ENVIRONMENTAL REGULATION OF BUSINESS (for masters students, Fall 2010) Finance 580, M&W 2:00-3:20, in BIF 2001

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1 ENVIRONMENTAL REGULATION OF BUSINESS (for masters students, Fall 2010) Finance 580, M&W 2:00-3:20, in BIF 2001 Professor Don Fullerton (A different Fin 580 is for PhD students; get the right topic.) Finance Dept, BIF 4030 Phone: (217) , Cell: (512) University of Illinois at Office Hours: Tu&Th 10:30-12noon Urbana-Champaign This course will study the economic impacts on businesses and individuals from public policies that address natural resources and the environment. We welcome those in MBA or MSF programs, or MS in Agricultural Economics. (If it is not over-subscribed, I will allow senior undergraduates from the College of Business only.) It is designed primarily for masters students who have had some undergraduate intermediate microeconomics. We will start with the concepts of externalities, public goods, property rights, market failure, and social cost-benefit analysis. We then consider a few additional problems such as information, uncertainty, and risk analysis. The first set of applications of these tools will involve natural resources. Other applications include air pollution, water pollution, solid waste management, and hazardous substances. In addressing each of these problems, we compare public policy responses such as administrative regulation, marketable permits, tax incentives, and direct subsidies. We will study several methods to value environmental benefits. The course will study models that enable us to analyze the economic impacts of such regulations, including effects on output, costs, investment, R&D, and the amount of pollution. Also, distributional effects include who bears the burdens and who gets the benefits. We will learn how to analyze what is the best type of regulation for each pollutant, and we'll look at enforcement models (where government sets the price or quantity of pollution, the rate of inspection, and the penalty for noncompliance). Other specific topics include "carbon finance" and "environmental accounting." In the case of nonrenewable resources, such as fossil fuels, we will consider the "efficient" or ideal rate of extraction, the market-driven rate of extraction, and then policy interventions that might achieve the efficient rate. For renewable resources, such as forests and fisheries, we consider the common property problem and public policies to correct it. We will also look at the disposal of wastes, policies to encourage alternatives such as recycling, and policies to discourage other alternatives such as illegal dumping or burning. Requirements: Short papers will be due every second week. Together, these papers will determine sixty points (30% of the total). The midterm exam will constitute 40 points (20% of the total), and the final exam will account for 80 points (40%). Attendance is mandatory, and participation in class will count for the remaining 20 points (10%). Scores out of the 200 possible points will be ranked on a relative scale, but grades will be assigned on an absolute scale. In other words, the cut-off between A's and B's will depend on how well those folks did. Social Contract: The first requirement is that you read this entire syllabus with all rules, regulations, procedures, and due-dates. Because you see them listed here, you will be responsible for all requirements or assignments whether or not you hear the announcements in class. If you are worried about potential problems, then do assignments early. If you remain in this course, I will presume that you agree to these conditions. You may give up some flexibility, but you will know well in advance exactly what is expected.

2 -2- Reading Material: You will have to buy one textbook (and one packet of readings to be made available later). Two other paperback books listed below contain readings for those with further interest. Required readings from the text and packet are marked with asterisk. (1) Frank A. Ward, Environmental and Natural Resource Economics, Pearson Prentice Hall, Columbus, Ohio, (2) Stavins, Robert N., ed., Economics of the Environment: Selected Readings, Fifth Edition, New York: W. W. Norton and Company, (Cited below as EESR.) (3) Portney, Paul R. and Robert N. Stavins, eds., Public Policies for Environmental Protection, Second Edition, Washington DC: Resources for the Future, II. Office Hours I. Introduction (above) V. Exams II. Office Hours VI. Readings III. Is this Course Theoretical? VII. Calendar IV. Assignments Tue.&Thu. 10:30 12:00 noon Phone: (217) BIF 4030, Cell: (512) At other times, you are welcome to stop by my office or to call. If I am not able to meet with you right then, we can arrange an appointment for later. III. Is This Course Theoretical? You might find this course to be "theoretical," but I think of it as "conceptual." We could provide a lot of hard facts about pollution, resources, and public policy interventions, such as which government agencies spend how much money to provide what environmental services. You would not find such a course to be useful, however, because the few facts or numbers that you remember will soon be out-of-date. Rather, we will try to teach techniques for evaluating public policy. You will learn concepts and methodology that should prove useful in doing policy analysis yourself. Hopefully, you will learn to think like an economist. Thus, we might use equations with Greek letters in place of numbers, without ever giving the input numbers or the current numerical answers. Once you get an idea of how to obtain the right input numbers, you will always be able to use these techniques and derive your own current answers. No need to memorize old numbers. Some of you may not become economists, but all of you will want to read and understand what economists write. IV. Assignments One of the most constructive features of this course in the past has been the biweekly papers. They reinforce your learning by putting it to immediate use, they help keep everybody up with the readings, they give you examples of the kinds of questions I am likely to ask on exams, and they give me useful feedback from students. In order to encourage succinct and incisive reasoning, your answers will be strictly limited to three typed double-spaced pages (12- point font, one-inch margins).

