ECONOMICS ECONOMICS and the and the

ENVIRONMENTENVIRONMENT

EconomicsStudy of how people use their limited resources to try to satisfy their unlimited wants.– Use analytical tools to understand

consequences of the allocation of limited resources.

• Develop hypotheses• Test models• Analyze observations• Analyze data

Free Market EconomyFree Market EconomyFree Market The price of a good is determined by supply & demand.Ex: U.S. has a Free Market Economy

• High Supply = ____ demand = ____ price• Low Supply = ____ demand = ____ price

• High prices encourage suppliers to continue production• Economic Expansion : increase in economic activity• Economic Recession : slowdown in economic activity

• Economists try to predict the consequences of particular economic actions.• May lead to policy decisions with environmental consequences

Natural Environmental CapitalNatural Environmental Capital

Economy depends on the environment.Source: part of the environment from which

materials move. (where stuff comes from)Sink: part of the environment that receives an input

of materials. (where stuff goes)

Natural Environmental Capital continued….

Natural Capital Earth’s resources & processes that sustain living

organisms.• Includes minerals, forest, soil,

water, air, wildlife…• Includes both sources and sinks.

Resource Degradation & Pollution represent the overuse of natural capital. • Resource Degradation is the overuse of sources.• Pollution is the overuse of sinks. These threaten our long-term economic future!

The Environment & The Environment & National Income AccountsNational Income Accounts

Our economic well-being flows from natural assets. land, rivers, ocean,

resources, air

Use & misuse of natural resources is measured in National Income Accounts

National Income Accounts : Represent the total income of a nation for a given year.– Includes:

• Gross Domestic Product (GDP)

GDP Cartogram

• Net Domestic Product (NDP)

GDP & NDP continued….

• Gross Domestic Product (GDP) Market value of all final goods and services produced by the country

• Net Domestic Product (NDP) Equals the GDP minus the depreciation of capital

Ex: A firm produces some product but in the process wears out a portion of its plant and equipment.

GDP – Depreciation = NDP

GDP & NDP provides estimates of national economic performance used to make

important policy decisions.

Flaws in Calculating GDP & NDP

1.Natural Resource Depletion GDP doesn’t calculate for depleting Natural Resources.

Ex: Oil Company drains oil. Value of the oil is counted as part of the nation’s GDP No offsetting deduction to NDP is made to account for the depletion

of a non-renewable resource.

How to fix this…. Draining the oil field should be considered to be “depreciation”And the net product of the oil company should be decreased.

Natural Capital is a very large part of a country’s economic wealth, and it should be treated the same as human-

made capital.

Flaws in Calculating GDP & NDP Continued…

2. Cost and Benefits of Pollution Control National income accounts attach no explicit value to a clean environment.

Ex: - A company receives $100 M worth of output but causes pollution in a local river. - If 10% of the workers were used to properly dispose of the waste (avoid polluting!) - Only a $90M profit.

Contribution to GDP will be larger without pollution control because the national income

accounts attach no explicit value to a clean river!

An ideal accounting system…• Env. Degradation would take away from GDP • Env. Improvement activities would add to GDP

Some countries have attempted to raise their GDP by overexploiting their natural resources and

impairing the environment.– What is the problem with doing this?

There is much support for replacing traditional GDP and NDP estimates with estimates that include

environmental effects.

Flaws in Calculating GDP & NDP Continued… (Cost & benefits of pollution control)

An Economist’s View of Pollution

External Costs External Costs (Negative Externalities)(Negative Externalities)

• External Cost Harmful side effect not reflected in a products market priceExample A company makes a product and releases a pollutant into the

environment. The product’s price reflects the cost of making the product,

NOT the cost of the damage to the environment by the pollutant.

Consumer is unaware of the pollution aspect of the product because they didn’t have to pay for the negative environmental effects.

Pollution aspect has no influence on the consumer’s decision to buy.

External Costs External Costs ((Negative Externalities) continued….Negative Externalities) continued….

The failure to add the price of environmental damage to the cost of products generates a market force that increases pollution.

Economist perspective: The root cause of the world’s pollution problem is the failure to consider negative externalities in the pricing of goods.

What is the meaning of this cartoon in terms of cost-

benefit anaylsis & the economic impact?

How much pollution should be allowed in our environment?Imagine two extremes…

In our world, a move toward a better environment almost always entails a cost in terms of goods.

How much pollution is acceptable?How much pollution is acceptable?

Wilderness

No pollution produced

Highest Environmental quality possible

Many goods would be scarce or non-

existent

Sewer

Completely polluted from excess production

Lowest environmental

quality possible

Many goods produced

Marginal CostAdditional cost associated with one more unit of

something.Two examples of marginal costs of pollution:

• Effects of pollution on human health• Effects of pollution on organisms in natural environment.

The trade-off between environmental quality and more goods involves balancing 2 marginal costs.…1.Cost (in terms of environmental damage) of more

pollution = MARGINAL COST OF POLLUTION2.Cost (in terms of giving up goods) of eliminating

pollution = MARGINAL COST OF POLLUTION ABATEMENT

Marginal CostMarginal Cost

…. Added cost for all present and future members of society of an additional unit of pollution.

