14 environmental economics


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14 environmental economics

  1. 1. Chapter 14Environmental Economics • Key Concepts • Summary • Practice Quiz • Internet Exercises ©2000 South-Western College Publishing 1
  2. 2. In this chapter, you will learn to solve these economic puzzles:Why do competitive markets How can government Can governmentproduce too largereduce a quantity legislation, taxes, and intervention permits achieve and charge too low a price environmental quality? environmental efficiency? for products that pollute? 2
  3. 3. What assumption is made in this chapter?There is sufficient foreign and domestic competition to allow us to use the perfectly competitive model 3
  4. 4. When does Economic Efficiency exist?Efficiency exists when the price to consumers, reflecting marginal benefit, equals marginal cost 4
  5. 5. Who is a Third Party?People outside the market transaction who are affected by the product 5
  6. 6. What are PrivateBenefits and Costs?Benefits and costs to the decision maker, ignoring benefits and costs to third parties 6
  7. 7. What are Externalities?Benefits or costs that are not considered by market buyers and sellers 7
  8. 8. What is an example of an Externality? Air pollution is an externality that affects third parties not driving automobiles 8
  9. 9. What is an example ofa Positive Externality? The enjoyment you derive from your neighbors well-kept yard 9
  10. 10. What happens whenExternalities are present? Competitive markets are not likely to achieve economic efficiency 10
  11. 11. What are Social Benefits?The sum of benefits to everyone, including both private benefits and external benefits 11
  12. 12. What are Private Costs? Production costs of capital, labor, land, and entrepreneurship 12
  13. 13. What are Social Costs? The sum of costs to everyone, including both private costs and external costs 13
  14. 14. When is Social Welfare maximized? It is achieved when marginal social benefitequals marginal social cost 14
  15. 15. Why can’t businessesacting on their own solvethe problem of Pollution?The added costs of cleaning up the environment will make them less competitive in the market place 15
  16. 16. What may happen to afirm that takes on the added costs of Anti- pollution Devices?They eventually will be driven out of business by lower cost firms 16
  17. 17. The following graphs show the short-run marginal cost curves and the long-run average cost curves for two firms; one pays private costs (typical) and the other pays both private and external costs (green firm) 17
  18. 18. P Short-run Marginal Cost PMC (typical) SMC (green) PSR=SRPMC QS QP Q 18
  19. 19. P Long-run Average Cost SAC (green) PLR=LRSAC PAC (typical) PLR=LRPAC QLR Q 19
  20. 20. What happens when External Costs are ignored?Competitive firms produce “too much,” and the market equilibrium price is “too low,” compared to a socially efficient industry 20
  21. 21. Comparisons of Equilibriums for TypicalP Competitive and “Green Industries” SS = ∑ SMC (green)PS PS = ∑ PMC (typical)PC D QS QC Q 21
  22. 22. Do Markets Fail whenExternalities are present? Externalities illustrate that private markets fail to produce society’s preferred outcome 22
  23. 23. How can societyachieve Efficiencywhen markets fail?Government has a potential role when there is market failure 23
  24. 24. What is an example ofGovernment Failure?Government can fail to correct market failure by doing too little or too much about pollution 24
  25. 25. What are twoGovernment Approaches?• Incentive-based regulations• Command-and-control regulations 25
  26. 26. What is a Command-and-control Regulation?Government regulations that set an environmental goal and dictate how the goal will be achieved 26
  27. 27. What is an example of a Command-and- control Regulation? Mandatory installation of catalytic converters on automobiles 27
  28. 28. What is an Incentive- based Regulation?Government regulations that set an environmental goal, but are flexible in how buyers and sellers achieve the goal 28
  29. 29. What is an Effluent Tax? A tax on the pollutant 29
  30. 30. P Using an Effluent Tax to Achieve Environmental Efficiency SS = ∑ (MC, t) (green)PS tax PS = ∑ MC =PC ∑ PMC (typical) D QS QC Q 30
  31. 31. What isEmissions Trading?Trading that allows firms to buy and sell the right to pollute 31
  32. 32. What is New-source Bias?Bias that occurs when there is an incentive to keep assets past the efficient point as a result of regulation 32
  33. 33. Is the Efficient amount ofPollution typically Zero? No, the marginal social cost of achieving one more unit of clean air may be greater than the marginal social benefit 33
  34. 34. What is the Coase Theorem?The proposition that private market negotiations can achieve social efficiency, regardless of the initial definition of property rights 34
  35. 35. How comprehensive isthe Coase Theorem?Only a small number of environmental problems qualify for Coase Theorem solutions 35
  36. 36. Which cases qualify for the Coase Theorem? • no transaction costs • no income effects • only two parties in the negotiation 36
  37. 37. What is a Transaction Cost?The costs of negotiating and enforcing a contract 37
  38. 38. What is theFree-rider Problem?If some people benefit while others pay, few will be willing to pay for improvement of the environment or other public goods 38
  39. 39. What is the result of the Free-rider Problem? Goods affected are underproduced 39
  40. 40. Key Concepts 40