3 -3- Also, a word on joint efforts: much can be learned from your peers, and I encourage discussion of the assignments. The most effective method seems to be maximum individual effort with occasional hints from your friends. Nothing can be gained from wallowing about, if you don't have a clue about what to do next. But avoid doing entire sections of homework together, because you will only learn how to approach these problems if you get some practice at doing it alone. (More concretely, do not copy on the homework!) Six assignments will count for sixty points, or 30% of your total grade. Each assignment will be scored from a possible ten points. The calendar provides relevant due dates. If you miss a class when homework is distributed, be sure to get a copy from a friend or from me. Your homework is due no later than the beginning of the class indicated. Because: - you know about due-dates well in advance, - you have a week for each homework, - it should only take a couple of hours, if you're up on the readings, - everybody has other assignments, - and I don't want to judge the quality of excuses, a one point penalty will apply to every late paper (up to five days late). This apparently picky approach helps avoid the more picky business of deciding what excuses qualify. V. Exams Do not ask me if you can move an exam, as I will follow only university procedures for rescheduling examinations. The Midterm will be held in class on Wednesday October 20. It might include a few short warm-up questions such as definitions or identification of key concepts. The longer question(s) will be similar in nature to the previous assignments. The midterm will constitute forty points, or 20% of your total grade. A review session will be held two days beforehand. The Final Exam will be held on schedule. You should check, but my guess from the website is that our final exam is on the last day of exams, Friday December 17 at 1:30-4:30. Again, it will probably include some short questions and some longer questions. Eighty points on the final will make up 40% of the total grade. A review session will be held two days beforehand. VI. Readings To ensure a fairly uniform starting place, students should already be familiar with concepts like the Edgeworth box diagram, marginal conditions for Pareto Optimality, social welfare functions, economic efficiency, and the theory of the second best. These concepts are discussed in all intermediate microeconomics textbooks, such Pindyck and Rubinfeld's Microeconomics, or Varian's Intermediate Microeconomics. Please re-read corresponding sections from your text. Separate topics are not shown on the calendar because we will be flowing from one to another. I do not wish to be constrained on the timing of each topic: we will cover about 15 topics in 28 lectures. Thus, the average topic will take only one or two lectures. You should keep up on readings accordingly, and always be prepared to start the next topic. Required readings are marked with an asterisk (*). VII. Calendar

4 -4- Fall 2010 Calendar Week Monday Tuesday Wednesday Thursday Friday 1 Aug First Class Sept Labor Day Distribute # #1 Due Distribute # Oct. 1 #2 Due Distribute #3 No office hours #3 Due 9 18 Review Q&A, 8pm Midterm Distribute #4 11 Nov #4 Due Distribute # #5 Due ///////////// 23 ////////////////// 24 /////////////// 25 ///////////////// 26 ///////////////// Thanksgiving Dec Distribute # Last Class #6 Due 9 10 First day of exams, but We are last! (1:30-4:30pm)

5 1. Introduction: The Role of Government -5- *Ward, Chapters 1&2. *Fullerton, Don and Robert Stavins, How Economists See the Environment, Nature 395, October 1998: (Chapter 1 in EESR, and on my website at: ). Portney, Paul R. and Robert N. Stavins, Introduction, and Portney, Paul R., EPA and the Evolution of Federal Regulation, Chapters 1&2 in Portney and Stavins, eds., Public Policies for Environmental Protection, Washington, DC: RFF, Economic Efficiency *Ward, Chapter 3. Frederick, Kenneth D., Marketing Water: The Obstacles and the Impetus, in W. Oates, ed., The RFF Reader in Environmental and Resource Management, Resources for the Future, Washington, DC, Goulder, Lawrence H. and Ian W. H. Parry, Instrument Choice in Environmental Policy, Review of Environmental Economics and Policy 2 (2), Summer 2008: Public Goods and Externalities *Ward, Chapter 4. Coase, Ronald H., "The Problem of Social Cost," The Journal of Law and Economics 3, October 1960: 1-44 (Chapter 3 in EESR). Pigou, Arthur C., The Economics of Welfare, London: Macmillan, Command and Control vs. Market-Based Incentives *Ward, Chapter 16. *Fullerton, Don, A Framework to Compare Environmental Policies, Southern Economic Journal 68 (2), October 2001: (and on my website). Sandel, Michael J., It s Immoral to Buy the Right To Pollute, New York Times, Dec : p.a29 (Chapter 18 in EESR; also read replies in EESR). 5. Cost-Benefit Anaylsis *Ward, Chapter 5&6. *Arrow, Kenneth, et al, Is There a Role for Benefit-Cost Analysis in Environmental, Health, and Safety Regulation?, Science, April 12, 1996 (Chapter 12 in EESR).

