: • Formulating a dynamic optimisation model for an infinite horizon and solving using optimal control theory. Steady state illustration by phase diagram Summing up