  41. 41. Key Concepts• When does Economic Efficiency exist?• Who is a Third Party?• What are Private Benefits and Costs?• What are Externalities?• What are Social Benefits?• What are Private Costs?• What are Social Costs?• Where is Social Welfare maximized?• Why can’t businesses action on their own solv 41
  42. 42. Key Concepts cont.• How can society achieve Efficiency when mark• What is a Command-and-control Regulation?• What is an Incentive-based Regulation?• What is an Effluent Tax?• What is Emissions Trading?• What is New-source Bias?• What is the Coase Theorem? 42
  43. 43. Summary 43
  44. 44. Externalities are benefits orcosts that fall on third parties whoare neither buyers nor sellers.Pollution is a negative externality orexternal cost that is a byproduct ofmany industrial productionprocesses. 44
  45. 45. Market failure is present when themarket produces a socially inefficientoutcome. One instance is when thereare externalities All firms , includingcompetitive firms, consider privatecosts, but disregard external costs, inmaking decisions.. 45
  46. 46. Government failure occurswhen public-sector actions move usaway from desired outcomes, suchas efficiency. Government officialsseeking campaign contributions andvotes may choose environmentalmeasures that favor wealthycontributors over society’s bestinterests. 46
  47. 47. Command-and-controlregulations occur when thegovernment dictates the approach toachieving an environmental goal. 47
  48. 48. Command-and-control (CAC)regulations are generally inefficienton three grounds: They do notdistinguish between high and lowpollution areas, they do not allowfirms to choose lower costtechnologies that could achieve theenvironmental standard, and they donot encourage improved technologyto lower future emissions. 48
  49. 49. Incentive-based regulationsbuild on markets to achieveenvironmental efficiency. Effluenttaxes are taxes that reflect externalcosts. Emissions-trading allows firmsto buy and sell the “right to pollute.” 49
  50. 50. The Coase Theorem maintainsthat markets can be efficient in thepresence of externalities withminimal government intervention.Even in the presence of externalities,markets may produce efficientoutcomes so long as property rightsare clearly established. 50
  51. 51. Transactions costs, income effects,and free-rider problems are obstacles toachieving environmental efficiencythrough markets. Transactions costs arethe costs of negotiating an agreement,income effects are present when limitedincome prevents one party from beingable to afford the efficient solution, andfree-rider problems are present whenparticipants are better off hiding thanrevealing their willingness to pay for anenvironmental improvement. 51
  52. 52. Chapter 14 Quiz ©2000 South-Western College Publishing 52
  53. 53. 1. Recently the city of New Orleans discovered chemical compounds in its drinking water. The source is the waste discharges of industrial plants upstream. This is an example of a. an external cost imposed on the citizens of New Orleans by the industrial plants upstream. b. a market failure where the market price of the output of these industrial plants does not fully reflect the social cost of producing these goods. c. an externality where the marginal social costs of producing these industrial goods differ from the marginal private costs. d. all of the above. 53
  54. 54. 1.D. The upstream firm is releasing chemicals into the water, an external cost to the citizens of New Orleans. The upstream firm is not including these costs when pricing its product; hence, the market price is too low. Marginal social costs would include the marginal private cost of the industrial product (their costs of labor, capital, materials, etc.) and the external cost of the chemicals released into the water. Choices (a), (b), and (c)each are correct, so that all of the above is the correct choice. 54
  55. 55. 2. A government policy that charges steel firms a fee per ton of steel produced (an effluent charge) where the fee is determined by the amount of pollutants discharged into the air or water will lead to a. a decrease in the market equilibrium quantity of steel produced. b. a decrease in the market equilibrium price of steel. c. an increase in the market equilibrium price of steel. d. the results in (a) and (b). e. the results in (a) and (c ). 55
  56. 56. 2.E. Essentially, the government is employing an effluent tax to reduce pollution. The tax increases the cost of production. Supply decreases, leading to a higher price and smaller quantity. So choice (e), where (a) quantity decreases and (c)price increases, is the best choice. 56
  57. 57. 3. Social costs are a. the full resource costs of an economic activity. b. usually less than private costs. c. the costs of an economic activity borne by the producer. d. all of the above. 57
  58. 58. 3.A. Social costs include both private costs (the costs of the firm’s inputs, including labor, capital, land, etc.) and external costs (the costs to third parties, such as pollution emitted by the producer). Social costs are at least as large as private costs. Producers will not consider external costs, which are a part of social costs, unless they are forced to do so by government or court. 58
  59. 59. 4. As a general rule, if pollution costs are external, firms will produce a. too much of a polluting good. b. too little of a polluting good. c. an optimal amount of a polluting good. d. an amount that cannot be determined without additional information. 59
  60. 60. 4.A. Private firms will make their production decision using private costs. If there are external costs, social costs exceed private costs. If production decisions included external costs, supply would be smaller than when private costs alone are considered. So if external costs are ignored, the firm will produce too much, as compared to the social efficient level. 60
