Chapter 32
Environmental
Economics
Introduction
Most people would agree that there is great
value in protecting the habitats of
endangered species around the world.
But sometimes the economic interests of
one region will threaten a critical
environment. Could economic incentives
be used to protect fragile habitats?
Slide 32-2
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
Slide 32-3
Learning Objectives
 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
Slide 32-4
Chapter Outline
 Private versus Social Costs
 Externalities
 Correcting for Externalities
 Pollution
 The Optimal Quantity of Pollution
Slide 32-5
Chapter Outline
 Common Property
 Recycling
Slide 32-6
Did You Know That...
 There are potential environmental benefits in
converting to electronic payment systems
from the current model of predominant bill
paying by mail?
 People will more readily switch to
environmentally-friendly methods of
conducting their daily lives if they have a
personal incentive to do so?
Slide 32-7
Private versus Social Costs
 Private Costs (internal costs)
– Costs borne solely by the individuals who
incur them
Slide 32-8
Private versus Social Costs
 Social Costs
– The full costs borne by society whenever
a resource use occurs
– Measured by adding internal to external
costs
Slide 32-9
Private versus Social Costs
 Environmental issues occur when social
costs exceed private cost
 The cost of polluted air
– How would you alter your transportation demand
if you had to pay the social cost of driving a car?
Slide 32-10
Externalities
 Externality
– A situation in which a private cost or
benefit diverges from a social cost
– A situation in which the costs or benefits
of an action are not fully borne or gained
by the two parties engaged in scarceresource-using activity
Slide 32-11
Reckoning with Full Social Costs
Price of Good X per Unit
S 2 (including externalities)
S1 = S MC (excluding externalities)
E2
P2
P1
E1
D
Q2
Q1
Quantity of Good X per Time Period
Figure 32-1
Slide 32-12
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.
Slide 32-13
Correcting for Externalities
 The polluters’ choice
– Install pollution abatement equipment or
change production techniques
– Reduce pollution-causing activity
– Pay the price to pollute
Slide 32-14
Correcting for Externalities
 Is a uniform tax appropriate?
– Consider
• The social cost of a given amount of water
pollution varies from location to location
• A uniform tax might make sense when
administrative costs are relatively high
Slide 32-15
Policy Example:
Why Diesel Engines are Catching On
 Diesel engines are more fuel efficient than
gasoline engines.
 Vehicle manufacturers, who must meet
federal fuel economy standards, are looking
to diesel engines as a means of satisfying
these requirements.
 Recent technological improvements have
also reduced the pollutants arising from the
use of diesel fuel.
Slide 32-16
Pollution
 Question
– How much pollution is too much?
– The optimal quantity is determined by a
comparison of costs and benefits.
Slide 32-17
Marginal Cost and Benefit
of Pollution Abatement ($)
The Optimal
Quantity of Air Pollution
Marginal
benefit
E
P0
Marginal
cost
0
Figure 32-2
Q0
100
Degree of Air Cleanliness (%)
Slide 32-18
Marginal Cost and Benefit
of Pollution Abatement ($)
The Optimal
Quantity of Air Pollution
Marginal
benefit
The optimal quantity
of pollution occurs
where MC = MB
E
P0
Marginal
cost
0
Figure 32-2
Q0
100
Degree of Air Cleanliness (%)
Slide 32-19
Pollution
 Optimal Quantity of Pollution
– The level of pollution for which the marginal
benefit of one additional unit of clean air
just equals the marginal cost of that
additional unit of clean air
Slide 32-20
Common Property
 Private Property Rights
– Exclusive rights of ownership that allow
the use, transfer, and exchange
of property
Slide 32-21
Common Property
 Common Property
– Property that is owned by everyone and
therefore by no one
• Examples are air and water
Slide 32-22
Common Property
 What do you think?
– Why does pollution occur when property
rights are poorly defined?
• No one has recourse to damages to the
property from misuse
Slide 32-23
Common Property
 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?