6 -6- Kelman, Steven, Cost-Benefit Analysis: An Ethical Critique, AEI Journal on Government and Society Regulation, Jan/Feb. 1981: (Chapter 14 in EESR). Freeman, A. Myrick, "Environmental Policy Since Earth Day I: What Have We Gained?, Jnl of Econ Perspectives 16(1), Winter 2002: (Ch. 30 in EESR). 6. The Measurement of Benefits *Ward, Chapter 7. Portney, Paul R., "The Contingent Valuation Debate: Why Economists Should Care," Journal of Economic Perspectives 8 (4), Fall 1994: 3-17 (Chapter 7 in EESR). Diamond, Peter A. and Jerry A. Hausman, "Contingent Valuation: Is Some Number Better than No Number?", Journal of Economic Perspectives 8 (4), Fall 1994: (Chapter 9 in EESR). Carson, Richard T., et al, "Contingent Valuation and Lost Passive Use: Damages from the Exxon Valdez Oil Spill," Environmental and Resource Economics 25, 2003: (Chapter 10 in EESR). 7. Renewable Resources *Ward, Chapter 8&12 (and skim 9,10,&11). Pearce, David W. and R. Kerry Turner, Economics of Natural Resources and the Environment, Baltimore: Johns Hopkins University Press, Chap. 16&17, Neher, Philip A., Natural Resource Economics: Conservation and Exploitation, New York: Cambridge University Press, 1990, "A Seal Hunt," Exhaustible Resources *Ward, Chapter 13. Pearce, David W. and R. Kerry Turner, Economics of Natural Resources and the Environment, Baltimore: Johns Hopkins University Press, Chapter 18, Arrow, Kenneth, et al, "Are We Consuming Too Much?" Journal of Economic Perspectives 18(3), Summer 2004: Livernois, John, On the Empirical Significance of the Hotelling Rule, Review of Environmental Economics and Policy 3 (1), Winter 2009: Population, Growth, and Sustainability *Ward, Chapter 14&19. Porter, Michael E. and Claas Van der Linde, Toward a New Conception of the Environment-Competitiveness Relationship, Journal of Economic Perspectives 9 (4), Fall 1995: (Chapter 5 in EESR).

7 -7- Solow, Robert M. "Sustainability: An Economist's Perspective," Lecture to the Marine Policy Center, Woods Hole, MA, June (Chapter 26 in EESR). 10. Climate Change *Ward, Chapter 15. Nordhaus, William D., Reflections on the Economics of Climate Change, Journal of Economics Perspectives 7 (4), Fall 1993: (Chapter 22 in EESR). Heal, Geoffrey, Climate Economics: A Meta-Review and Some Suggestions for Future Research, Review of Environmental Econ and Policy 3 (1), Winter 2009: Carbon Trading McKibbon, Warwick J. and Peter J. Wilcoxen, "The Role of Economics in Climate Change Policy," Journal of Economics Perspectives 16(2), Spring 2002: (Chapter 25 in EESR). Ellerman, Denny, and Barbara Buchner, "The European Union Emissions Trading Scheme: Origins, Allocation, and Early Results" Review of Environmental Economics and Policy 1(1), Winter 2007: Metcalf, Gilbert E., Market-based Policy Options to Control U.S. Greenhouse Gas Emissions, Journal of Economic Perspectives 23 (2), Spring 2009: Environmental Risk Assessment *Ward, Chapter 17. Sigman, Hilary, Liability Funding and Superfund Clean-Up Remedies, Journal of Environmental Economics and Management 35(3), May 1998: Aldy, Joseph E. and W. Kip Viscusi, Age Differences in the Value of Statistical Life: Revealed Preference Evidence, Review of Environmental Economics and Policy 1 (2), Summer 2007: Distributional Effects of Environmental Policy *Ward, Chapter 18. Cooper, Richard N., Environment and Resource Policies for the World Economy, Washington, DC: The Brookings Institution, Dasgupta, Susmita, et al, "Confronting the Environmental Kuznets Curve,", Journal of Economic Perspectives 16(1), Winter 2002: (Chapter 20 in EESR). 14. Air Pollution Harrington, W. and M. A. Walls, Shifting Gears: New Directions for Cars and Clean Air, in W. Oates, ed., The RFF Reader, RFF, Washington, DC, 1999.

