Chapter 1

What is
Environmental
Economics?
 Overview
• Distinguish between efficiency and equity concepts and why they are central to
environmental economics.
• Describe the incentives that contribute to pollution arising from people and
firms.
• Define and distinguish between open access, private, and common property
rights and explain why the assignment of property rights can help reduce
pollution.
• Explain why people do not take into account the air pollution their vehicle emits
when they drive.
• Describe the anthropogenic sources of greenhouse gas emissions and what
changes are needed in the economy to reduce these emissions.
• Explain the tradeoffs between economic growth and the environment.
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 Chapter 1
What is
Environmental
Economics?
(Part 1-1)
 Overview

• What is Environmental Economics?

• Evaluating outcomes and policies
• Efficiency vs. Equity

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What is Environmental Economics?
• Economics is the study of how and why people
make decisions about the use of valuable
resources.

• Environmental Economics focuses on how

economic activities affect our natural
environment, with a goal of helping society
reduce its degradation of the environment.

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 Important Questions
• Why don’t people take into account the effect
of their economic activity on the natural
environment?

• What inhibits economic systems from using its

resources wisely and efficiently to protect the
sustainability of the planet and people’s
livelihoods over time?

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 Evaluating outcomes and policies
• Environmental economics uses efficiency as a
central criteria for evaluating outcomes and
policies.
– To find policies that that provide a maximum
amount of protection for the environment at a
minimum cost of resources.
• Equity is also an important consideration in
the evaluation of outcomes and policies
– It is important for policies to be both fair and
efficient.
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 Efficiency vs. Equity
• An outcome is economically efficient if all resources are put to
their highest valued use, or alternatively if a desired outcome
is reached using the fewest resources.

• Should we pick A, B, or c?

• Example: walk in the forest versus computers

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 Efficiency vs. Equity
• Equity relates to how resources are divided
among different people or groups.
– Horizontal equity: treats equals, equally.
– Vertical equity: treats unequals, unequally.
– Intergenerational equity: looks at whether
Future generations have the same
opportunities as current ones.

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 Chapter 1
What is
Environmental
Efficiency vs. Equity
Economics?
(Part 1-2)
 Overview

• Why do people pollute?

• Externalities and Property Rights
• Open Access Resources
• Common Property

2
 Why do people pollute?
The economic approach
• Why do people behave in ways that cause
environmental destruction?
– Is it because people are unethical or immoral?
– Or is it because people have incorrect incentives?

• A challenge with a moral approach is that people

have different moral values, and it is hard to
motivate people to change behavior based on
morality

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 Why people pollute
• People pollute because it is the cheapest way to
dispose of the waste products remaining after the
production and consumption of a good

• In many situations, people have an incentive to pollute.

– An incentive is something that attracts or repels people
and leads them to modify their behavior in some way.
– Economic incentives relate to production and consumption
decisions,
• consist of payoffs in terms of material wealth
• People have incentives to behave in ways that provide them
with increased wealth.

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 Why people pollute
• One incentive-type statement is that pollution is a result of the
profit motive.
– People are rewarded for maximizing profits.
– In pursuit of maximizing profits, entrepreneurs give no thought to
the environmental impacts of their actions because it “doesn’t pay.”
• It is not only “profit-motivated” corporations that cause
pollution; individual consumers are also guilty
– Pouring paint thinner down the drain,
– Leaving all the chargers for electronic gadgets plugged in.
• government agencies have also been serious polluters
– Subsidizing industries that degrade the environment even though
they are not profit-motivated.
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 Externalities and Property Rights
• Externalities and property rights are two important
concepts to an understanding of the incentives that
exists regarding the environment.
• Property rights or the lack of ownership are crucial
in understanding why today’s environmental
problems exist.
– Lack of ownership rights to environmental resources
means that there are few incentives to take the
environmental consequences of our actions into
account.
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 Open Access Resources
• Many environmental resources do not have clearly
defined property rights
– no one “owns” the atmosphere or ocean

• An open access resource does not have one clear

owner, and anyone can use it without paying
– For example you do not have to ask permission or pay when
your car emits pollution into the atmosphere
• A Private property right gives the owner rights to
exclude others from using their resource
– no one can use your car without your permission and you
have to pay to rent a car
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 Common Property
• Common property rights give power to the
community to govern their resources within its
borders
• Common property is a resource shared among a
group of people
– Common property can be open access if no one controls
the resource – such as the ocean or atmosphere
– Some common property resources are not open access
because the set of users is well defined and access can
be controlled.
• For example a small fishing community is shared common
property, but is not open access.
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 Chapter 1
What is
Environmental
Economics?
(Part 1-3)
 Overview

• Externalities: Smog and Motor

• Incentives to address external Costs
• Greenhouse Gas Emissions
• GHG and Climate Change
• Costs of Mitigation
• Precautionary Principle

