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Environmental Economics
AECS 32032
Department of Agricultural Economics
Faculty of Agriculture
Economic approach
• Human-Environment relationship
• Environmental problems and Economic efficiency
• Property rights
• Externalities
• Persuit of Efficiency
1. Human-Environment relationship
• Environment as an asset
• Raw materials → consumer
• Energy → facilitate the process
• Goods & services
• Is it a closed or open system?
(closed:no inputs/outputs outside the system)
• Environment as an asset
• Treated our planet and its environs as a closed system
• The first law of thermodynamics (mass of materials flowing into the
economic system is equal to the mass of waste flowing into the
environment)
• What would happen when waste flow exceed its absorptive capacity ?
(illness, pollution, warming…)
1. Human-Environment relationship
• Environment as an asset
• The second law of thermodynamics (entropy law, entropy increases)
• What would happen to a closed system without new energy flow ? (used up
of energy, life ceases…)
1. Human-Environment relationship
• Environment as an asset
• Our planet is not a closed system. However, solar energy flow has an upper
limit.
• In the long run, the growth process will be limited by the availability of solar
energy and our ability to use it.
• What and how can we do ?
1. Human-Environment relationship
• Economic approach
• Positive Economics : what was, what is and what will be
• Normative Economics : what ought to be (value judgment)
• Discuss: which one is useful ?
2. Environmental problems &
Economic efficiency
• Static efficiency (Normative)
• Allocation of resources that maximizes the economic surplus is said to
satisfy the static efficiency criterion
• Economic surplus = consumer’s surplus + producer’s surplus
• Consumer’s surplus = the value that consumers receive – the cost to obtain
it
2. Environmental problems &
Economic efficiency
• Static efficiency
• Consumer’s surplus
• The excess of total willingness
to pay over the (lower) actual
expenditure.
Economic efficiency
• Static efficiency
• Producer’s surplus = the value that producers receive – the cost to provide it
Market Failure
• An externality exists whenever
• the welfare of some agent, either a firm or household, depends not only on
his or her activities, but also on activities under the control of some other
agent.
• Example : Suppose two firms are located near a river. The upstream firm is a
steel company that discharges waste into the river, and the downstream one
is a hotel that uses river to carry out recreational activities.
3. Externalities as a Source of
Market Failure
• The effect of the external cost on the steel industry
Market Failure
• Consequences of pollution externalities
• Excessive production
• Excessive pollution
• Lower price of potentially polluting products
• No incentives to search for ways to yield less pollution are introduced by the
market
• Recycling and reuse of polluting substances are discouraged because release
is so cheap
3. Externalities as a Source of
Market Failure
• Types of externalities
• Positive externality vs Negative externality (a beautiful garden owned by a
private individual; pollution emissions discharged by a private producer)
• Pecuniary externality: the entry of new firms leads to higher rents on land (Is
the market out of order?)
• Pollution externality vs Pecuniary externality (identity: negative externality;
difference: whether a feedback mechanism of prices signal exists)
3. Externalities as a Source of
Market Failure
• Tragedy of the commons
• Property right structures: state-property regimes (government) (forest),
common-property regimes (jointly owned and managed by a group of co-
owners) (rural land), res nullius or open-access regimes (no one owns or
controls over) (American bison, common-pool)
• res nullius: nonexclusivity and divisibility + scarcity
3. Externalities as a Source of
Market Failure
• Tragedy of the commons
• Why the hunters harvest under AR=AC
(TC=TR) other than MR=MC ?
• Oportunity cost
• Consequences: (1) Excessive hunting; (2)
Scarcity rent is dissipated. (zero profit)
Market Failure
• Tragedy of the commons
• Why ?: Unlimited access destroys the incentive to conserve; hence, leads to
inefficient allocation.
• Another case: open-access for fisheries (discussed in Chapter 12)
3. Externalities as a Source of
Market Failure
• Public goods
• Public goods: both consumption indivisibilities and nonexcludability.
• Indivisibilities : one person’s consumption of a good does not diminish the
amount available for others.
• Nonexcludability : one can enjoy the benefits of a resource whether he/she
pay for it or not.
3. Externalities as a Source of
Market Failure
• Public goods
• Examples: charming landscape, clean air, clean water, and biological diversity.
• Biological diversity involves: (1) genetic diversity among individuals within a
single species (produces new crops and livestock); (2) species diversity within a
biological community (keep balance of food chain).
3. Externalities as a Source of
Market Failure
• Public goods
• Problem: the biological diversity is decreasing.
• Question: Can efficient biological diversity be supplied only by private sectors ?
• Answer: No!
• Reason: free rider effect
3. Externalities as a Source of
Market Failure
• Public goods
• Free rider : who derives the value from a
commodity without paying efficiently for its
supply.
• Because of the consumption indivisibility and
nonexcludability of public goods, consumers
receive the value of any diversity paid by others.
Everyone won’t pay more.
3. Externalities as a Source of
Market Failure
• Imperfect market structures
• Environmental problems can also arise when one of the parties in an property
right exchange holds inordinate power over the outcome. (monopoly)
• Why we say that monopolies violate the definition of efficiency ?
3. Externalities as a Source of
Market Failure
• Imperfect market
structures
• Can you see the loss of social
economic surplus ?
• Example: Oil Cartel
Market Failure
• Asymmetric Information
• Asymmetric information distribution: One or more parties have more
information than the others.
• Consequence: inefficient choice of consumers. (insufficient provision of organic
foods, lemon market effect)
3. Externalities as a Source of
Market Failure
• Government Failure
• Market failure is not the only source of inefficiency.
• The common features of market failure and government failure are: improper
incentives.
• Rent seeking: the use of resources in lobbying and other activities directed at
securing legislation that results in more profitable outcomes for those funding
this activity.
3. Externalities as a Source of
Market Failure
• Government Failure
• Consequences of Rent seeking: increase the net benefits for the special
interest group, but frequently reduce the surplus of the whole society.
• Noting: rent seeking is not the only source of inefficient government policy.
Inefficient policies can also occur if the government has not full information.
(the new technological strategy was designed to promote cleaner combustion
turned out to produce water pollution)
4. The Pursuit of Efficiency