Understanding Environmental Economics: Policies, Balances, and Market Models.

1. Economics 350 EPA Water pollution Abatement costs Environmental Economics Air pollution Optimal pollution Solid municipal waste Cost-benefit analysis Hazardous wastes Tradable discharge permits Global warming Command and control Endangered species Emission taxes

2. Why do people behave in ways that harm the environment? Moral Approach Economic Approach • Households: “pay as you throw” garbage systems • Firms: CO2 taxes and tradable SO2 permits Appeals to moral behavior Recognizes that people respond to incentives • Households: “give a hoot, don’t pollute” • Firms: emission standards

3. Economic Way of Thinking • Rationality • Scarcity • Marginal analysis • Equilibrium • Positive vs. normative analysis

4. Environmental Policy • Objectives • Environmental quality • Sustainable development • Biodiversity • Types of Policies • Command and Control • Market Approaches • Effectiveness • Cost/Benefit Analysis

5. Environmental Policy • Politics • Special interests • Fairness issues • Outlook • Pessimists • Thomas Malthus Bootleggers & Baptists ?

6. Malthusian Model Population Food production time Thomas Malthus

7. Environmental Policy • Politics • Special interests • Fairness issues • Outlook • Pessimists • Neo-Malthusians • “Limits to Growth” • Optimists • “cornucopians” • Technology and markets Julian Simon

8. Economy and Environment Nature resources residuals Economy Natural Resource Economics Environmental Economics

9. PPC Economy and Environment: PPC Production Possibilities Curve Environmental Quality • PPC shows all combinations of two goods that can be produced from given resources and technology • Illustrates tradeoff between the two goods unattainable B ΔEQ A Market Goods ΔG Note: Environmental degradation may shift PPC inward over time.

10. 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: fall by 10 units. fall by less than 10 units. fall by more than 10 units. increase by less than 10 units.

11. Fundamental Balance Recycled: rRp Residuals: Rp Discharged: dRp Raw Materials M Producers Goods: G Residuals: Rc Discharged: dRc Consumers Recycled: rRc M = dRp + dRc M = G + Rp – (rRp + rRc)

12. Fundamental Balance M = G + Rp – (rRp + rRc) • 3 Ways of Reducing M • Reduce G • Reduce “consumerism” • Zero population growth? • Reduce Rp • Reduce residual intensity of production • Sectoral shift • Increase (rRp + rRc) • Mandatory content requirements

13. Types of Pollutants Radioactive waste, plastics, many chemicals Noise • Cumulative • Noncumulative • Local • Regional • Global • Point Source • Non-Point Source • Stationary Source • Mobile Source • Continuous Emissions • Episodic Emissions 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

14. US Pollution Control Expenditures: 2005 U.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

15. Review of Microeconomic Theory • Rational man model • An 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

16. Market Model Price • What Q is produced? • What Q should be produced? Supply P* Demand quantity Q* Positive Normative

17. Market Model: Demand Side Price Buyer’s Marginal Benefit or WTP • Consumer Surplus = ∑(WTP – Price) • Total Expenditure = P*Q $50 Consumer Surplus $25 Market price Total Expenditure Demand 1 5 quantity

18. Market Model: Supply Side Price • Producer Surplus = ∑(Price – Marginal Cost) Supply $25 Market price Producer Surplus Seller’s Marginal Cost $10 Total Cost 3 quantity

19. Market Model Price Supply • Free Market Outcome: P*, Q* • Maximizes social welfare: SW = CS + PS CS Deadweight Loss P* PS Demand Q* quantity

20. Market Model • Problem Set 1, #8 • Problem Set 1, #9

21. Equimarginal Principle __________________ 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? Plant A: Q = 4 Plant B: Q = 3 Plant C: Q = 4 Define: MC = $30 in all plants TC = 80 + 60 + 77 = $217 Allocate output such that MCA = MCB = MCC

22. Market Failures • Imperfect competition • Imperfect information • Externalities • Public goods/Common Resources

23. Externalities • Occur when decision makers do not consider all costs (or benefits) of their actions • Two views A. C. Pigou Ronald Coase

24. Cashmere Externalities

25. Externalities: Pigou Social Cost = Private Cost + External Cost • Free Market: P1, Q1 • Optimal Outcome: P2, Q2 Ssocial $ Sprivate P2 P1 Marginal external cost TEC D1 Free market overproduces goods that generate a negative externality Q2 Q1 cashmere How can society achieve social optimum? Internalize the externality!  Impose tax = marginal external cost

26. M&M Experiment

27. Excludability: can you be excluded from consuming the good? Rivalry: does my consumption hinder your consumption? Public Goods & Common Resources Artificially Scarce Goods Private Goods Common Resources Public Goods

28. Garrett Hardin Tragedy of the Commons • Commonly-owned resources tend to be over-exploited • Conflict between self-interest and the common good • Examples Am I in danger of being over-harvested?

29. Sample Problems • Problem Set 1: #20(Externality) • Problem Set 1: #18 (Public Goods)

30. ΣMB MBH $ MBA MBS MC SO2 (μg/m3) Dirtier air  Social Optimum occurs where ΣMB = MC

31. dH dA dS D = Σd

32. 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 • reducing G (output of goods) • increasing Rp (production residuals) • increasing rRp + rRc (recycled production and consumption residuals) • all of the above.

33. All of the following are examples of point-source pollutants except one. Which one is not an example of a point-source pollutant? • municipal waste treatment plants • agricultural chemical runoff • electric power plants • Eramet Metals manufacturing plant

34. Public goods are distinguished by two primary characteristics. These are: • market failure; high prices • government intervention; high prices • nonrivalry; nonexclusivity • rivalry; exclusivity

35. The efficient output will be less than the free market output when: • Marginal social cost and marginal private cost are equal • Marginal social cost is greater than marginal private cost • Marginal social benefit and marginal private benefit are equal • Marginal social benefit is greater than marginal private benefit

36. 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? • 1 • 2 • 3 • 4 • 5 • 6