2
Externalities: Smog and Motor Vehicles
• An externality occurs when the actions of one or
more individuals affect the well-being of others
without compensating them
• When you drive your car, you receive a personal
benefit, but also impose costs on other people due
to the air pollution, noise pollution and congestion
you create.
– These costs are known as externalities or external costs
or effects, because you impose the costs on others, but
do not have to pay compensation.
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 Incentives to address external costs
Incentives might be used to address the problems created
by external costs
• What are examples of incentives that might be
introduced to force drivers to account for the external
costs created when they drive cars?
• What are examples of incentives that might be
introduced to influence companies such as car makers
and gasoline producers to address the pollution
problems associated with cars?
– Targeting the number of vehicles on the road, the average
number of kilometres travelled, and emissions per
kilometre as well as where people drive their vehicles
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Incentives to address external costs
• What are some possible incentives to change people’s behaviour?
• Number of vehicle:
– levy a charge per year for owning a vehicle in addition to one’s licence fee
– Improving public transit
• Average kilometres travelled:
– Higher costs per kilometre:
• tax on the number of kilometres travelled (direct incentive)
• tax gasoline (indirect incentive)
• Emissions per kilometre:
– Tax on emissions
• E.g. the carbon tax in British Columbia.
– A buyback program that pays people to retire their older vehicles
– Advertising and education programs that inform people about how their
driving decisions affect air quality and, hence, their well-being.
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Incentives to address external costs
• Firms have an incentive to use the services of the
environment for waste disposal.
• The challenge is to find incentives to change firms’
behaviour so they treat environmental services as a
costly activity rather than a free good.
• Enforcing laws or regulations that direct the amount of
pollution a firm can emit, thus reducing emissions per
kilometre
– Regulating the sulphur content of gasoline
– Taxing oil refiners on the basis of the sulphur content of their
gasoline produced
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 Greenhouse Gas Emissions
• The emissions of carbon dioxide (CO2) and other Greenhouse
Gases (GHG) have been rising over time due primarily to our
growing use of carbon fuels, such as gasoline, coal and oil.

Total Annual
Anthropogenic GHG
Emissions by Groups
of Gases, 1970-2010

• Due to GHG accumulation, the concentration of GHG in the

atmosphere has been rising with the increases in emissions.
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© 2015 McGraw-Hill Ryerson Ltd.
 GHG and Climate Change
• GHG trap heat in the earth’s atmosphere, creating global
climate change.
• Costs of global climate change are estimated to be $70-
100 billion per year
– The loss of crops, health impacts, the loss of species and
ecosystems, etc.
Global Anthropogenic
Sources of GHG Emissions

The largest source of GHG emissions is

electricity generation and heat, especially from
coal fired power plants. Transportation is also a
major contributor.

© 2015 McGraw-Hill Ryerson Ltd. 7

 Costs of Mitigation
• In order to slow global climate change, we must find
ways to burn fewer carbon fuels such as gasoline,
coal and oil
• However we use these energy sources due to their
low cost and ease of use
• Alternative energy sources, such as wind and solar
power, generally cost more and may be unreliable.
– Trade off between the costs associated with changing
energy sources, and the costs associated with not
changing energy sources

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 Precautionary Principle
• The precautionary principle says that society
should weigh the trade offs between the costs
we face today to switch to lower carbon
sources of energy, versus the benefits we will
receive in the future due to a lower level of
global climate change and lower risk.

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 Chapter 1
What is
Environmental
Economics?
(Part 1-4)
 Overview

• Sustainability
• Social Capital
• Trade-offs and Sustainability
• Trade-offs over time

2
 Sustainability
• A sustainable economy is one that allows people’s well
being to rise (or at least stay the same) over time (but
not fall) while sustaining the health of ecological
systems.
– By “using up” natural resources, we will not be able to
sustain our economy in the future.
– “Human ingenuity” will allow us to find ways to
overcome resource scarcity
• to find new resources or new ways to do things when certain
natural resources run low.
– E.g. the “Green Revolution” increased food production,
and today the world has more food per person than ever
before in history, even as global population is still rising
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 Social Capital
• Social capital refers to a broad definition of economic
capital
– including human capital (labour and knowledge),
natural capital (natural resources) and produced
capital (machines and tools).
• A sustainable economy would be one where overall
social capital continues to grow, and ecological
integrity is maintained
– As natural resources are “used up”, human capital
must increase to find new ways produce goods
and limit pollution
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 Trade-offs and Sustainability
• A production possibilities frontier (PPF) shows the trade off between
the output of goods and services and environmental quality
• The choice is between good and services produced in a fossil fuel
intensive economy and the destruction of the ecosystem and
economy from climate change

• PPF depends on the technical and

ecological capacities in the
economy.
• PPF gives the maximum possible
combination of output for a given
level of environmental quality
when all resources are fully and
efficiently used.

A PPF between a High-Carbon Economy

and Environmental Quality 4
© 2015 McGraw-Hill Ryerson Ltd.
 Trade-offs and Sustainability
• A Community Indifference Curve (CIC) gives the combinations of
output and environmental quality perceived by society to provide
a given level of well-being.
• CIC depends on social values and preferences
• As the output of goods and services
grows, more GHG is released, and
environmental quality is diminished

• Based on our community preferences

(CIC), society will decide what
quantity of goods and services it
wants and the corresponding level of
environmental quality

A PPF between a High-Carbon Economy

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and Environmental Quality
© 2015 McGraw-Hill Ryerson Ltd.
 Trade-offs over time: Future PPF Scenarios
• Over time, society’s choices will influence the position
of the PPF.
PPF in 50 Years:
Pessimistic Scenario

Pessimistic Scenario:
High use of natural resources
today might lower the PPF
over time, leading to an
unsustainable economy with
lower consumption in the
future

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© 2015 McGraw-Hill Ryerson Ltd.
Trade-offs over time: Future PPF Scenarios

PPF in 50 Years: Optimistic Scenario:

Optimistic Scenario Investments in research and
efficiency today may yield
technological improvements,
shifting the PPF outward
Sustainable economy allows
consumption to grow in the
future while improving the
environment

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© 2015 McGraw-Hill Ryerson Ltd.