  61. 61. 5. Many economists would argue a. the optimal amount of pollution is greater than zero. b. all pollution should be eliminated. c. the market mechanism can handle pollution without any government intervention. d. central planning is the most efficient way to eliminate pollution. 61
  62. 62. 5.A. The optimal amount of pollution is where marginal social cost equals marginal social benefit. This amount typically exceeds zero. The marginal cost of eliminating all pollution would likely be very high. For example, we would have to eliminate all cars. However, firms tend to ignore external costs such as pollution, in an unfettered market. While government is likely to be needed, pollution has actually been worse in centrally planned economies. 62
  63. 63. 6. Which of the following used marketable pollution permits as an incentive for reducing pollution? a. The 1970 Clean Air Act. b. The Comprehensive Environmental Response, Compensation, and Liability Act of 1980. c. The 1990 Clean Air Act amendments. d. The Water Quality and Improvement Act of 1970. 63
  64. 64. 6.C. The 1990 Clean Air Act was the first piece of federal legislation to introduce emissions trading. It introduced this approach for sulfur emissions, thought to contribute to acid rain. 64
  65. 65. 7. The disposable diaper industry is perfectly competitive. Which of the following is true? a. Since the industry is perfectly competitive, price and quantity are at the socially efficient levels. b. Competitive price is higher and competitive quantity lower than the socially efficient point. c. Competitive price is higher and competitive quantity higher than the socially efficient point. d. Competitive price is lower and competitive quantity higher than the socially efficient point. 65
  66. 66. 7.D. Disposable diapers have an external cost, to the extent that they are not biodegradable and sit in landfills. Producers in a competitive market consider only private costs, ignoring disposal issues. Similarly, consumers just want to prevent leaks that affect them, but ignore leaks that affect landfills. So producers and consumers use private costs and benefits. Social costs are higher, so that social supply is smaller. The competitive price, based on private costs and benefits, is lower than the social cost. Competitive quantity is larger, given the larger supply, than the socially efficient quantity. 66
  67. 67. 8. An example of the command-and-control approach to environmental policy is a. placing a tax on high-sulfur coal to reduce its use and the corresponding sulfur emissions (which contribute to acid rain). b. requiring electric utilities to install scrubbers to reduce sulfur dioxide emissions (which contribute to acid rain). c. allowing coal producers to buy and sell permits to allow sulfur emissions. d. allowing individuals to sue coal producers if sulfur emissions exceed government-set standard. 67
  68. 68. 8.B. Command-and-control is a regulation whereby the government establishes a pollution target and dictates the method to achieve the target. An example is requiring scrubbers to reduce sulfur emissions. Sulfur emission permits and effluent taxes are example of incentive-based approaches. With taxes, for example, the firm can choose low-sulfur coal to avoid the tax. 68
  69. 69. P EXHIBIT 6 Social Private MC Social MC PrivateP1 Demand G ATC H ATCL C AKJ F E B Q1 Q2 Q3 Q4 Q 69
  70. 70. 9. The profit-maximizing firm in Exhibit 6 creates water and air pollution as a consequence of producing its output of beef cattle. If pollution costs are borne by third parties, the firm will maximize economic profit by choosing to a. voluntarily incur costs to reduce its pollution. b. produce at output rate Q3 c. produce at output rate Q2 d. produce at output rate Q4.. D. The firm will produce at Q4 where demand (MR) intersects Private MC. 70
  71. 71. 10. Use Exhibit 6 to complete the following: To maximize social welfare, the firm should produce at output rate a. Q1 b. Q2 c. Q3 d. Q4B. The firm will produce at Q2, where demand (MR) intersects Social MC. 71
  72. 72. Exhibit 7 Impact of Flights on House Value Number Total Marginal Value ofof Flights Profits Profits Wilbur’s House 1 $10,000 $10,000 $100,000 2 18,000 8,000 95,000 3 24,000 6,000 90,000 4 28,000 4,000 85,000 5 30,000 2,000 80,000 72
  73. 73. 11. As shown in Exhibit 7, if Orville has the property right to fly over Wilbur’s house, but Wilbur is allowed to negotiate with Orville on the number of flights, what will be the number of flights? a. 2. b. 3. c. 4. d. 5.B. At 3 flights, marginal profits for Orville is $6,000 and the value of Wilbur’s property goes down by $5,000. 73
  74. 74. 12. As shown in Exhibit 7, Wilbur has the property right to have no planes flying over his house, but Orville is allowed to negotiate with Wilbur, what will be the number of flights? a. 2. b. 3 c. 4 d. 5B. At 3 flights, marginal profits for Orville is $6,000 and the value of Wilbur’s property goes down by $5,000. 74
  75. 75. 13. As shown in Exhibit 7, at the socially efficient number of flights, what will be the market value of Orville’s house? a. $100,000. b. $95,000. c. $90,000. d. $85,000.C. At 3 flights, this is the last number of flights that the marginal profits are greater than the marginal costs (ie. the amount that Orville’s house declines in value) 75
  76. 76. Internet ExercisesClick on the picture of the book, choose updates by chapter for the latest internet exercises 76
  77. 77. END 77