Welcome to Environmental Economics

What is environmental economics? Economics – study of how society allocates scarce resources. Environmental economics – offers explanations and solutions for both the causes and consequences of environmental degradation (env. econ). The study of how society allocates scarce natural resources such as fish, trees, water, oil, etc. (resource econ.)

What is environmental economics? 2 parts of a whole – every economic action can impact the environment, and every environmental change can impact the economy. Recognizes that we need not give up environmental quality to have a better economy or give up economic benefits to have better environmental quality.

Class Objective Develop a framework for thinking about the significance of an environmental problem and about what constitutes a feasible set of solutions to the problem. Economics alone incapable of generating either understandings of or solutions to environmental problems Integrate ecology, physics, chemistry, philosophy, sociology, other disciplines to develop solutions

Part I. Principles A.Markets B.Market failure C.Discounting & PV D.Dynamic efficiency E.Pollution solutions

A. Markets Chapter 2, handout

Demand The relationship between the quantity demanded and the price of a good when all other influences (tastes and preferences, prices of substitutes and complements, income, numbers of consumers and consumer expectations) on buying plans remain the same

Demand Law of demand – ceteris parabis (With all other factors remaining the same) – if p ↑, QD ↓ if p ↓, QD ↑ Demand curve downward sloping

$ Quantity Demand

Demand = MB Demand curve for pizza tells us dollar’s worth of other goods give up to get 1 more pizza Consumer surplus: MB – price paid

Consumer surplus

Supply The relationship between the quantity supplied and the price of a good when all other influences on selling plans (production costs such as labor, energy, capital, and materials) remain the same

Supply Law of supply – ceteris parabis – if p ↑, QS ↑ if p ↓, QS ↓ Supply curve upward sloping

$ Quantity Supply

Supply = MC Supply curve for pizza tells us dollar’s worth of other goods give up to produce 1 more pizza. Producer surplus: Price – MC

Producer surplus

Market equilibrium Buyers and sellers’ plans consistent QD = QS

Equilibrium Equilibrium is the price at which quantity demanded equals to quantity supplied. What happens when price is not at equilibrium? If price QS and there will be pressure on price to rise (up to equilibrium). If price > P*, then QS > QD and there will be pressure on price to fall (down to equilibrium).

Shortage If p QS, price ↑, suppliers supply more. or, If MB > MC – good valued more highly than it costs – ↑ production

Surplus If p > p*, QS > QD, price ↓, suppliers supply less. or, If MC > MB – good costs more than it is valued – ↓ production

Market equilibrium

At q*, MB = MC, net benefits maximized. Cannot increase benefits by changing q MB = MC → Efficiency – cannot make one person better off without hurting another Why?

$ Quantity MB = MC q* MB > MCMC > MB S = MC D = MB

MB = MC If MB > MC, can increase quantity → increases benefits more than increases costs → total net benefits increase If MC > MB, can decrease quantity → decreases cost by more than decreases benefits → total net benefits increase Only at q* impossible to increase net benefits by changing quantity

Measuring Net Benefits The market demand curve is the sum of all individual demand curves. Every individual demand curve reflects a WTP based on a perceived value (or benefit) of the good. As a result, the market demand curve reflects private benefits.

Measuring Net Benefits The supply curve reflects the costs of producing the good or service. These costs are incurred in production and can be viewed as private, since all these costs are borne by the suppliers. As such, the supply curve embodies private costs.

Social costs and benefits: MSC, MSB MSC – marginal cost incurred by entire society, by the producer and by everyone else on whom the cost falls = MC + MEC MSB – marginal benefit enjoyed by society, by the consumers and by everyone else who benefits from it = MB + MEB

Maximizing Private & Social Benefits We know private net benefits are maximized at equilibrium. In order for social net benefits to be maximized, it is necessary that private MB be identical to MSB and private MC be identical to MSC. If this condition holds, then market forces will equate both marginal private costs and benefits and marginal social costs and benefits: social welfare maximized.

Will MB = MSB, MC = MSC? For many goods (sushi, surfboards), YES For many environmental-related goods (paper produced by water polluting paper mill, snorkeling at Hanauma Bay), NO MB ≠ MSB and/or MC ≠ MSC → market failure, the topic of the next lecture