Environmental Economics

Environmental Economics

1. Unit 1 Introduction to Environmental Economic Theories

2. Environment The Environment is our basic life support system and is composed of living beings, physical surroundings, and climatic conditions. It is derived from a French word, “ Environner ” , which means “to surround”. The term environment includes all biotic and abiotic entities around us. Biotic refers to the world of living organisms, whereas Abiotic refers to the world of non-living elements . The Environment provides us with the essential elements – air, water, food, and land which are essential for life to flourish on the Earth Our Environment comprises three components Natural components (air, water, land & living things), Human components (individual, family, community), and H uman-made components (roads, monuments, industries), and is a combination of natural and human-made phenomena

3. Environment Natural components (air, water, land & living things), Includes means “to surround”. French word, “ Environner Derived from climatic conditions Physical surroundings composed of living beings Basic life support system Environment comprises three components Abiotic Biotic Human components (individual, family, community) Human-made components (roads, monuments, industries

4. Environment The Natural Environment could be further classified into four domains- lithosphere, Hydrosphere, Biosphere, and Atmosphere . These are also called the domains of the environment. The solid crust is called the lithospher e . It is covered by a thin layer of soil and is formed of rocks and minerals. It supports life on Earth and provides forests, and grasslands for grazing has various landforms – plains, valleys, and mountains, and also makes available land for agriculture and human settlements. The hydrosphere is referred to as the domain of water . It includes different types of water bodies – lakes, rivers, seas, oceans, etc., along with various sources of water . The thin layer of air surrounding the Earth is the atmosphere, it consists of water vapor, gases, and dust particles.

5. Environment Environment classified Lithosphere Hydrosphere Biosphere Atmosphere The solid crust It is covered by a thin layer of soil and is formed of rocks and minerals. It supports life on Earth and provides forests, and grasslands for grazing has various landforms It referred to as the domain of water . It includes different types of water bodies The thin layer of air surrounding the Earth is the atmosphere, it consists of water vapor, gases, and dust particles The biosphere is also called the living world, the plant and the animal kingdom together constitute the biosphere. Role of human As the human needs grew and became varied, the pressure on the environment also spiked Emphasis was given on judiciously using our environmental resources T o safeguard biodiversity and to protect life on Earth. Early humans used to adapt to the natural surroundings

6. Environment The upper layer of the atmosphere has the ozone layer. It protects life on Earth from the sun's ultraviolet (UV) radiation . The Earth’s gravitational force holds the atmosphere around it, this is an essential process for life to thrive on the planet . The biosphere is also called the living world, the plant and the animal kingdom together constitute the biosphere . The interaction between land, water, and air takes place in this narrow zone of the Earth to support life . Humans form an integral part of the environment. They interact with the environment and modify it as per their needs and requirements, thus forming a human-made environment. With time, as humans evolved, their interaction with the environment also revolutionized, resulting in global environmental impact. Early humans used to adapt to the natural surroundings, however, contemporarily, as the human needs grew and became varied, the pressure on the environment also spiked, and more emphasis was given on judiciously using our environmental resources for meeting the needs of both present and future generations, to safeguard biodiversity and to protect life on Earth . Our Environmental resources are finite, living in harmony, and maintaining a perfect balance between the natural and human environment is of utmost importance and is the only way forward to a sustainable future.

7. Environmental Economics Environmental economics is a discipline of economics that studies the economic effects of environmental policies around the world. Its main focus is on the efficient allocation of environmental and natural resources and how alternative environmental policies deal with environmental damage, such as air pollution, water quality, toxic substances, solid waste, and global warming . Origin The origins of environmental economics date back to the 1960s, when industrialization was experiencing a boom, particularly in the western world, and pollution from industrial activity became an increasing concern. Environmental activism also started to increase due to the perceived negative consequences of environmental degradation. The world became aware of rapid economic growth and its consequences to the environment Environmental economists see the environment as a form of natural capital that provides amenities and life support functions to the earth’s inhabitants. Environmental economics was premised on the neoclassical approach dealing with issues such as inefficient natural resource allocation, market failure, negative externalities, and management of public goods. As the movement developed over time, other intricate details on the relationship between the environment and the economy became apparent. The study brought about powerful environmental arguments and propositions, which gave rise to contemporary environmental policies and regulations around the world. It led to the establishment of new environmental bodies – chief among them, the United Nations Environment Programme (UNEP) in 1972.