– difficult to determine because the risks associated with the pollution must be assessed.

Example: Sulfur Dioxide– Creates acid rain.– At high levels:

• one additional unit of sulfur dioxide will cause great harm because the environment more and more overloaded.

• (marginal cost of pollution = high!)– At low levels:

• one additional unit may cause little or no harm if the environment can absorb the damage.

• (marginal cost = low)

Marginal Cost of PollutionMarginal Cost of Pollution

Marginal Cost of Pollution Continued….

This graph specifies the cost of damage associated with additional units of pollution.

Shows that as the level of pollution rises, the social cost (health, environmental damage) increases sharply

…. Added cost for all present and future members of society of reducing a given type of pollution by one unit.

Pollution abatement costs more as the level of pollution is lower. Example

It’s not very expensive to decrease auto fuel emissions by half, but thetechnology to decrease itin half again is VERY expensive!!

Marginal Cost of Pollution AbatementMarginal Cost of Pollution Abatement

What is the Optimum Level of Pollution???

Cost-Benefit Diagram Shows the Optimum amount of pollution Shows the point at which the marginal cost of

pollution equals the marginal cost of abatement.

If more pollution is allowed, the social / env. cost will be

unacceptably high.

If less pollution is allowed, the abatement cost will be

unacceptably high.

What if the actual pollution level is different from the optimum level?

If the Actual Level is ABOVE the Optimum Level:

– Harm done exceeds the cost of reduction.– Social/env. cost of pollution is too high.– What do we do?

• It’s economically more efficient to reduce the pollution.

If the Actual Level is BELOW the Optimum Level:

– Less harm done, so it’s not costing much to pollute.

– Pollution abatement cost is too high.– What do we do?

• Polluters “should” be allowed to pollute more (or pay less for their pollution).

A “Real” Cost Benefit Diagram

Flaws in the Optimum Pollution ConceptFlaws in the Optimum Pollution Concept

1. The true cost of environmental damage by pollution is difficult to determine.

• What is the value of environmental beauty?• What is the value of a species going extinct?• How do you give a value to resource degradation over

a large area that affects many communities?

2. The risks of unanticipated environmental catastrophe are not taken into account in assessing the potential environmental damage of pollution.

• The whole is MUCH more than simply the sum of its parts… economists can’t just add up the costs of lost elements in a polluted environment!

The passage of laws that set limits on levels of pollution.– Sometimes set specific control

methods… Ex: Catalytic Converters in cars.

– Sometimes set quantitative goals…• Ex: Clean Air Act (’90) established a goal of 60%

nitrogen oxide emissions by 2003.

– All polluters must comply with the same rules and regulations, regardless of their circumstances.

1. Command & Control Regulations1. Command & Control Regulations

Criticism of Command-ControlCriticism of Command-Control

Can be more costly than necessary

• Command & control regulation sets environmental pollution levels much lower than the economically optimum level of pollution

• Many economists prefer incentive-based regulation over command & control

…………………………………………………………….

Emissions Charge “green tax”– Basically a tax on pollution.– Meant to correct what is considered to

be a distortion in the market –Environmental costs of

manufacturing aren’t included in market values.

Incentive-Based Regulation continued….Incentive-Based Regulation continued….

Emission targets are established and industries are given incentives to reduce emissions.• Considered a market-oriented strategy

–Depends on market incentivesto reduce pollution & minimize

the cost of control.

• Ex: Emission Charge!! (popular in Europe)

2. Incentive-Based Regulation2. Incentive-Based Regulation

• GERMANY– Increased tax on gas, heating oil

and natural gas • Carpooling increased 25%

• BRITAIN– Increased fuel tax

• 13% increase in truck efficiency • Fuel consumption dropped

• NETHERLANDS– Tax on gas, electricity, fuel oil, heating oil & Income

taxes decreased to offset tax burden • electricity and fuel use declined

Incentive-Based Regulation continued….Green tax examplesIncentive-Based Regulation continued….Green tax examples

Green Taxes… good or bad?• Not notably successful in actual

practice:– People usually have strong objections

because they think creating pollution is free.

– Even when it’s publicized that this will benefit them during income tax time, people still aren’t excited about it

– TOO MANY TAXES!!!

Incentive-Based Regulation continued….Green tax- good or bad?Incentive-Based Regulation continued….Green tax- good or bad?

Often, the Green Taxes are set too low to have much effect on Often, the Green Taxes are set too low to have much effect on polluting behavior.polluting behavior.

Another approach to incentive-based pollution control…• Government sets a cap on pollution at an “acceptable” level • Government issues a fixed number of permits allowing the

holder to emit a specified amount of a given pollutant.

– Emission Reduction Credits (ERC’S) can be bought and sold by industries freely• Produce too much pollution costly to companies that have to

purchase more ERC’s• Produce less pollution than permitted may sell excess ERC’s.

– … it pays to pollute less… literally!• Allows companies to determine what level of pollution

abatement measures are economically appropriate for them.

3. Marketable Waste-Discharge Permits3. Marketable Waste-Discharge Permits

A five-cent tax on plastic shopping bags has cut the use of the bags by more than half

in Washington, D.C. It's a compelling example of how a small incentive can have a big

effect.