8 -8- Portney, Paul R., Air Pollution Policy, Chapter 4 in Portney and Stavins, eds., Public Policies for Environmental Protection, Second Edition, Washington, DC: Resources for the Future, Hubbell, Bryan J., Richard V. Crume, Dale M. Evarts, and Jeff M. Cohen, Policy Monitor: Regulation and Progress under the 1990 Clean Air Act Amendments, Review of Environmental Economics and Policy 4 (1), Winter 2010: Water Pollution *Ward, parts of Chapter 10 (again). Freeman, A. Myrick, Water Pollution Policy, Chapter 6 in Portney and Stavins, eds., Public Policies for Environmental Protection, Second Edition, Washington, DC: Resources for the Future, Sheila M. Olmstead, The Economics of Water Quality, Review of Environmental Economics and Policy 4 (1), Winter 2010: Hazardous Waste and Toxic Substances *Ward, parts of Chapter 18 (again). Sigman, Hilary, Hazardous Waste and Toxic Substance Policies, Chapter 7 in Portney and Stavins, eds., Public Policies for Environmental Protection, Second Edition, Washington, DC: Resources for the Future, Macauley, Molly K. and Margaret A. Walls, Solid Waste Policy, Chapter 8 in Portney and Stavins, eds., Public Policies for Environmental Protection, Second Edition, Washington, DC: Resources for the Future, Jenkins, Robin R., Elizabeth Kopits, and David Simpson, The Evolution of Solid and Hazardous Waste Regulation in the United States, Review of Environmental Economics and Policy 3 (1), Winter 2009: Polluter Liability Shavell, Steven, Liability for Harm versus Regulation of Safety, Journal of Legal Studies 13 (2), June 1984: Hutchinson, Emma, and Klaas van t Veld, Extended Liability for Environmental Accidents: What You See is What You Get, Journal of Environmental Economics and Management 49(1), January 2005: Kolstad, C., T. Ulen, and G. Johnson, Ex Post Liability for Harm vs. Ex Ante Safety Regulation: Substitutes or Complements?, AER 80 (4), Sept.1990: Environmental Accounting *Nicholas Muller, William Nordhaus, Robert Mendelsohn, "Environmental Accounting: Methods with an Application to the United States Economy", Yale U., 2009.

9 -9- Banzhaf, H. Spencer, Green Price Indices, Journal of Environmental Economics and Management 49(2), March 2005: Dasgupta, Susmita, Kirk Hamilton, Stefano Pagiola, and David Wheeler, Environmental Economics at the World Bank, Review of Environmental Economics and Policy 2 (1), Winter 2008: Critical Habitat and Endangered Species *Ward, parts of Chapter 9 (again). Metrick, Andrew and Martin L. Weitzman, Conflicts and Choices in Biodiversity Preservation, Journal of Economic Perspectives 12 (3), Summer 1998: (Chapter 28 in EESR). Brown, Gardner, and Jason Shogren, The Economics of the Endangered Species Act, Journal of Economic Perspectives 12(3), Summer 1998: 3-20 (Ch. 27 in EESR). 20. Political Economy 21. Wetlands Keohane, Nathaniel O., Richard L. Revesz, and Robert N. Stavins, The Choice of Regulatory Instrument in Environmental Policy, Harvard Environmental Law Review 22, 1998: (Chapter 29 in EESR). Maloney, Michael T. and Robert E. McCormick, "A Positive Theory of Environmental Quality Regulation", Journal of Law & Economics 25, April 1982: Fisher, Anthony C., and John V. Krutilla, "Economics of Nature Preservation," in Allen V. Kneese and James L. Sweeney, eds., Handbook of Natural Resource and Energy Economics, Vol. I, Amsterdam: North-Holland, Stavins, Robert N. and Adam B. Jaffee, "Unintended Impacts of Public Investments on Private Decisions: The Depletion of Forested Wetlands," American Economic Review 80 (3), June 1990: Not In My Back Yard (NIMBY) Frey, Bruno S., et al, The Old Lady Visits Your Backyard: A Tale of Morals and Markets, Journal of Political Economy 104 (6), December 1996: Levinson, Arik, "State Taxes and Interstate Hazardous Waste Shipments," American Economic Review 89 (3), June 1999: