Introduction to environmental economics

Introduction to Environmental Economics Objectives  After studying this chapter you should be able to:      Explain the basic functioning of the traditional economic system & its limitations as far as the environment is concerned Explain the relationships between the economic & environmental systems Explain the laws of thermodynamics & their implications for the economic-environment system Describing various approaches to incorporating environmental concerns into economic models Explain how intervention can take account of the negative externalities in production Introduction What is the Natural Environment?  Comprises types of resources:  Renewable Resources (RR) Non-Renewable Resources (NRR) Renewable Resources (RR) Biological resources that have the capacity for regeneration Examples incl forests, animals • • Non-Renewable Resources (NRR) Finite in supply sub-classes • • • • • Exhaustible Resources – coal, oil Recyclable Resources – tin, copper, gold NRR with renewable service flows – land, sea, rivers Introduction Contd…  A RR can become a NRR if not properly managed  Brings to the fore the issue of sustainability  Traditional Economic systems tend to ignore the role of the environment  For sustainable development to occur, must consider the relationship between the economy and the environment Ecological Economics  Concerned with the interaction between the economy and the environment  NATURAL RESOURCE ECONOMICS only concerned with optimal extraction & therefore depletion of RR & NRR  ENVIRONMENTAL ECONOMICS concerned with the environment, pollution & ways to minimise the negative impact of economic activity on economy  Ecological economics considers all of the above as well as social & ethical issues  To explain the main difference between Ecological Economics & Natural Resource Economics:    Assume we start with a FOREST Natural Resource Eco’s looks at the optimal rate of extraction of the trees (the Maximum Sustainable Yield) given a range of factors (interest rates, stumpage, tree growth rates) Ecological Eco’s looks at how this exploitation will affect the rights of future generations & other forms of life in the ecosystem, such as birds, insects, wildlife, etc…  How else does Ecological Eco’s differ from traditional economics?  Neoclassical eco’s based on • Rational economic behaviour of cost minimisation or profit maximisation • Views environmental problems as an externality problem  Ecological eco’s • Takes social & ethical issues into account • Views environment as integral part of the economic system  EVOLUTION    Changes in the gene pool that is common to a group of organisms belonging to the same species Enables species to adapt to its environment through selective replacement of weaker individuals SPACESHIP EARTH   Human beings live in a closed system (the earth) & are dependent on it for sustenance The earth only receives the sun’s energy Economic-Environment Systems  What is a system? • Collection of objects that are bounded in space and time • Entities interact through processes    ISOLATED SYSTEM: Neither energy nor matter is exchanged with surrounding environment CLOSED SYSTEM: energy is exchanged with surrounding environment, but not matter OPEN SYSTEM: both energy & matter is exchanged with surrounding system TRADITIONAL ECONOMIC SYSTEMS  Consists of Consumers, producers, markets     Firms: produce goods & services offered for sale in the market Consumers: purchase g&s, supply labour & capital to firms Can add government as participant This is a CLOSED system as it does not consider the flows of materials & energy Unpriced resources that have no place in market have no place in this system Second Law of Thermodynamics       Entropy law Entropy = Amount of Energy avail for work Work incl all forms of energy except heat, can be converted into heat completely But heat cannot be 100% efficiently converted into work Converting heat into work entails the loss of some heat In isolated or closed systems, entropy always increases or remains constant Implications of the Laws…  First Law: • • • Engery inputs must equal energy outputs Mass inputs must equal mass outputs Therefore, raw material inputs into production & consumption will eventually return to the environment as waste • Recycling can help, but won’t be 100% effective Implications of the Laws…  Second Law: • Economic processes are time irreversible; waste products cannot be fully converted into useful energy • This led economists to propose “steady-state” economy • In this steady-state, extraction of resources should equal the growth rate of resources Let’s look at this from the other side  COMPETITIVE MARKETS & ENVIRONMENTAL EFFICIENCY     Society values goods & services & environmental amenities Environ amenities not priced in the market (treated as if were free) So what does the market do? In striving for Economic Efficiency, where Marginal Benefit = Marginal Cost, they fail to take account of any external costs or benefits So what’s next?   Georgescu-Roegen says that economic processes are entropic: they neither create nor consume matter & energy, but convert low-entropy energy into high-entropy energy In the absence of intervention, externalities will continue to increase We’ve already said some amount of pollution is acceptable, so how we determine that amount? Competitive Markets    Buyers only consider private (personal) benefits & costs, ignoring costs to third parties Costs/benefits to third parties are known as External costs/benefits or EXTERNALITIES Once we include these externalities in our cost/benefit decisions, we seek to maximise social welfare where marginal social benefit = marginal social cost Private & Social Cost    Producer motivated by profit Production costs incl., capital, labour, inputs (natural res) & entrepreneurship External costs such as pollution not incl In production costs   Hence firm only considers private costs Thus producers will tend to produce too much of this polluting good because not accounting for social costs Competitive market inefficiency when externalities exist     When externalities are present, competition leads to a lower price & greater quantity that is socially efficient In competition, firms choose the least cost method of production (lowest cost) Firms that produce above this level are eventually squeezed out the industry (no room for firms that not cost minimise) Not fair to punish firms that are environmentally friendly (with higher production costs)  We recognise a need for government intervention MSC P MPC Ps Pp Qs Qp Q    Efficient outcome is where Ps=Qs (with lower levels of pollution) Left to the market, competitive firms will have no reason to reduce emissions Eg      Firms produce lawnmowers One is a green firm (accounts for social costs) Green mower uses 5L petrol Other uses 10L petrol You would be willing to pay more for 5l than 10L because you get to keep the monetary benefit Pollution    Some level of pollution is acceptable occurs where MSB=MSC Why not zero pollution?    