Environmental Environmental EconomicsEconomics

Sedef AkgüngörSedef Akgüngör

Lecture 2Lecture 2

Economic Reasons for PollutionEconomic Reasons for Pollution

Pollution as an externalityPollution as an externality What is pollution?What is pollution?

• Tyler is eating in a smoky restaurantTyler is eating in a smoky restaurant• Karen comes into contact with Karen comes into contact with

radioactive wasteradioactive waste• Ann is trying to get some sleep but the Ann is trying to get some sleep but the

neighbors are constantly talking and neighbors are constantly talking and laughing.laughing.

Market failureMarket failure is a situation in which is a situation in which marketsmarkets do do not efficiently organize production or allocate not efficiently organize production or allocate goods and services to consumers.goods and services to consumers.

On the other hand, many market failures are On the other hand, many market failures are situations where market forces do not serve the situations where market forces do not serve the perceived perceived public interestpublic interest. .

The two main reasons that markets fail are:The two main reasons that markets fail are:• the inadequate expression of costs or benefits in prices the inadequate expression of costs or benefits in prices

and thus into microeconomic decision-making in and thus into microeconomic decision-making in markets. markets.

• sub-optimal market structures. sub-optimal market structures.

Market FailureMarket Failure

Types of Market FailuresTypes of Market Failures

Imperfect competition/market powerImperfect competition/market power ExternalityExternality

• Public goodPublic good• Common pool resourceCommon pool resource

Information asymmetryInformation asymmetry

Economists define pollution as a Economists define pollution as a negative externality: A human made, negative externality: A human made, unbagained for, negative element of unbagained for, negative element of the environment.the environment.

Market systems generate pollution Market systems generate pollution because many natural inputs in the because many natural inputs in the production of goods and services are production of goods and services are underpriced. No one owns these underpriced. No one owns these resources.resources.

A factory causing pollution. If the A factory causing pollution. If the factory were forced to compensate factory were forced to compensate the victims (internalize the the victims (internalize the externality), the firm would pay for externality), the firm would pay for the water it used up.the water it used up.

Water would no longer be Water would no longer be underpricedunderpriced

Free Access ProblemFree Access Problem

Arises when the property is Arises when the property is commonly held.commonly held.

If people weigh private benefits If people weigh private benefits against private as opposed to social) against private as opposed to social) costs, they will overexploit the costs, they will overexploit the reserves.reserves.

Gennett Hardin: “The Tradegy of the Gennett Hardin: “The Tradegy of the Commons”Commons”

Example from HardinExample from Hardin

Herder whose cattle forage on the Herder whose cattle forage on the common land.common land.

Each herder seeks to maximize his gain. Each herder seeks to maximize his gain. He asks: “what is the utility to me of He asks: “what is the utility to me of adding one more animal to my herd?”adding one more animal to my herd?”• A positive componentA positive component• A negative component (shared by all A negative component (shared by all

herdmsmen)herdmsmen)

Result: Ultimate exhaustion…Result: Ultimate exhaustion…

Example from the book….Example from the book….

………….. When there is regulation, less boats will be When there is regulation, less boats will be

in the sea, therefore causing a loss in in the sea, therefore causing a loss in industry profits. Resource rent.industry profits. Resource rent.

Conclusion: When there is free access, the Conclusion: When there is free access, the individual fisherman do not recognize that individual fisherman do not recognize that much of their catch is diverted from much of their catch is diverted from others.others.

Need for regulation and rules.Need for regulation and rules.

Public Goods ProblemPublic Goods Problem

Free access problem explains why there is Free access problem explains why there is a tendency for commonly held resources a tendency for commonly held resources are overexploited.are overexploited.

But why does the government intervene?But why does the government intervene? Free market environmentalists’ view..Free market environmentalists’ view.. Transaction costsTransaction costs Free riding problemFree riding problem Difference between demand curve for a Difference between demand curve for a

public good and a private good.public good and a private good.

