Chapter 18
The Environment
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Chapter Outline
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•
•
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HOW CLEAN IS CLEAN ENOUGH?
THE EXTERNALITIES APPROACH
THE PROPERTY RIGHTS APPROACH
ENVIRONMENTAL PROBLEMS AND
THEIR ECONOMIC SOLUTIONS
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How Clean is Clean Enough
• Economists answer most “how much is
enough” questions with the same
answer: “until the marginal benefit
equals the marginal cost.”
• The right level of environmental
cleanliness is achieved when the value
of cleaning the environment a little more
equals the cost of doing so.
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The Dirty Room Example
• Cleaning your room (dorm room or your own
bedroom) can be done to many degrees
– A short time can be spent getting things off the
floor (high marginal benefit, low marginal cost).
– More time can be spent with vacuuming and
straightening (moderate marginal benefit,
moderate marginal cost).
– Even more time can be spent deep cleaning,
removing stains from carpets, dusting all shelves
and moving furniture so as to clean behind them
(for most low marginal benefit and high marginal
cost.)
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Modeling Environmental Cleanup
Marginal Cost
Marginal Benefit
Marginal Cost
Marginal Benefit
EQ*
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Environmental Quality
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
The Externalities Approach
• Externalities are the effects of a
transaction that hurt or help people who
are not a part of that transaction.
• When a product affects someone other
than the consumer of producer in a
negative way, such as pollution,
economists suggest that the market has
failed.
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When the Market Works for Everyone
•
P
Supply
A
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•
P*
C
•
•
B
Value to the Consumer:
• 0ACQ*
Consumers Pay Producers:
• OP*CQ*
The Variable Cost to
Producers:
• OBCQ*
Consumer Surplus:
• P*AC
Producer Surplus:
• BP*C
Demand
0
McGraw-Hill/Irwin
Q*
Q/t
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When Externalities are Present
• If there are externalities then there is
overproduction of a good.
• The total cost of a good to society
(called social cost) includes the costs of
production incurred by the firm as well
as the external costs.
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When the Market Does Not Work for Everyone
Social Cost
External Cost
SMarginal Cost
P
P’
P*
D(Marginal Benefit)
0
McGraw-Hill/Irwin
Q’ Q*
Q/t
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
The Property Rights Approach
• Coase’s Theorem
– If there are no costs of bargaining between
people and polluters then by assigning a
property right (either the right of the firm to
pollute or the right of people to be free from
pollution) people and firms can negotiate to
the correct level of production.
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Why Coase’s Theorem Makes Sense
• People do not pollute up their own
private property nearly as much as they
pollute Common Property.
– Common Property is not owned by any
individual but is owned by government or
has some other collective ownership
property.
• This is because when they do they are
removing value from themselves.
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Problems with Coase’s Theorem
• It is impossible for companies to
negotiate with millions of citizens
affected by their pollution.
• The system picks a winner and a loser
when it establishes the property right.
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Natural Resources and Property Rights
• Uses the concept of present value
• Choose the rate of exploitation that
maximizes profit.
• The rate of exploitation that maximizes
profit depends on whether the firm owns
the property (or at least the long term right
to exploit it.)
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Various Environmental Problems
and their Solutions
• Problems of
– Water pollution, Air Pollution, Extinction of
Species, Acid Rain, Global Warming
• Legal Solutions
– Clean Water Act
– Clean Air Act
– Endangered Species Act
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Legal vs. Economic Solutions
• Legal solutions to environment
problems typically limit or make illegal
activities that harm the environment.
• Economic solutions to environmental
problems tend to discourage activities
that harm the environment by making
the people doing the harm recognize
the cost of that harm.
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Taxation as an Economic Solution
S+tax
tax
SMarginal Cost
P
P’
P*
D(Marginal Benefit)
0
McGraw-Hill/Irwin
Q’ Q*
Q/t
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Other Economic Solutions
• Emission permits for SO2 in the Clean
Air Act of 1990.
• California’s old-car purchases
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