Economics for Leaders Lesson 7: Economics & The Environment

Joke Of The Day A woman hears from her doctor that she has 6 months to live.   The doctor advises her to marry an economist and to live in South Dakota. The woman asks: will this cure my illness? The doctor replies: No, but the 6 months will seem PRETTY LONG. 

Joke Of The Day A: He's ALL RIGHT now! Q: Did you hear about the guy who lost his left arm and left leg in a car crash? A: He's ALL RIGHT now!

Can we can use economic reasoning to think about environmental issues? YES!

Institutions Matter Institutions – rules of the game/incentives Opportunity costs – alternatives, what is given up Socially desirable outcome

How do we manage our scarce resources? Markets Buyers & Sellers Voluntary Transactions The Invisible Hand Efficient, Maximize Well-Being

How do we manage our scarce resources? D = MB = WTP (private value/benefit) S = MC = WTS (private production cost) What happens when the private costs or benefits do not equal the social costs or benefits from an activity? Market Failure = EXTERNALITY

Negative Externalities Automobile exhaust Factory pollution Cigarette smoking Barking dogs (loud pets) Airplanes (landing/take-off) Landfills Chicken litter Over-fishing/grazing/driving

Coal-Fired Power Plant The owner of the plant bears the costs of the labor, land, concrete, steel, etc… used in production but does NOT pay for the clean air used. People also agree to buy electricity (electric bill). Social Cost > Private Cost Price does not reflect true cost! Over Do It!

A Voluntary Exchange between a willing buyer and seller But…..

Social Value < Private Value Although the car owner has paid for the gasoline, he has NOT paid for the clean air used as he drives. Social Value < Private Value Price does not reflect true cost! Over Do it! . . . COSTS that spill over onto people who don’t receive the benefits. . . . COSTS that spill over onto people who don’t receive the benefits.

Property Rights The incentives are not correct! Auto/factory pollution could be addressed….. tailpipe Smokestack B.O.

How do we address negative externalities through policy? Two Helpful Tools: Markets & Property Rights Common Resources Air Water Highways Microwave ovens

Two Examples Chicken Litter Ft. Lauderdale Airport Arkansas vs. Oklahoma Ft. Lauderdale Airport Neighborhood vs. Airlines Costs and Benefits are difficult to determine litigation and transaction costs are the norm

The Story Of The Citrus Farmer And The Fisherman

Optimal Clean-up? $2,000 $100 $300 $600 citrus farmer fisherman profits per week profits per week $2,000 $100 $300 $600 high output low output

Optimal Clean-up? $2,000 $100 $300 $600 citrus farmer fisherman profits per week profits per week $2,000 $100 $300 $600 high output = $2,100 low output = $900

Optimal Clean-up? $2,000 $100 $300 $600 citrus farmer fisherman profits per week profits per week $2,000 $100 $300 $600 high output = $2,100 low output = $900 MC = $1,700 MB = $500 Optimal Outcome: Do Not Clean Up

Optimal Clean-up? $2,000 $1,000 $300 $6,000 citrus farmer fisherman profits per week profits per week $2,000 $1,000 $300 $6,000 high output low output

Optimal Clean-up? $2,000 $1,000 $300 $6,000 citrus farmer fisherman profits per week profits per week $2,000 $1,000 $300 $6,000 high output = $2,100 low output = $6,300

Optimal Clean-up? $2,000 $1,000 $300 $6,000 citrus farmer fisherman profits per week profits per week $2,000 $1,000 $300 $6,000 high output = $2,100 low output = $6,300 MC = $1,700 MB = $5,000 Optimal Outcome: Do Clean Up

What is the CORRECT amount of pollution? Captain Planet, he's our hero, Gonna take pollution down to zero. He's our powers magnified, and he's fighting on the planet's side. Captain Planet, he's our hero Gonna take pollution down to zero Captain Planet Capt Planet doesn’t understand marginal analysis

“And then one day some wise men realized that it didn’t matter what happened to the environment so long as we wore these nice shiny suits!”

There are just TRADE-OFFS Policy Conundrum There are no SOLUTIONS. There are just TRADE-OFFS & OPPORTUNITY COSTS!