McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 22 Natural Resources, the Environment, and Climate Change

1- 2 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 22-2 Chapter Outline Using Natural Resources How Clean Is Clean Enough? The Externalities Approach The Property Rights Approach Environmental Problems And Their Economic Solutions

1- 3 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 22-3 Natural Resources Limited natural resources: Resources that cannot be replaced. Renewable Natural Resources: Resources that can be replaced. Stewardship: The management of resources in a fashion that weighs their value through time.

1- 4 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 22-4 Optimal Resource Use Present value can be used to determine the optimal usage of resources. The optimal usage plan depends on the discount rate. With a 0% discount rate optimal usage would spread out the use of limited natural resources over eternity. Would have renewable natural resources used only at the rate at which they are generated by nature. With a positive discount rate, the usage plan would be more frontloaded.

1- 5 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 22-5 Sustainability Sustainability requires that renewable natural resources be used only at a rate at which they can be replaced. Limited natural resources be used as sparingly as possible.

1- 6 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 22-6 How Clean is Clean Enough Economists answer most “how much is enough” questions with the same answer: “until the marginal benefit equals the marginal cost.” The right level of environmental cleanliness is achieved when the value of cleaning the environment a little more equals the cost of doing so.

1- 7 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 22-7 The Dirty Room Example Cleaning your room (dorm room or your own bedroom) can be done to many degrees A short time can be spent getting things off the floor (high marginal benefit, low marginal cost). More time can be spent with vacuuming and straightening (moderate marginal benefit, moderate marginal cost). Even more time can be spent deep cleaning, removing stains from carpets, dusting all shelves and moving furniture so as to clean behind them (for most low marginal benefit and high marginal cost.)

1- 8 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 22-8 Modeling Environmental Cleanup Marginal Benefit Marginal Cost Environmental Quality Marginal Cost Marginal Benefit EQ*

1- 9 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 22-9 The Externalities Approach Externalities are the effects of a transaction that hurt or help people who are not a part of that transaction. When a product affects someone other than the consumer of producer in a negative way, such as pollution, economists suggest that the market has failed.

1- 10 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin When the Market Works for Everyone Supply Demand Q* P* P Q/t A B C 0 Value to the Consumer: 0ACQ* Consumers Pay Producers: OP*CQ* The Variable Cost to Producers: OBCQ* Consumer Surplus: P*AC Producer Surplus: BP*C

1- 11 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin When Externalities are Present If there are externalities then there is overproduction of a good. The total cost of a good to society (called social cost) includes the costs of production incurred by the firm as well as the external costs.

1- 12 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin When the Market Does Not Work for Everyone S Marginal Cost D (Marginal Benefit) Q* P* P Q/t 0 Social Cost External Cost Q’ P’

1- 13 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin The Property Rights Approach Coase’s Theorem If there are no costs of bargaining between people and polluters then by assigning a property right (either the right of the firm to pollute or the right of people to be free from pollution) people and firms can negotiate to the correct level of production.

1- 14 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin Why Coase’s Theorem Makes Sense People do not pollute up their own private property nearly as much as they pollute Common Property. Common Property is not owned by any individual but is owned by government or has some other collective ownership property. This is because when they do they are removing value from themselves.

1- 15 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin Problems with Coase’s Theorem It is impossible for companies to negotiate with millions of citizens affected by their pollution. The system picks a winner and a loser when it establishes the property right.

1- 16 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin Natural Resources and Property Rights Uses the concept of present value Choose the rate of exploitation that maximizes profit. The rate of exploitation that maximizes profit depends on whether the firm owns the property (or at least the long term right to exploit it.)

1- 17 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin Various Environmental Problems and their Solutions Problems of Water pollution, Air Pollution, Extinction of Species, Acid Rain, Global Warming Legal Solutions Clean Water Act Clean Air Act Endangered Species Act

1- 18 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin Legal vs. Economic Solutions Legal solutions to environment problems typically limit or make illegal activities that harm the environment. Economic solutions to environmental problems tend to discourage activities that harm the environment by making the people doing the harm recognize the cost of that harm.

1- 19 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin Taxation as an Economic Solution S Marginal Cost D (Marginal Benefit) Q* P* P Q/t 0 S+tax tax Q’ P’

1- 20 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin Other Economic Solutions Cap-and-trade: Any policy that imposes a limit on the total amount of emissions and allows for the free exchange of emission permits within that cap. Emission permits for SO 2 in the Clean Air Act of Obama preferred limits on GHGs California’s old-car purchases Cash for Clunkers

1- 21 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin When There is No Authority to Tax or Regulate Global Warming crosses governmental boundaries. There is no motivation for an individual country to limit pollution that contributes to global warming. No government can enforce the Kyoto Protocol

1- 22 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin Economic Consequences of Kyoto (if it were implemented) The United States is 25% above its Kyoto target for Greenhouse gasses. Estimates vary of how much energy prices would have to rise in order to reduce US GHG production to the Kyoto targets. Low-end estimates: 25% High-end estimates: 67%