Two Characteristics of Public Two Characteristics of Public GoodsGoods

NonrivalnessNonrivalness Non exclusivenessNon exclusivenessMarginal cost to an additional consumer is Marginal cost to an additional consumer is

zero.zero. With private goods, marginal benefit is the With private goods, marginal benefit is the

benefit that the consumer receives. So we benefit that the consumer receives. So we should horizontally sum.should horizontally sum.

With public goods, we must ask how much With public goods, we must ask how much each person values an additional unit of each person values an additional unit of output. So we should vertically sum.output. So we should vertically sum.

What have we learned?What have we learned? A negative externality s an unbargained for, A negative externality s an unbargained for,

negative impacy on a third party of private negative impacy on a third party of private transaction.transaction.

Internatizing an externality means forcing source Internatizing an externality means forcing source of externality to bear external costs.of externality to bear external costs.

Negative externalities arise when there is free Negative externalities arise when there is free access to common property.access to common property.

Informal laws and restraints.Informal laws and restraints. Restriction by Government action creates a Restriction by Government action creates a

resource rent.resource rent. Is Government necessary?Is Government necessary?

Free market environmentalists argue that Free market environmentalists argue that bargaining of partners is possible and that bargaining of partners is possible and that there is no need for a third party there is no need for a third party involvement.involvement.

However, most economists argue hat However, most economists argue hat because clean environment is a public because clean environment is a public good, the obstacles of high transaction good, the obstacles of high transaction costs and free riding mean that private costs and free riding mean that private negotiation in the courts would be negotiation in the courts would be inefficient and unsafe.inefficient and unsafe.

The Efficiency StandardThe Efficiency Standard

Achiving the goal of zero pollution is not Achiving the goal of zero pollution is not expensive but might be expensive but might be counterproductive.counterproductive.

Costs and benefits of pollution reduction.Costs and benefits of pollution reduction. We have to achieve an efficient level of We have to achieve an efficient level of

pollution.pollution. The term efficient in everyday language is The term efficient in everyday language is

when no resources are wasted.when no resources are wasted. Economic definition by Vilfred Pareto.Economic definition by Vilfred Pareto.

A situation when it is not possible to make A situation when it is not possible to make one person better off without making one person better off without making anyone else worse off.anyone else worse off.

Economic definition.Economic definition. What is the advantage of efficiency?What is the advantage of efficiency?

• Net monetary benefits produced by the Net monetary benefits produced by the economy will be maximized.economy will be maximized.

• Difference between all banafits which can be Difference between all banafits which can be giveb a monetary value minus all private an giveb a monetary value minus all private an external costs will be as large as possible.external costs will be as large as possible.

Efficient Pollution LevelsEfficient Pollution Levels

Right amount of pollution.Right amount of pollution. Example in the book (see reading Example in the book (see reading

package)..package).. Note that we are focusing on reducing Note that we are focusing on reducing

cigarettes (pollution) ine at a time.cigarettes (pollution) ine at a time.• Marginal analysisMarginal analysis• Marginal unitMarginal unit• Marginal costsMarginal costs• Marginal benefitsMarginal benefits

PuzzlePuzzle

Joe who lives to smoke would smoke Joe who lives to smoke would smoke five cigarettes a day if he were in the five cigarettes a day if he were in the office by himself. Joe is a selfish office by himself. Joe is a selfish individual. Would he continue to individual. Would he continue to smoke if Anne were around? smoke if Anne were around?

Hint: There is a possibility of Hint: There is a possibility of bargaining.bargaining.

(see notes in your reading package)(see notes in your reading package)

Whether polluters have a right to Whether polluters have a right to pollute or victims have right to pollute or victims have right to prevent pollution is an issue for the prevent pollution is an issue for the Government to decide.Government to decide.

Marginal costs of poullution controlMarginal costs of poullution control Marginal benefits of pollution controlMarginal benefits of pollution control

Coase TheoremCoase Theorem

If polluter and victim can bargain If polluter and victim can bargain easily and effectively, private easily and effectively, private negotiation should arrive at the negotiation should arrive at the efficient outcome, regardless of who efficient outcome, regardless of who has the initial right to pollute or has the initial right to pollute or prevent pollotion.prevent pollotion.

Polluter pays principlePolluter pays principle