8. Environmental Economics It is discipline of economics that studies the economic effects of environmental policies around the world The origins of environmental economics date back to the 1960s Main focus is on the efficient allocation of environmental and natural resources How environmental policies deal with environmental damage, such as air pollution, water quality, toxic substances, solid waste, and global warming. Environmental bodies - chief among them, the United Nations Environment Programme (UNEP) in 1972. The world became aware of rapid economic growth and its consequences to the environment Environmental economists see the environment as a form of natural capital powerful environmental arguments and propositions, led to contemporary environmental policies and regulations around the world

9. Environmental economics encompasses the following concepts Sustainable Development Sustainable development is defined by UNEP as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” The concept analyzes the role of economic development in supporting sustainable development. The four basic components of sustainable development are economic growth, environmental protection, social equity, and institutional capacity . 2. Market Failure Market failure occurs if, the functioning of a perfect market is compromised; hence, it is unable to efficiently allocate scarce resources at a given price as conditions for laws of demand and supply are not met. An example can be an environmental good such as clean oceans. It is difficult to price the value of clean seas and oceans, and there exist no markets for clean water bodies where it is traded depending on the degree of cleanliness. It is a standard case of market failure.

10. 3. Externalities Externalities are inadvertent consequences of economic activity that affect people over and above those directly involved in it. Externalities are also another form of market failure. They can either be negative or positive. A  negative externality  creates unplanned outcomes that are harmful to the environment or directly to the general public. An example can be pollution through industrial production, which results in unclean air and water and other health risks. The polluting entities may not incur any costs to address the pollution, even though their activities harm the environment and negatively affect the surrounding community. A  positive externality  is a benefit to other people not directly involved in its generation. A community nature park can benefit people outside the community who visit family and friends in the area and would not have contributed to its development. People who benefit from an economic resource without contributing to its establishment are called “free riders .” 4. Valuation Valuation is an important aspect of environmental economics, as it helps to evaluate a variety of options in managing challenges with the use of environmental and natural resources. The valuation of ecological resources is a complex process, as it is difficult to assign value to intangible benefits, such as clean air and an unpolluted environment. Resources that offer multiple benefits are difficult to value – for example, mountains may prevent flooding, provide scenic beauty, direct river flow patterns, and provide fertile soils for agriculture. Environmental resources can be assigned values depending on use and non-use methods. It’s easier to assign value to a product in use by observing what consumers are willing to pay. Opportunity cost pricing, replacement cost, and hedonic pricing techniques can be employed in the “use” method. The contingent valuation technique is used for the “non-use” method by measuring what consumers are willing to pay for a product they do not use or enjoy.

11. 5. Cost-Benefit Analysis Cost-benefit analysis (CBA) involves weighing the benefits arising from a policy against the perceived benefits. Hence, the best policy is one in which there is the greatest surplus of benefits over costs. CBA starts with a base policy where no changes are made to the status quo. A time horizon is selected where the perceived costs and benefits are expected to be realized. Benefits are instances where human well-being is improved, and costs decrease human well-being. Costs and benefits to be realized in the future are discounted using a discount factor to cater to the time value of money. Benefits include extra income, improved quality of life, clean water, and beaches, and costs include opportunity costs, internal and external costs, and externalities.

12. Environmental economics encompasses the following concepts 2. Market Failure Market failure is the economic situation defined by an inefficient distribution of goods and services in the free market. 4. Valuation it helps to evaluate a variety of options in managing challenges with the use of environmental and natural resources. Sustainable Development D evelopment that meets the needs of the present without compromising the ability of future generations to meet their own needs.” 3. Externalities Externalities refers to situations when the effect of production or consumption of goods and services imposes costs or benefits on others which are not reflected in the prices charged for the goods and services being provided. 5. Cost-Benefit Analysis Cost-benefit analysis is  a way to compare the costs and benefits of an intervention, where both are expressed in monetary units .

13. Ecological economics Ecological economics is a trans-disciplinary field. It's not trying to be a sub discipline of economics or a sub discipline of ecology, but really it's a bridge across not only ecology and economics but also psychology, anthropology, archaeology, and history. That's what’s necessary to get a more integrated picture of how humans have interacted with their environment in the past and how they might interact in the future . It’s an attempt to look at humans embedded in their ecological life-support system, not separate from the environment. It also has some design elements, in the sense of how do we design a sustainable future.? It’s not just analysis of the past but applies that analysis to create something new and better . Environmental economics is a subdiscipline of economics, so it's applying standard economic thinking to the environment. Mainstream economics, I think, is focused largely on markets and while it recognizes that there are externalities, they are external—they're out there. Ecological economics tries to study everything outside the market as well as everything inside the market and bring the two together

