McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 19 The Environment

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter Outline HOW CLEAN IS CLEAN ENOUGH? THE EXTERNALITIES APPROACH THE PROPERTY RIGHTS APPROACH ENVIRONMENTAL PROBLEMS AND THEIR ECONOMIC SOLUTIONS

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. 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.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. 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.)

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Modeling Environmental Cleanup Marginal Benefit Marginal Cost Environmental Quality Marginal Cost Marginal Benefit EQ*

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. 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.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. 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

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. 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.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. 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’

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. 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.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. 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.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. 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.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. 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

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. 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.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Taxation as an Economic Solution S Marginal Cost D (Marginal Benefit) Q* P* P Q/t 0 S+tax tax Q’ P’

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Other Economic Solutions Emission permits for SO 2 in the Clean Air Act of California’s old-car purchases