Chapter 32. Introduction. Learning Objectives. Environmental Economics. Distinguish between private costs and social costs

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1 Chapter 32 Environmental Economics Introduction Many people see wild horses as a living symbol of the nation s natural beauty, while others regard them as pests. One thing is certain: U.S. taxpayers spend more than $50 million per year on more than 50,000 wild horses and 5,000 of their cousins, wild burros. Copyright 2008 Pearson Addison Wesley. All rights reserved Learning Objectives Distinguish between private costs and social costs Understand market externalities and possible ways to correct externalities Describe how economists can conceptually determine the optimum quantity of pollution Copyright 2008 Pearson Addison Wesley. All rights reserved

2 Learning Objectives (cont'd) Explain the roles of private and common property rights in alternative approaches to addressing the problem of pollution Discuss how the assignment of property rights may influence the fates of endangered species Contrast the benefits and costs of recycling scarce resources Copyright 2008 Pearson Addison Wesley. All rights reserved Chapter Outline Private versus Social Costs Correcting for Externalities Pollution Common Property Wild Species, Common Property and Tradeoffs Recycling Copyright 2008 Pearson Addison Wesley. All rights reserved Did You Know That... Every decision involving the environment involves a tradeoff? The economic way of thinking about endangered species requires considering the costs of protecting them? Economists want to help us opt for informed policies that have maximum net benefits? Copyright 2008 Pearson Addison Wesley. All rights reserved

3 Private versus Social Costs Private Costs Costs borne solely by the individuals who incur them Also called internal costs Copyright 2008 Pearson Addison Wesley. All rights reserved 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 Copyright 2008 Pearson Addison Wesley. All rights reserved 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? Copyright 2008 Pearson Addison Wesley. All rights reserved

4 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 scarceresource-using activity Copyright 2008 Pearson Addison Wesley. All rights reserved 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. Copyright 2008 Pearson Addison Wesley. All rights reserved Figure 32-1 Reckoning with Full Social Costs Copyright 2008 Pearson Addison Wesley. All rights reserved

5 Correcting for Externalities (cont'd) The polluters choice 1. Install pollution abatement equipment or change production techniques 2. Reduce pollution-causing activity 3. Pay the price to pollute Copyright 2008 Pearson Addison Wesley. All rights reserved 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. Copyright 2008 Pearson Addison Wesley. All rights reserved Policy Example: Belgian Governments Forgo a Uniform Tax and Kill Off Jobs In 2004, DHL announced plans to expand its operations in Brussels. The expansion correlated with an increase in late-night flights. National and regional Belgian governments objected. DHL moved 1,300 jobs to Leipzig, Germany. Copyright 2008 Pearson Addison Wesley. All rights reserved

6 Pollution Question How much pollution is too much? Answer The optimal quantity is determined by a comparison of marginal costs and benefits. Copyright 2008 Pearson Addison Wesley. All rights reserved Figure 32-2 The Optimal Quantity of Air Pollution The optimal quantity of pollution occurs where MC = MB Copyright 2008 Pearson Addison Wesley. All rights reserved 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 Copyright 2008 Pearson Addison Wesley. All rights reserved

7 International Policy Example: Canada Confronts a High Marginal Cost of Pollution Abatement Under the Kyoto protocol, Canada promised that it would reduce emissions of global warming gasses. Since signing the treaty, Canada s emissions have actually increased by 1.5% per year. Copyright 2008 Pearson Addison Wesley. All rights reserved International Policy Example: Canada Confronts a High Marginal Cost of Pollution Abatement (cont'd) Canada s government continues to promise that the nation will reach its promised level of emissions. Although the estimated explicit and opportunity costs to the entire Canadian economy would be at least $30 billion per year. Copyright 2008 Pearson Addison Wesley. All rights reserved Common Property Private Property Rights Exclusive rights of ownership that allow the use, transfer, and exchange of property Copyright 2008 Pearson Addison Wesley. All rights reserved

8 Common Property (cont'd) Common Property Property that is owned by everyone and therefore by no one Examples are air and water Copyright 2008 Pearson Addison Wesley. All rights reserved 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. Copyright 2008 Pearson Addison Wesley. All rights reserved Common Property (cont'd) Voluntary agreement 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? Copyright 2008 Pearson Addison Wesley. All rights reserved

9 Common Property (cont'd) Voluntary agreement and transactions costs Voluntary agreements: contracting Opportunity cost always exists, whoever has property rights. Copyright 2008 Pearson Addison Wesley. All rights reserved Common Property (cont'd) Voluntary agreement and transactions costs Transaction Costs All costs associated with making, reaching, and enforcing agreements Must be low relative the expected benefits Copyright 2008 Pearson Addison Wesley. All rights reserved Common Property (cont'd) Changing property rights Closing the gap between private costs and social costs Taxation Subsidization Regulation Copyright 2008 Pearson Addison Wesley. All rights reserved

10 Common Property (cont'd) Are there alternatives to pollutioncausing resource use? Why aren t we shifting to solar panels and electric cars? Could manufacturing solar panels cause pollution? Copyright 2008 Pearson Addison Wesley. All rights reserved Example: Profiting by Generating Electricity from Thin Air in Ireland The northern portion of Ireland abounds with farmland. Although the extreme northern tip of the country is too rugged to farm. Yet numerous landowners in this part of Ireland generate revenues. Copyright 2008 Pearson Addison Wesley. All rights reserved Example: Profiting by Generating Electricity from Thin Air in Ireland (cont'd) The source of the landowner s earnings is not the land itself, but the steady winds that blow across it. Several companies now harness the winds to power turbines that generate electricity. Copyright 2008 Pearson Addison Wesley. All rights reserved

11 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. Copyright 2008 Pearson Addison Wesley. All rights reserved 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. Copyright 2008 Pearson Addison Wesley. All rights reserved Recycling Recycling The reuse of raw materials derived from manufactured products Copyright 2008 Pearson Addison Wesley. All rights reserved

12 E-Commerce Example: Boom Times in Personal Computer Recycling In a typical year, owners of more than 2 billion pounds of unwanted electronic equipment pay 400 companies nearly $1 billion to find something to do with it. Recycling firms profit from charging businesses and individuals to collect their computers, remove data, refurbish and resell them. Copyright 2008 Pearson Addison Wesley. All rights reserved Recycling (cont'd) Recycling s invisible costs Costs include Resources used in recycling Pollution created during recycling Copyright 2008 Pearson Addison Wesley. All rights reserved Recycling (cont'd) Landfills An argument in favor of recycling is to avoid using landfills. Data indicate we are not running out of solid waste landfill sites. Expansion of solid waste disposal sites may be outpacing demand. Copyright 2008 Pearson Addison Wesley. All rights reserved

13 Recycling (cont'd) Should we save scarce resources? Some resources may not be getting scarcer at all. The inflation-corrected price of most resources has been falling for decades. Copyright 2008 Pearson Addison Wesley. All rights reserved Issues and Applications: The Government s Climbing Costs to Protect Wild Horses The common property problem Confronting transaction costs in caring for wild horses Turning again to the private sector Copyright 2008 Pearson Addison Wesley. All rights reserved 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 Copyright 2008 Pearson Addison Wesley. All rights reserved

14 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. Copyright 2008 Pearson Addison Wesley. All rights reserved 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. Copyright 2008 Pearson Addison Wesley. All rights reserved Summary Discussion of Learning Objectives (cont'd) Benefits and costs of recycling Benefits Limits use of natural resources Costs Recycling uses resources Copyright 2008 Pearson Addison Wesley. All rights reserved

15 End of Chapter 32 Environmental Economics 15