14. Conventional economics doesn't really recognize the importance of scale—the fact that we live on a finite planet, or that the economy, as a subsystem, cannot grow indefinitely into this larger, containing system. There are some biophysical limits there. The mainstream view doesn’t recognize those limits or thinks that technology can solve any resource constraint problems. It’s not that we can't continue to improve the human situation. But we have to recognize that the environment creates certain limits and constraints on that, and we can define a safe operating space within which we can do the best we can . Ecological economics recognises local to global environmental limits. It ranges from research for short-term policy and local challenges through to long-term visions of sustainable societies. Ecological economists also consider global issues such as carbon emissions, deforestation, overfishing and species extinctions.

15. Ecological economics

16. Environment - Economy Linkages

17. The Material Balance Model The functions of an economy are related to production, consumption and distribution activities . These activities have a direct relation with nature . Nature provides raw materials to the economy for its production and consumption activities. Residuals from both the production and consumption processes usually remain and they usually render disservices like killing fish, reducing public health, soiling and deteriorating buildings due to industrial pollution . Some wastes (residuals) from production and consumption activities are ultimately returned to nature . Remaining wastages are recycled. Further , all emission of residuals do not cause pollution damage because of assimilative capacity of the environment . Further, energy that is taken out of the environment must reappear somewhere else in the economic system. Its form may, however, be changed so that it appears as waste products and gases. Moreover, waste energy cannot be recycled but waste materials can be used up to a point. It means that economic activity always affects environment in a direct or indirect manner.

18. Thus the law of conservation of matter and energy holds that matter can be transformed to other matter or into energy but can never vanish . All inputs (fuels, raw materials, water and so forth) used in the economy’s production processes will ultimately result in an equivalent residual or waste. The material flow diagram implies that mass inputs must equal mass outputs for every process. Moreover, all resources extracted from the environment must eventually become unwanted wastes and pollutants. This means, among other things, externalities (market failures) associated with production and consumption of materials are actually pervasive and they tend to grow in importance as the economy itself grows. Materials recycled can help but recycling is energy intensive and imperfect, so it cannot fully compensate. The Material Balance Model E conomics of the environment may be defined as a study which concerns allocation of resources among alternative uses in such a way that there is an efficient reduction of the waste or residuals in the environment, which lead to an increase in social welfare.

19. The material balance model: I mportant implications Task

20. F unctions of an economy Related to production , consumption distribution activities. Nature provides raw materials to the economy for its production and consumption activities. Some wastes (residuals) from production and consumption activities are ultimately returned to nature. All emission of residuals do not cause pollution damage because of assimilative capacity of the environment. It means that economic activity always affects environment in a direct or indirect manner

21. Private Vs Social Cost Private costs are the those costs that are incurred by the individuals and firms who are directly involved in some economic activity. When goods and services are produced, then certain direct and indirect costs are borne by the producing agents . Examples of private costs are the factors payments made and expenditure on raw materials incurred by the producing agent concerned . Social costs: The social costs are the costs incurred by the society as a whole. These are the private costs plus any costs borne by the rest of the society. So social costs are higher than private costs when firms are able to escape some of the economic costs of production. Such a situation is called negative externalities. For example, a firm releasing untreated waste into air imposes a cost on the society in the form of, say, breathing ailments or higher cleaning bills in respect of the third parties that is not reflected in the cost of the firm itself. Similarly, noise pollution, water pollution etc. are examples of social costs. Private costs can be made equal to social costs by public regulation that requires the firm to install anti-pollution equipment.

22. Types of Social Costs: Positive and Negative Externalities There are two types of externalities: positive and negative . You are probably more familiar with the negative ones. Things like noise disturbance and pollution are  negative externalities  because they have a negative external impact on other people.  Positive externalities  occur when our actions bring a positive impact on other people. For example, when we get the flu vaccine, it also gives partial protection to those around us, so that's a positive externality of us getting the vaccine

23. Market Failure Market failure occurs when the market outcome does not maximize netbenefits of an economic activity. Due to the nature of environmental resources, the market often fail in dealing with environmental resources. There are three main environmental market failures . • a. Externality • b. Public Goods • C. Tragedy of the Commons

24. Coase`s Theorem Ronald Harry Coase was a British economist and author. Coase received a bachelor of commerce degree and a PhD from the London School of Economics, where he was a member of the faculty until 1951 . Born:  29 December 1910, Willesden, London, United Kingdom Died:  2 September 2013, Chicago, Illinois, United States Awards:  Nobel Memorial Prize in Economic Sciences Ronald Coase received the Nobel Prize in 1991 “for his  discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy .” Ronald Coase British economist

25. Property rights ( Coase`s Theorem) Prof. R. Coase points out that, if property rights are clearly defined, the affected parties will adopt policies to internalise the externality. In other words, if property rights and liability are properly defined and there are no transaction costs, then people can be held responsible for any negative externalities they impose on others and market transactions will produce an efficient outcome.

