Chapter 31

1. Chapter 31 Environmental Economics

2. Introduction In recent years, honeybees have suffered a condition called “colony collapse disorder,” in which colonies of honeybees suddenly shrink or disappear altogether for reasons not fully understood. There is growing evidence that human activities may contribute to colony collapse disorder. In this chapter, you will learn about the relationship between markets and the environment.

3. Learning Objectives Distinguish between private costs and social costs Understand market externalities and possible ways to correct externalities Explain how economists can conceptually determine the optimum quantity of pollution

4. Learning Objectives (cont'd) Contrast the roles of private and common property rights in alternative approaches to addressing the problem of pollution Describe how many of the world’s governments are seeking to reduce pollution by capping and controlling the use of pollution generating resources Discuss how the assignment of property rights may influence the fates of endangered species

5. Chapter Outline Private versus Social Costs Correcting for Externalities Pollution Common Property Reducing Humanity’s Carbon Footprint: Restraining Pollution-Causing Activities Wild Species, Common Property and Tradeoffs

6. Did You Know That ... In the 1970s, many news magazines ran cover stories about how the world was descending into a new ice age? Today global warming is the consensus, leading to policies aimed at reducing greenhouse gases. Economists want to help citizens and policymakers opt for informed policies that have the maximum possible net benefits (benefits minus costs). As you will see, every decision made in favor of “the environment” involves a trade-off.

7. Private versus Social Costs Private Costs Costs borne solely by the individuals who incur them Also called internal costs

8. Private versus Social Costs (cont'd) Social Costs The full costs borne by society whenever a resource use occurs Measured by adding internal to external costs

9. Private versus Social Costs (cont'd) Environmental issues occur when social costs exceed private cost The cost of polluted air—consider both private and social costs Question What if you had to pay the social cost of driving a car?

10. Private versus Social Costs (cont'd) Externality A situation in which a private cost (or benefit) diverges from a social cost (or benefit) A situation in which the costs (or benefits) of an action are not fully borne (or gained) by the two parties engaged in a scarce-resource-using activity

11. Figure 31-1 Reckoning with Full Social Costs

12. Correcting for Externalities An externality arises when there is a divergence between private cost and social cost The remedy is to change the signal for decision making In the case of industrial pollution, the firm must be forced to internalize the cost of the environmental damage

13. Correcting for Externalities (cont'd) The polluters’ choice Install pollution abatement equipment or change production techniques Reduce pollution-causing activity Pay the price to pollute

14. Correcting for Externalities (cont'd) Is a uniform tax appropriate? It may be appropriate to levy a uniform tax, as external costs might vary from location to location We must establish the amount of economic damages;we have to come up with a measure of economic costs

15. Policy Example: Why Higher Cigarette Taxes Might Be Preferable to Smoking Bans Studies have found that some smokers respond to the ban on smoking in certain public places by spending more time in bars, where they end up drinking more, which results in more deaths in accidents involving drunk drivers. Other studies have found that each 10 percent increase in a uniform tax on cigarettes is associated with a 3 to 4 percent reduction in nonsmokers’ exposure to cigarette smoke perhaps because smokers cut back on smoking alone instead of in the presence of nonsmokers.

16. Thus, well-intended partial bans on smoking contribute to an unintended but deadly spillover effect. However, imposing higher uniform taxes on cigarettes may be more effective at shielding nonsmokers from cigarette smoke than bans on public smoking. Policy Example: Why Higher Cigarette Taxes Might Be Preferable to Smoking Bans (cont’d)

17. Pollution Question How much pollution is too much? Answer The optimal quantity is determined by a comparison of marginal costs and benefits.

18. Pollution (cont'd) Optimal Quantity of Pollution The level of pollution for which the marginal benefit of one additional unit of pollution abatement just equals the marginal cost of that additional unit

19. Figure 31-2 The Optimal Quantity of Air Pollution The optimal quantity of pollution occurs where MC = MB

20. Common Property Private Property Rights Exclusive rights of ownership that allow the use, transfer, and exchange of property

21. Common Property (cont'd) Common Property Property that is owned by everyone and therefore by no one Examples are air and water

22. Common Property (cont'd) Question What do you think: Why does pollution occur when property rights are poorly defined? Answer When no one owns a particular resource, no one has any incentive (conscience aside) to consider misusing it.

23. Common Property (cont'd) Voluntary agreements and transactions costs Is it possible for externalities to be internalized via voluntary agreement? What are the costs incurred by the parties who seek to negotiate an agreement?

