Environmental Economics Sedef Akgüngör Lecture 2

Economic Reasons for Pollution Pollution as an externality Pollution as an externality What is pollution? What is pollution? Tyler is eating in a smoky restaurantTyler is eating in a smoky restaurant Karen comes into contact with radioactive wasteKaren comes into contact with radioactive waste Ann is trying to get some sleep but the neighbors are constantly talking and laughing.Ann is trying to get some sleep but the neighbors are constantly talking and laughing.

Market failure is a situation in which markets do not efficiently organize production or allocate goods and services to consumers. Market failure is a situation in which markets do not efficiently organize production or allocate goods and services to consumers.markets On the other hand, many market failures are situations where market forces do not serve the perceived public interest. On the other hand, many market failures are situations where market forces do not serve the perceived public interest.public interestpublic interest The two main reasons that markets fail are: The two main reasons that markets fail are: the inadequate expression of costs or benefits in prices and thus into microeconomic decision-making in markets.the inadequate expression of costs or benefits in prices and thus into microeconomic decision-making in markets. sub-optimal market structures.sub-optimal market structures. Market Failure

Types of Market Failures Imperfect competition/market power Imperfect competition/market power Externality Externality Public goodPublic good Common pool resourceCommon pool resource Information asymmetry Information asymmetry

Economists define pollution as a negative externality: A human made, unbagained for, negative element of the environment. Economists define pollution as a negative externality: A human made, unbagained for, negative element of the environment. Market systems generate pollution because many natural inputs in the production of goods and services are underpriced. No one owns these resources. Market systems generate pollution because many natural inputs in the production of goods and services are underpriced. No one owns these resources.

A factory causing pollution. If the factory were forced to compensate the victims (internalize the externality), the firm would pay for the water it used up. A factory causing pollution. If the factory were forced to compensate the victims (internalize the externality), the firm would pay for the water it used up. Water would no longer be underpriced Water would no longer be underpriced

Free Access Problem Arises when the property is commonly held. Arises when the property is commonly held. If people weigh private benefits against private as opposed to social) costs, they will overexploit the reserves. If people weigh private benefits against private as opposed to social) costs, they will overexploit the reserves. Gennett Hardin: “The Tradegy of the Commons” Gennett Hardin: “The Tradegy of the Commons”

Example from Hardin Herder whose cattle forage on the common land. Herder whose cattle forage on the common land. Each herder seeks to maximize his gain. He asks: “what is the utility to me of adding one more animal to my herd?” Each herder seeks to maximize his gain. He asks: “what is the utility to me of adding one more animal to my herd?” A positive componentA positive component A negative component (shared by all herdmsmen)A negative component (shared by all herdmsmen) Result: Ultimate exhaustion…

Example from the book…. ……. ……. When there is regulation, less boats will be in the sea, therefore causing a loss in industry profits. Resource rent. When there is regulation, less boats will be in the sea, therefore causing a loss in industry profits. Resource rent. Conclusion: When there is free access, the individual fisherman do not recognize that much of their catch is diverted from others. Conclusion: When there is free access, the individual fisherman do not recognize that much of their catch is diverted from others. Need for regulation and rules. Need for regulation and rules.

Public Goods Problem Free access problem explains why there is a tendency for commonly held resources are overexploited. Free access problem explains why there is a tendency for commonly held resources are overexploited. But why does the government intervene? But why does the government intervene? Free market environmentalists’ view.. Free market environmentalists’ view.. Transaction costs Transaction costs Free riding problem Free riding problem Difference between demand curve for a public good and a private good. Difference between demand curve for a public good and a private good.

Two Characteristics of Public Goods Nonrivalness Nonrivalness Non exclusiveness Non exclusiveness Marginal cost to an additional consumer is zero. With private goods, marginal benefit is the benefit that the consumer receives. So we should horizontally sum. With private goods, marginal benefit is the benefit that the consumer receives. So we should horizontally sum. With public goods, we must ask how much each person values an additional unit of output. So we should vertically sum. With public goods, we must ask how much each person values an additional unit of output. So we should vertically sum.

What have we learned? A negative externality s an unbargained for, negative impacy on a third party of private transaction. A negative externality s an unbargained for, negative impacy on a third party of private transaction. Internatizing an externality means forcing source of externality to bear external costs. Internatizing an externality means forcing source of externality to bear external costs. Negative externalities arise when there is free access to common property. Negative externalities arise when there is free access to common property. Informal laws and restraints. Informal laws and restraints. Restriction by Government action creates a resource rent. Restriction by Government action creates a resource rent. Is Government necessary? Is Government necessary?

Free market environmentalists argue that bargaining of partners is possible and that there is no need for a third party involvement. Free market environmentalists argue that bargaining of partners is possible and that there is no need for a third party involvement. However, most economists argue hat because clean environment is a public good, the obstacles of high transaction costs and free riding mean that private negotiation in the courts would be inefficient and unsafe. However, most economists argue hat because clean environment is a public good, the obstacles of high transaction costs and free riding mean that private negotiation in the courts would be inefficient and unsafe.

The Efficiency Standard Achiving the goal of zero pollution is not expensive but might be counterproductive. Achiving the goal of zero pollution is not expensive but might be counterproductive. Costs and benefits of pollution reduction. Costs and benefits of pollution reduction. We have to achieve an efficient level of pollution. We have to achieve an efficient level of pollution. The term efficient in everyday language is when no resources are wasted. The term efficient in everyday language is when no resources are wasted. Economic definition by Vilfred Pareto. Economic definition by Vilfred Pareto.

A situation when it is not possible to make one person better off without making anyone else worse off. A situation when it is not possible to make one person better off without making anyone else worse off. Economic definition. Economic definition. What is the advantage of efficiency? What is the advantage of efficiency? Net monetary benefits produced by the economy will be maximized.Net monetary benefits produced by the economy will be maximized. Difference between all banafits which can be giveb a monetary value minus all private an external costs will be as large as possible.Difference between all banafits which can be giveb a monetary value minus all private an external costs will be as large as possible.

Efficient Pollution Levels Right amount of pollution. Right amount of pollution. Example in the book (see reading package).. Example in the book (see reading package).. Note that we are focusing on reducing cigarettes (pollution) ine at a time. Note that we are focusing on reducing cigarettes (pollution) ine at a time. Marginal analysisMarginal analysis Marginal unitMarginal unit Marginal costsMarginal costs Marginal benefitsMarginal benefits

Puzzle Joe who lives to smoke would smoke five cigarettes a day if he were in the office by himself. Joe is a selfish individual. Would he continue to smoke if Anne were around? Joe who lives to smoke would smoke five cigarettes a day if he were in the office by himself. Joe is a selfish individual. Would he continue to smoke if Anne were around? Hint: There is a possibility of bargaining. (see notes in your reading package)

Whether polluters have a right to pollute or victims have right to prevent pollution is an issue for the Government to decide. Whether polluters have a right to pollute or victims have right to prevent pollution is an issue for the Government to decide. Marginal costs of poullution control Marginal costs of poullution control Marginal benefits of pollution control Marginal benefits of pollution control

Coase Theorem If polluter and victim can bargain easily and effectively, private negotiation should arrive at the efficient outcome, regardless of who has the initial right to pollute or prevent pollotion. If polluter and victim can bargain easily and effectively, private negotiation should arrive at the efficient outcome, regardless of who has the initial right to pollute or prevent pollotion. Polluter pays principle Polluter pays principle