26. Property rights ( Coase`s Theorem) Coase explains property rights in two theorems : First Theorem : Assumptions The first theorem is based on the following assumptions : 1. It assumes that the number of contracting parties is very small. 2 . The cost of negotiating by the interested parties is also small. 3 . There are no transaction costs. 4 . There are no income or wealth effects. 5 . There is no government interference. Let us take Coase’s famous example of only two parties—a cattle raiser and a wheat producing farmer. They are operating on neighbourhood properties without any fencing . The externality is the damage done by cattle roaming on the unfenced land of the farmer. As the cattle raiser increases the size of the herd, the damage to the farmer’s crop increases

27. Property rights ( Coase`s Theorem) According to Coase , property rights should be properly defined and enforced . First , the farmer has the right that his wheat be not destroyed . Therefore , the cattle raiser will then be forced to pay damages to the farmer for the crop destroyed . These will be added to the marginal costs of the cattle- raiser who will reduce the number of cattle to be raised to a manageable level. Second , if the law is that the cattle raiser has no liability for damage done by his herd to the farmer’s crop, it will now be advisable for the farmer to bribe the cattle raiser to keep his herd to a minimum level. According to Coase , market failure due to property rights can be eliminated through private bargaining among the affected parties . He points out that if property rights are clearly defined and marketable and transaction costs are zero, a perfectly competitive economy will allocate resources optimally even under conditions of externalities. By transaction costs he means costs of negotiating or enforcing a contract. The existence of differential transaction costs creates opportunities for one person’s choice to impact on others . It is property rights that direct and control these choices.

28. Second Theorem On the other hand , if bargaining becomes costly, then property rights matter significantly . In the words of Coase , “If bargaining is costly and information is imperfect, then liability rules help to achieve optimality and the party that has the least costly way of dealing with the harmful effects of an externality should be made responsible for paying the costs associated with the externality.” Thus the second theorem of Coase provides a natural link between economics and law, offering an efficiency rationale for deciding externality liability rules . Coase has related his second theorem to the problems caused by the sparks emitted by coal and wood-power steam engines. The problem is that fires sometimes caused by the sparks damage nearby agriculture fields . In the absence of rules governing compensation for firm’s damages, it creates negative externalities since rail companies have little incentive to prevent sparks. On the other hand, rail companies may pay full compensation that may leave property owners with little or no incentive to protect themselves. Is it better for rail companies to take defensive measures or for farmers to take defensive measures? Which is done, depends on whether farmers can sue for damages?

29. The problem of sparks can be solved in the following ways : (a) Limit the amount of train traffic ; (b) Rail companies should install some type of spark- inhibiting device; or (c) Farmers should plant their crops several yards further away from the railway tracks

30. Pigouvian Taxes A  Pigouvian  tax is a government cost on any activity that creates socially harmful externalities .  An externality is an activity that creates a negative effect on others in a society but not necessarily the person who does that activity . Pollution is an externality, for example. Drivers of non-compliant vehicles don't suffer immediately from their exhaust, but everyone behind them does. Their exhaust also increases pollution for everyone in the community . The government imposes Pigouvian taxes on non-compliant vehicles to impose a higher cost on the drivers to compensate for the suffering they cause . The revenue from the tax is often used to ameliorate the external cost.

31. Pigouvian Taxes Ideally, a Pigouvian tax will cost the producer the amount equivalent to the harm it causes others . British economist Arthur Pigou developed the concept of externalities . He argued that the government should intervene to correct them by taxing activities that harm the economy as a whole and subsidizing activities that help society as a whole. A  Pigouvian  tax is placed on any activity that creates socially harmful externalities. Pigouvian taxes shift the costs from society to the producers of these externalities.  Gas, carbon, and noise taxes are examples of Pigouvian taxes .

32. Pigouvian Tax Pros and Cons Pros Reduces negative externalities Promotes social welfare Can generate tax revenue Cons Pigouvian taxes are difficult to calculate properly Imposing the wrong tax would be inefficient and costly Can unequally impose higher costs on lower-income areas Find the difference between Pigouvian tax and Sin Tax