Slide 32-24
Common Property
 Voluntary agreement and transactions
costs
– Voluntary agreements: contracting
– Opportunity cost always exists, whoever
has property rights
Slide 32-25
Common Property
 Voluntary agreement and transactions
costs
– Transaction Costs
• All costs associated with making, reaching,
and enforcing agreements
– Must be low relative the expected benefits
Slide 32-26
Common Property
 Changing property rights
– Closing the gap between private costs
and social costs
• Taxation
• Subsidization
• Regulation
Slide 32-27
Policy Example: Laying Claim to
Trees that Sop Up Pollution
 A good portion of the carbon dioxide
emitted into the atmosphere comes
from electric power plants.
 One way to address this problem is to
plant trees which absorb carbon
dioxide from the air.
Slide 32-28
Policy Example: Laying Claim to
Trees that Sop Up Pollution
 In finding the optimal number of trees
to plant, decision-makers must know
how much carbon dioxide can actually
be absorbed this way.
 As with any economic decision, a good
choice in this instance involves
comparing costs with benefits.
Slide 32-29
Common Property
 Are there alternatives to using
resources in a way that creates
environmental damage?
• Why aren’t we shifting to solar panels and
electric cars?
• Could manufacturing solar panels cause
pollution?
Slide 32-30
Example: Solar Power is Fine,
but Not in My Neighborhood
 Solar energy can be very efficient in areas
that experience a good measure of
sunshine, such as many parts of Arizona.
 However, many homeowners associations in
the state restrict the use of solar panels on
the grounds that they detract from the
neighborhood appearance.
Slide 32-31
Example: Solar Power is Fine,
but Not in My Neighborhood
 An Arizona law forbids neighborhood
associations from restricting the use of
solar panels.
 But some Arizona homeowners have
found that the legal expenses incurred
in enforcing their rights have exceeded
the cost savings of using the sun’s
energy.
Slide 32-32
Wild Species, Common Property,
and Trade-Offs
 Question
– Dogs, cats, cows, and pigs are numerous,
but spotted owls, bighorn sheep,
and rhinoceros are endangered.
– What role does private property play in
explaining why some animals are
endangered?
Slide 32-33
International Example: How Chinese Fish
Farming Helps Wild Fish Populations
 As more fish are cultivated in small
freshwater ponds and sea inlets in
China, there is less of a need to
harvest fish from oceans and rivers.
 The population of fish in these natural
habitats is now less threatened by
commercial fishing.
Slide 32-34
Recycling
 Recycling
– The reuse of raw materials derived from
manufactured products
• Fewer resources are used
• Are total resources necessarily saved?
Slide 32-35
Recycling
 Recycling’s invisible costs
– Costs include
• resources used in recycling
• pollution created during recycling
Slide 32-36
Recycling
 Landfills
– An alternative to recycling
– Expansion of solid waste disposal sites is
outpacing demand increases
Slide 32-37
Recycling
 Should we save scarce resources?
– Resource may not be getting scarcer
– The inflation-corrected price of most
resources has been falling for decades
Slide 32-38
Issues and Applications:
Protecting the Komodo Islands
 The Komodo Islands of Indonesia are home
to some rare species of turtles and to the
unique Komodo dragon.
 Their habitats have been damaged by
commercial fishing.
 By encouraging the development of
separate fish and turtle farms, the
Indonesian government has been able to
protect these natural habitats.
Slide 32-39
Issues and Applications:
Protecting the Komodo Islands
 The development of nature parks in these
fragile environments has also provided
incentives for their protection.
 The economies of the Komodo islands have
benefited from employment provided by the
fish farms and by tourism generated by the
parks.
 And animal populations in the natural habitat
are recovering.
Slide 32-40
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
Slide 32-41
Summary Discussion
of Learning Objectives
 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
Slide 32-42
Summary Discussion
of Learning Objectives
 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.
Slide 32-43
Summary Discussion
of Learning Objectives
 Benefits and costs of recycling
– Benefits
• Limits use of natural resources
– Costs
• Recycling uses resources
• Could entail a reduction in the incentive to
preserve forests that are currently used for
paper products
Slide 32-44
End of
Chapter 32
Environmental
Economics