24. Common Property (cont'd) Voluntary agreements and transactions costs Voluntary agreements: contracting Opportunity cost always exists, whoever has property rights

25. Common Property (cont'd) Voluntary agreements and transactions costs Transaction Costs All costs associated with making, reaching, and enforcing agreements Must be low relative the expected benefits

26. Common Property (cont'd) Changing property rights Closing the gap between private costs and social costs Taxation Subsidization Regulation

27. Reducing Humanity’s Carbon Footprint: Restraining Pollution-Causing Activities In light of the costs arising from spillovers that polluting activities create, one solution might seem to be for governments to try to stop them from taking place Why don’t more governments simply require businesses and households to cut back on pollution-causing activities?

28. Reducing Humanity’s Carbon Footprint: Restraining Pollution-Causing Activities (cont’d) Kyoto Protocol (1997) aims to reduce overall emissions of greenhouse gases by 2020 by as much as 20% below 1990 levels The EU’s Emissions Trading Scheme (2005) Each EU nation is established an allowance of emissions that a company can release If a company exceeds its limit, it must purchase additional allowances (at the market clearing price) from companies who are not emitting their quota

29. Why Not … eliminate nearly all U.S. carbon emissions? To attain the official target of the U.S. government, the carbon emissions of the typical U.S. resident in 2050 will have to fall to levels not observed since the eighteenth century. Thus, costly investments in new energy technologies will be required to meet the official U.S. target while continuing to generate energy for a much larger—and growing—U.S. population.

30. Reducing Humanity’s Carbon Footprint: Restraining Pollution-Causing Activities (cont'd) Are there alternatives to pollution-causing resource use? Why aren’t we shifting to solar panels and electric cars? The plain fact is that the cost of generating solar power in many circumstances is much higher than generating that same power through conventional means In addition, the manufacturing of solar panels could itself cause pollution

31. Wild Species, Common Property, and Trade-Offs One of the most distressing common property problems involves endangered species Virtually all species not endangered are private property (dogs, cats, cattle, sheep and horses) Endangered species (spotted owls, bighorn sheep and condors) are typically common property

32. Wild Species, Common Property, and Trade-Offs (cont'd) In 1973, the federal government passed the Endangered Species Act in an attempt to keep species from dying out As more and more species were put on the endangered list, a trade-off became apparent

33. International Example: Fisheries Hook a Solution to the Common Property Problem Because the fish in large bodies of water are common property, no one has a vested interest in preventing depletion of fish populations. Recently, some governments have developed individual transferable quotas (ITQs) as a means of conferring private property rights to fish. Evidence shows that fish populations have stabilized and even expanded with ITQs.

34. You Are There: Fuel Efficiency Rules and the “Rebound Effect” David Greene of Oak Ridge Laboratory has found that the U.S. requirement that vehicles meet minimum fuel efficiency standards has a “rebound effect,” in which people drive more when vehicle efficiency improves, leading to additional carbon emissions. Greene has also found that the rebound effect has declined because a typical new vehicle’s price has risen by about $1,000 for every 10 mpg increase in minimum fuel economy standards.

35. Issues & Applications: Human Activitiesand Honeybee Colony Collapse Disorder During the 2000s, an epidemic of “colony collapse disorder” (CCD) began to devastate honeybee colonies. Because bees help crops to pollinate, the CCD has threatened the reduce agricultural yields worldwide. Scientists have found that limited sources of nutrients for honeybees in human-managed colonies have led to the CCD, so that some beekeepers now provide supplemental nutrition to their bees.

36. Summary Discussion of Learning Objectives Private costs versus social costs Private costs are borne solely by those who use resources Social costs are the full costs that society bears when resources are used Market externalities and ways to correct externalities Tax those who create externalities

37. Summary Discussion of Learning Objectives (cont'd) Determining the optimal amount of pollution The level of pollution at which the marginal benefit of pollution abatement equals the marginal cost of pollution abatement Private and common property rights and the pollution problem Private property rights permit exchange and use of a resource Common property is owned by everyone and thus by no one

38. Summary Discussion of Learning Objectives (cont'd) Restraining pollution-causing activities through caps and allowances The EU has established the Emissions Trading Scheme Each EU nation’s government establishes an overall target level of greenhouse gas emissions and distributes allowances, granting companies the right to emit a certain amount of gases If exceeded, the company must purchase more allowances from firms emitting less than their quota

39. Summary Discussion of Learning Objectives (cont'd) Endangered species and the assignment of property rights Animals that are privately owned (e.g., dogs and livestock are abundant) Owners have incentives to take care of these animals Wild animals are common property resources and many are endangered because no one has an incentive to protect these animals