Economics and the Environment

Some mysteries

• Why are there so many chickens and so few bald eagles?

• Why do people waste water, which may be the world’s most precious resource?

More mysteries

• How did the American Bison survive?– Both the bison and the passenger pigeon

were slaughtered for food. The passenger pigeon is extinct.

More mysteries• Why is Disney World better taken care of

than Yellowstone National Park?

Still more mysteries• Why are salmon disappearing from the

Pacific Northwest?

NOTE: Read and consider all statements or questions carefully; don’t accept them as ``fact’’ or ``true.’’ The person or organization making the statement or asking the question may be trying to influence your thinking. e.g.: IS Disneyland better taken care of than Yellowstone???

Goal of the environmental movement

• Solve environmental problems—protect and conserve the natural environment—using the best methods possible.

• What does THAT mean? Methods that:– Protect the environment– Are as inexpensive as possible– Don’t have other bad consequences (such as putting

people out of work)– Lead to sustainable resource use

• What are some methods??

What is economics?• The study of how people use limited

resources to satisfy unlimited wants– The study of the allocation of scarce

resources

SCARCITY: not as much of something as people (or other organisms) want or need.

What does economics have to do with the environment??

Economics and the environment

• The environment is an economic good.a) It is SCARCE. (that is, limited)b) It has alternative uses

• Provide resources• Provide recreational opportunities• Provide various other services

c) Given a. and b.: we must choose among alternatives

Economics is about making choices

• Since resources are scarce people must make choices.

• They face opportunity costs– When you make one choice, the 2nd best alternative is

given up, or– What else could you use the resource be used for?

• Examples?– Should open space become farmland or housing?– Cleaner air/expensive cars or dirtier air/cheaper cars– Others??

To some economiststhese are both holes in the ground

• Mt. St. Helens– volcano

• Butte, Montana– remains of open pit copper mine

Substitutability

• If one resource can be replaced by another, they are substitutable.

• Examples?– Run out of heating oil, use natural gas– Run out of cod, use tilapia

Environment as economic good

• People want more of it as their incomes increase

Answer these:

• Do you believe people buy more at lower prices and less at higher prices?

• Do you believe sellers want to sell more at higher prices and less at lower prices?

Supply-demand

• Prices for goods set by ``supply’’ and ``demand’’– e.g. when prices go up, demand dropsso

supply (unpurchased goods) goes upsuppliers lower prices to get rid of inventoryeventually, price reached where demand equals supply

– This is the EQUILIBRIUM price

Supply-demand curve

• equilibrium price

• D, P, Q Increase

• Millions of Americans will drive their cars to visit family and friends over the Thanksgiving holiday even though gasoline is above $3.00 per gallon, travel and leisure group AAA said Thursday.

• About 38.7 million Americans, 1.5 percent more than last year, will travel 50 miles or more from home this holiday, AAA estimated, based on a national Web survey of 2,200 adults.

Two views about economics & environment

• Herman Daly: argues that growth can’t be forever and that ``enough is best.’’– Economic growth can lead to environmental

degradation and wealth inequality• Julian Simon: human welfare can continue

to improve– Population growth is good, puts pressure on

resources, leads to price increases, provides opportunity and incentive for innovation

Simon

• Key for him is human ingenuity:– Humans have capacity to increase knowledge

base– More people means more people trained to

solve problems means greater economic conditions in the future.

• In economics, as in ecology:• YOU CAN’T DO JUST ONE THING

– All choices or actions, be they about the environment or something else, have short and long-term consequences.

– Can you think of examples?

Economics• Again: the valuation and allocation of

scarce resources• Classical economics considers 3 ``factors

of production’’ – i.e. resources used in the production of goods and services:– Land – natural resources– Labor – human effort and expertise– Capital – human-made goods used to make

other goods, i.e. tools, machinery, buildings

Environmental economics

Includes also ``Natural Capital’’– Natural resources– Ecological services

Classical economists treat natural resources as ``substitutable’’: if we run out of oil, we’ll use hydrogen.

Ecological economists say some natural resources have no substitutes.

Natural capital• What the environment provides for our

production and consumption.– Source: that part of the natural environment

from which materials move– Sink: that part of the natural environment that

receives an input of materials• Resource degradation = overuse of

sources• Pollution = overuse of sinks

Change in demand

• If demand increases, curve shifts right. – Equilibrium price

increases• This increase in demand

is occurring at all price levels.– NOT a result of a

decrease in price

Some facts of economic life

• Everything has a cost– ``no such thing as a free lunch’’– May be in money, or in lost opportunity, or in

lost time, or in environmental degradation

Some facts of economic life• Tradeoffs are necessary

– That is, since resources are scarce, choices must be made

– It doesn’t mean that you CAN’T do something that improves two things at once• E.g., a technological advance might provide a

better product AND a greener, more sustainable one. An electric car, for instance, might be simply a better car as well as a more efficient one.

