Environmental Economics

Environmental Economics

Environmental Economics • Environmental economics air pollution, water quality, toxic substances, solid waste, and global warming (flows) • Natural resource economics natural assets valued for their productive capacity (usually resource stock)

Efficient Market Allocation • Consumers maximize their surplus Demand = Marginal Benefit (MB) • Producers maximize their surplus Supply = Marginal Cost (MC) In equilibrium, P = MB = MC • No further beneficial transactions are possible • Normally, a free market brings us to this point

Same socially optimal outcome for environmental goods? Characteristics of efficient property rights usually not satisfied for environmental goods

Characteristics of property rights • Enforceability – if you buy something, then it will not be taken away from you without permission • Transferability – can be transferred from one individual to another • Exclusivity – all benefits and costs associated with it are received by only one individual at a time

Non-exclusivity - Full costs and benefits borne not just by producers or consumers but also by the public. - Outcome is not socially optimal; there is room for further beneficial transactions. Why?

Private versus Social Costs • Private Costs (internal costs) • Costs borne solely by the individuals who incur them

Private versus Social Costs • Social Costs • The full costs borne by society whenever a resource use occurs • Measured by adding internal to external costs

Private versus Social Costs • Environmental issues occur when social costs exceed private cost

Private versus Social Costs • The cost of polluted air • How would you alter your transportation demand if you had to pay the social cost of driving a car?

Externalities • Are consequences of the use or ownership of a resource that affects someone other than the owner • Can be positive or negative • Result in situations in which a private cost or benefit diverges from a social cost

Reckoning with Full Social Costs

Externalities When social cost > internal cost • Output is excessive because the price is “too low”

Correcting for Externalities • Bargaining and negotiation - Coase theorem • Taxes and subsidies • Direct regulation • Auctioning/Selling pollution rights

Coase Theorem • Regardless of where rights are initially assigned, bargaining will bring about the socially optimal solution • Caveats

Correcting for Externalities • Taxes and subsidies • Measuring damages • Reducing damages to efficient level

Pollution • Question • How much pollution is too much?

The OptimalQuantity of Air Pollution The optimal quantity of pollution occurs where MC = MB

Pollution • Optimal Quantity of Pollution • The level of pollution for which the marginal benefit of one additional unit of clean air just equals the marginal cost of that additional unit of clean air

Environmental Economics