Erling Eide, ELE Day 2 2 Environmental issues (problems and goals) 2.1 Examples of what might be thought to be a problem 2.2 What is the problem? 2.3 Goal analysis: Modeling priorities and policy choices 1U/ELE/H13 day 2.ptt

2.1 Examples of what might be thought to be a problem Environmental services – Purification services (Nature as a purification plant) – Recreation services – Extraction of resources (animals, minerals,…) Problems – Degradation/reduction in these services Long list of what people consider as problems – Pollution damage – Damaged recreational services – Depletion of natural resources U/ELE/H13 day 2 rev3.ptt2

2.1 (cont.) Exhaustable resources (minerals, gas, oil, species…) – Depletion Non exhaustable resources (fish stocks, pastures, forests, clean atmosphere, clean rivers,…) – Overuse, reduction of stocks, pollution… STOP IT? – Pollution causes health problems. Stop it? – Waste causes degraded recreational services. Stop it? – Extraction of minerals reduces stock available to future generations. Stop it? Stop it at which level of depletion/degradation? U/ELE/H13 day 2 rev3.ptt3

2.2 What is the problem? Externalities Decision makers’ behaviour: – Decision makers do not take into account the negative effect on others of their activity. Damage costs to others (negative externalities) not included when producers and consumers are balancing benefits vs. costs. In market equilibrium consumers pay for the scarce resources used in production (at the margin), -- but not for the external effects. Products too cheap. Production too high. U/ELE/H13 day 2 rev3.ptt4

Example: The tragedy of the commons Definition of commons: – Resource that anybody can extract or use – Resource rent: The surplus value after all costs of extraction or use, and normal returns, have been accounted for. – The gift of nature – Competition to get hold of the gift – (Model) consequence: The tragedy of the commons: Resources depleted Examples of commons – Fish stocks in oceans (whales, cod,…) – Pastures – Atmosphere U/ELE/H13 day 2 rev3.ptt5

2.3 Goal analysis: Modelling priorities and policy choices Alternative goals: – Welfare based optimal emissions – Other standards of emissions Optimal production: See section 1.5 U/ELE/H13 day 2 rev3.ptt6

2.3.2 Optimal amount of emissions -- Emissions given level of production Example: Pollution of a given activity (Production in a given plant is held constant) Costs of pollution: – Reduced environmental quality requires purification measures in adjacent plant Causes health problems Reduces recreation services in the neighborhood Costs of reducing pollution – Higher quality of inputs – More air cleaners – Increased quality control of production –…–… 7U/ELE/H13 day 2 rev3.ptt

2.3.2 (cont.) Goal: Minimisation of total costs 8 EMISSIONS COSTS DAMAGE COSTS ABATEMENT COSTS TOTAL COSTS FIG. 2.1 Determination of optimal emissions U/ELE/H13 day 2 rev3.ptt

2.3 (cont.) Goal: Minimisation of total costs 9 MARGINAL ABATEMENT COSTS MARGINAL DAMAGE COSTS MARGINAL COSTS MDC=MAC EMISSIONS FIG. 2.2 MARGINAL COSTS AND OPTIMAL EMISSIONS U/ELE/H13 day 2 rev3.ptt

10 EMISSIONS COSTS DAMAGE COSTS ABATEMENT COSTS TOTAL COSTS U/ELE/H13 day 2 rev3.ptt MARGINAL COSTS MDC EMISSIONS MACMDC=MAC

Internalizing Externalities Allocation of ownership rights (property rights): – To the polluter Contract on pollution reduction (”laissez-faire rule”) – To the damaged party Contract on pollution increase (”polluter rule”) Transferability of ownership rights Allocation and transferability of ownership rights makes externalities into a marketable good. – The government set the rules – Actors act. 11U/ELE/H13 day 2 rev3.ptt

12 EMISSIONS COSTS DAMAGE COSTS ABATEMENT COSTS TOTAL COSTS U/ELE/H13 day 2 rev3.ptt MARGINAL COSTS MDC EMISSIONS MACMDC=MAC

2.3 (cont.) Internalisation of costs 13 MARGINAL ABATEMENT COSTS MARGINAL DAMAGE COSTS MARGINAL COSTS MDC=MAC EMISSIONS FIG. 2.2 MARGINAL COSTS AND OPTIMAL EMISSIONS U/ELE/H13 day 2 rev3.ptt E high E low

Internalizing Externalities (cont.) Environmental liability Pigouvian taxes Regulations 14U/ELE/H13 day 2 rev3.ptt