pollution would require use of lawnmowers, not realistic Optimal pollution levels determined by the socially efficient output level Alternatives to this would incl emission-free lawnmowers but costs too high Achieving Environmental Efficiency      Competitive markets not produce at the socially efficient output level So market failure occurs Must find alternative methods to achieve efficiency Can also get government failure, when government fails to correct market failures related to the government Incentives include:  Incentive Based Regulations (IB) • These set the environmental goals but is flexible to buyers/sellers how they achieve this goal  Command & Control Regulations (CAC) • Sets environmental goal & dictates how to get there  Economists prefer IB to CAC IB versus CAC  IB:    Allowing for advantages of market system Efficiency gains in Short Run & Long Run CAC:    similar to command economic system does not encourage technological innovation (IB does) eg Catalytic converters which decreases pollution from cars • can be a barrier to entry Incentive Based Regulations (IB)  Taxes:     impose tax on pollutant taxes approximate external cost & can achieve efficiency better to tax producer (force them to tax external cost into account) Emissions trading      Firms buying & selling the right to pollute there are real-life markets for air pollution rights most active market in sulfur emissions firms will actively trade is trading is better than any alternative Environmentalists can achieve pollution reduction by outbidding companies & then refusing to sell the permits, forcing companies to decrease pollution Conclusion  The environment is an intrinsic part of the economy  Need to recognise it as a valuable asset & treat is as such in the national accounts  Move towards sustainable development  Firms must be held accountable for pollution due to production [...]... output level Alternatives to this would incl emission-free lawnmowers but costs too high Achieving Environmental Efficiency      Competitive markets do not produce at the socially efficient output level So market failure occurs Must find alternative methods to achieve efficiency Can also get government failure, when government fails to correct market failures related to the government Incentives... Based Regulations (IB) • These set the environmental goals but is flexible to buyers/sellers how they achieve this goal  Command & Control Regulations (CAC) • Sets environmental goal & dictates how to get there  Economists prefer IB to CAC IB versus CAC  IB:    Allowing for advantages of market system Efficiency gains in Short Run & Long Run CAC:    similar to command economic system does not... alternative Environmentalists can achieve pollution reduction by outbidding companies & then refusing to sell the permits, forcing companies to decrease pollution Conclusion  The environment is an intrinsic part of the economy  Need to recognise it as a valuable asset & treat is as such in the national accounts  Move towards sustainable development  Firms must be held accountable for pollution due to production... converters which decreases pollution from cars • can be a barrier to entry Incentive Based Regulations (IB)  Taxes:     impose tax on pollutant taxes approximate external cost & can achieve efficiency better to tax producer (force them to tax external cost into account) Emissions trading      Firms buying & selling the right to pollute there are real-life markets for air pollution rights most... potential to do work/ supply heat We will examine the first two laws of thermodynamics & how it relates to the environment First Law aka Law of Conservation of Mass & Energy Second Law aka Entropy law First Law of Thermodynamics  Law of Conservation of Mass & Energy    Applies to a CLOSED system, in which only energy crosses the boundaries Although the form of energy may change, the total amount... heat, can be converted into heat completely But heat cannot be 100% efficiently converted into work Converting heat into work entails the loss of some heat In isolated or closed systems, entropy always increases or remains constant Implications of the Laws…  First Law: • • • Engery inputs must equal energy outputs Mass inputs must equal mass outputs Therefore, raw material inputs into production & consumption... energy, but convert low-entropy energy into high-entropy energy In the absence of intervention, externalities will continue to increase We’ve already said some amount of pollution is acceptable, so how do we determine that amount? Competitive Markets    Buyers only consider private (personal) benefits & costs, ignoring costs to third parties Costs/benefits to third parties are known as External costs/benefits... Efficient outcome is where Ps=Qs (with lower levels of pollution) Left to the market, competitive firms will have no reason to reduce emissions Eg      2 Firms produce lawnmowers One is a green firm (accounts for social costs) Green mower uses 5L petrol Other uses 10L petrol You would be willing to pay more for 5l than 10L because you get to keep the monetary benefit Pollution    Some level of pollution... Therefore, raw material inputs into production & consumption will eventually return to the environment as waste • Recycling can help, but won’t be 100% effective Implications of the Laws…  Second Law: • Economic processes are time irreversible; waste products cannot be fully converted into useful energy • This led economists to propose “steady-state” economy • In this steady-state, extraction of resources... Let’s look at this from the other side  COMPETITIVE MARKETS & ENVIRONMENTAL EFFICIENCY     Society values goods & services & environmental amenities Environ amenities not priced in the market (treated as if were free) So what does the market do? In striving for Economic Efficiency, where Marginal Benefit = Marginal Cost, they fail to take account of any external costs or benefits So what’s next?