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Natural Resources

and
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)

Figure 2.1 Economic system and Environment


1. Human-Environment relationship

• 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.

Figure 2.2 The Consumer’s Choice


2. Environmental problems &

Economic efficiency
• Static efficiency
• Producer’s surplus = the value that producers receive – the cost to provide it

Figure 2.3 The Producer’s Choice


2. Property rights

• Property rights and efficient market allocations


• Property rights: a bundle of entitlements defining the owner’s rights,
privileges, and limitations for use of the resource.
• How can we judge whether the pursuit of profits (for both individuals and
government ) is consistent with efficiency or not ?
2. Property rights

• Efficient property rights structures


• Exclusivity: all benefits and costs accrued as a result of owning and using
the resources should accrue to the owner, and only to the owner
• Transferability: all property rights should be transferable voluntarily
• Enforceability: property rights should be secure from involuntary seizure or
encroachment by others
2. Property rights

• Efficient property rights structures


• The exchange of well-defined property rights can facilitate efficiency.
(why?)
• Consider an allocation between a consumer and a producer. If the producer
owns the property rights, is this allocation efficient ?
• The answer is …… Yes!
2. Property rights

• Efficient property rights structures

Consider : what will happen if


E 1
(1) E0 → E1
(2) E0 → E2
E0
Which allocation is efficient ?
E2

Figure 2.4 Market Equilibrium


2. Property rights

• Producer’s surplus, scarcity rent, and long-run


competitive equilibrium
• Total revenue: the area under the price line
• Total variable cost: the area under the marginal cost curve
• In the short run (some costs are fixed): producer’s surplus = profits + fixed
cost
• In the long run (all costs are variable): producer’s surplus = profits + rent
2. Property rights

• Producer’s surplus, scarcity rent, and long-run


competitive equilibrium
• With free entry of new firms into profitable industries,
long-run profits and rent will equal zero.
• Scarcity Rent: producer’s surplus, which persists in long-run competitive
equilibrium.
• E.g.: land (high quality land earn economic profit)
3. Externalities as a Source of

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

1. Why MCs is higher than MCp ?

2. Can you find the social net


loss (deadweight loss) ?

Figure 2.5 The Market for Steel


3. Externalities as a Source of

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)

Figure 2.6 Bison Harvesting


3. Externalities as a Source of

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

Figure 2.8 Monopoly and Inefficiency


3. Externalities as a Source of

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

• Private Resolution through


Negotiation
• Property, Liability and the Coase
Theorem
• Prerequisite: the number of affected
parties is small.

Figure 2.10 Efficient output with pollution


damage
4. The Pursuit of Efficiency

• Private Resolution through


Negotiation
• Allocations I: the steel holds the rights
to emission
• Allocations II: the hotel holds the
rights of clean river.

Figure 2.10 Efficient output with pollution


damage
4. The Pursuit of Efficiency

• Private Resolution through


Negotiation
• Question I: what’s the change in the
surplus of each party and the social ?
• Question II: what’s the impact of rights
allocation on the optimal amount and
the producer’s surplus ?

Figure 2.10 Efficient output with


pollution damage
4. The Pursuit of Efficiency

• Private Resolution through


Negotiation
• For allocation I
• The steel: A+B+D → A+B+(C+D)
• The hotel: -B-C-D → -B-(C+D)
• The social: A-C → A
• Optimal amount: Q*

Figure 2.10 Efficient output with pollution


damage
4. The Pursuit of Efficiency

• Private Resolution through


Negotiation
• For allocation Ⅱ
• The steel: A+B+D-(C+D) → A+B
• The hotel: -B-C-D+(C+D) →-B
• The social: A-C → A
• Optimal amount: Q*

Figure 2.10 Efficient output with pollution


damage
4. The Pursuit of Efficiency

• Private Resolution through


Negotiation
• Conclusions
• As long as negotiation costs are
negligible and affected parties can
negotiate freely with each other, then

Figure 2.10 Efficient output with pollution


damage
4. The Pursuit of Efficiency

• Private Resolution through Negotiation


• Coase theorem
• ① the efficient allocation would result (Q*) whether the rights were allocated
to either party;
• ② the only effect of the court’s decision would be to change the distribution
of surplus among affected parties.
4. The Pursuit of Efficiency

• Private Resolution through Negotiation


• However,
• ① The decision to confer the property right on a particular party results in a
transfer of wealth to that party. (Wealth effects normally are assumed small)
• ② Negotiation will become difficult when the number of affected parties is
large. (We turn to liability rules)
4. The Pursuit of Efficiency

• Private Resolution through Negotiation


• Liability rules: The rules award monetary damages, after the fact, to the
injured party. The amount of the award is designed to correspond to the
amount of damage inflicted.
• A liability rule would force the steel to compensate the hotel for all damages
incurred. The efficient amount would result as well (Q*).
4. The Pursuit of Efficiency

• Private Resolution through Negotiation


• The limitations of liability rules: The costs for court’s determination would be
very expensive (time, lawyers’ fees, etc.)
• Legislative and Executive regulation
4. The Pursuit of Efficiency

• Private Resolution through Negotiation


• Legislative and Executive regulation
• The legislature dictate that no one produce more steel or pollution than Q*
(jail sentences or fines); or impose a tax on steel or on pollution; or require the
installation of pollution control equipment;
• Regulations;
• consumer boycotts; labeling for food products, etc.
5. An Efficient Role for Government

• The government action could well be used to


restore efficiency, but inefficiency is not a sufficient
condition to justify government intervention. Why?
• Any corrective mechanism involves transaction costs.
• If they surpass the benefits from the intervention, then the best choice would
be to live with the inefficiency.
Summary

• ① How producers and consumers use the resources


making up the environmental asset depends on the
nature of the entitlements embodied in the property
rights governing resource use.
• When property rights systems are exclusive,
transferable, and enforceable, the owner has a
powerful incentive to use them efficiently.
Summary

• ② The economic system will not always sustain


efficient allocations.
• Specific circumstances leading to inefficient
allocations include: externalities, improperly defined
property rights system, imperfect markets for trading
the property rights, and asymmetric information.
Summary

• ③ Due to rent-seeking behavior by special interest


groups or the less-than-perfect implementation of
efficient plans, the political system can produce
inefficiencies as well.
Summary

• ④ The efficiency criterion can assist in the


identification of circumstances in which our political
and economic institutions lead us astray.
• It can also assist in search for remedies by facilitating
the design of regulatory, judicial, or legislative
solutions.
Self-Test exercises

• Please try to answer the following questions


independently, and repeat your answers in the next
class if requested:
•① , ⑥
Answers to question “deadweight
loss”

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