• But often improvement in one dimension comes at some cost

Some facts of economic life

• Incentives matter

Some facts of economic life

• Voluntary trade creates value

Some facts of economic life

• Diminishing returns– As one input (or factor of production)

increases when others remain constant, the benefit realized reaches a maximum and then declines.

– Example: studying for test• 0 hrs: 60 1hr: 70 2 hrs: 82• 3hrs: 88 4hrs: 90 5hrs: 82

– Environmental example?

Some facts of economic life

• Supply and demand– These are key to a working market– Markets are ways to organize economic

activity between buyers and sellers– Why important? A way to allocate scarce

goods– Markets exist to find the equilibrium price

Use of supply and demand

• Many goods and services can be priced using law of supply and demand

• Often hard to use S & D to value environmental goods and services

• There isn’t a true market for most environmental goods or services

Some facts of economic life• Markets can fail• Often there may be factors not included in the cost of a

particular good• Example: What factors should be included in the price

we pay for electricity?– Cost of the fuel (natural gas) (inc. transportation)– Cost of the generating plant– Cost of labor to run the plant– Cost of transmission lines

• What’s missing??– Air pollution resulting from electricity generation– =EXTERNALITY

Free-market system• As in U.S.• Prices of goods and services influence

how much of a given good or service is produced and consumed

• True free market is open to all; supply and demand determine prices

• If market truly free, two technologies should compete on merits, including costs.

IS U.S. A TRUE FREE MARKET ECONOMY?

WHY OR WHY NOT?• Cost of fuel includes:

– Extraction– Transport– Refining– Storage– And… profit

• Does NOT include:– Health effects from air pollution– Ecological effects of increased CO2

Gross National Product

• GNP• The sum of all goods and services

produced (or consumed) in a country in a given time.

• Most commonly used indicator of economic health and wealth of a country.

GNP and the environment

• Much of our economic well-being depends on natural assets (true to varying degrees for all countries)

• Therefore, use and misuse of natural resources and the environment should be included in national income accounts such as GNP…

• ….They’re not.

Problems with GNP and NNP• Natural resource depletion

Imagine a company makes some product, wearing out machinery over time• Output is part of GNP; capital depreciation (the

wearing out of machinery) is SUBTRACTED to get NNP—the net production of the economy

Oil company drains oil from underground field; the value of the oil produced is part of GNP• But: no deduction to NNP to account for the

nonrenewable resource used up

Pollution

Imagine a company has these choices:– Produce $100 million of output and, in the

process, pollute local river by dumping wastesOR

– Use some workers to properly dispose of wastes but only make $90 million of output.

If the company chooses to pollute, its contribution to GNP is larger

• GDP was never intended to do what it commonly is used to do: assess the welfare of a population.

• Developer of GDP said, ``the welfare of a nation [can] scarcely be inferred from a measure of national income…’’

Alternative to GNP

• GPI = Genuine Progress Indicator• Idea: has a country’s growth, production

of goods and services, actually resulted in an increase in its citizens’ well-being?

The problem:

• The environment is a public good– A commons

• Everyone wants a clean environment– But not everyone is willing to pay what it

would cost– We want others to pay, and we get a ``free

ride’’– e.g.: Fireworks show

ExternalitiesCosts borne or benefits received from an economic transaction by people or others not directly involved in the transaction

• Costs (negative externalities)– Health effects of pollution– Global warming

• Benefits (positive externalities)– Increase in your home’s price when your

neighbors paint theirs and landscape their yards

NIMBYism

• What is it:– Not In My BackYard, meaning ``keep your

polluting, dirty, undesirable (development, hazardous waste site, landfill, etc) out of our neighborhood.’’

• Some related ideas:– LULU: Locally Unwanted Land Use– PIBBY: Put It in Blacks’ BackYards– NIMTOF: Not In My Term in Office

NIMBY

• Nobody wants these facilities • Who can fight them best?

– Rich, politically connected, educated• So, they often go into poor or minority

neighborhoods.– Sometimes, with sweeteners

NIMBY examples

• Your examples• Others

Cape Wind, MA

•

• CAPE WINDS TEST TOWER - A SIGN OF THINGS TO COME. NO TRESPASSING IN OUR OWN NANTUCKET SOUND! This tower was placed 11 miles from our coastline. It is less than

half the height, it is one-quarter of the width and IT IS STILL VISIBLE FROM MASHPEE TO CHATHAM ON ANY CLEAR DAY. The proposed wind farm comes as close as 4.7 miles, the

towers are 417 feet tall and 16 feet wide! They want to put 130 towers with a 10-story oil-filled transformer station covering 24 miles of our coastline. REMEMBER , your beach is Nantucket

Sound.•

externalities

• Costs (usually) that are not factored into the price of a product or service.

• Environmental externalities include – Pollution– Overuse of common pool resources (Tragedy

of the Commons)

How reduce externalities?

1. Government intervention1. Typically command-and-control2. Incentives

> Negative = TAX> Positive = SUBSIDY

2. Market-based approaches1. If market functions freely, some economists believe

there’ll be an optimal level of environmental protection and resource use

> People will pay for the amount of protection they want

Law of diminishing returns