Summing up1 ECON 4910 Spring 2007 Environmental Economics Lecture 12 Summing up Lecturer: Finn R. Førsund

Summing up 2 Content of course Background Environmental policy International issues Dynamic issues Valuation

Summing up 3 Background What is environmental economics? Building blocs:  Production of man-made goods and generation of pollutants  Production of environmental services  Interaction economic activity and the environment  Evaluation of man-made and environmental goods

Summing up 4 Tools for dealing with the building blocks Production and generation of pollutants  Multi-output production theory Production of environmental services and interaction pollutants – the environment  Knowledge about natural environments and effects of deposition of pollutants Evaluation of environmental goods  Externalities  Public-good theory

Summing up 5 The basic social-choice model Social choice: how much environmental protection, trade-off marketed goods – environmental services Benefit to the production sector from pollution and damage of pollution to consumers B = benefit, e = pollution, D = damage

Summing up 6 The basic social-choice model, cont. The social optimisation problem Necessary first order condition Second order sufficient condition

Summing up 7 Illustration of the social solution e b’,d’ b’ d’ e* b’* = d’*

Summing up 8 Explaining the benefit function and the purification function of the basic model Factorially determined multi-output production in the production sector  Marketed output: y  Pollutants: e  Production inputs: x 1 (K,L,E,M)  Purification inputs: x 2

Summing up 9 Factorially determined multi-output production, cont. Profit maximisation with environmental constraint  Output price: p  Input prices: q 1, q 2  Pollution constraint: e R

Summing up 10 Profit maximisation, cont. The Lagrangian First-order conditions Endogenous variables as function of exogenous variables

Summing up 11 The benefit function Environmental restriction is so lax that the constraint is not binding  e* < e R  No purification resources are used. x 2 = 0  The profit function with binding environmental constraint

Summing up 12 The damage function Utility of environmental services as public goods  Man-made goods: x i  Environmental services: M Demand for the environmental services, vertical summation

Summing up 13 The damage function Willingness to pay  Marshall demand functions  Indirect utility function in money  Max utility for given income, environmental services

Summing up 14 Willingness to pay, cont. Hicks demand functions Expenditure function  Min. expenditure for given income, environmental services E

Summing up 15 Willingness to pay, cont. Compensating surplus  Difference in expenditure keeping the old utility level U o when the environment improves from M o to M 1 Question to the consumer: what are you willing to pay for an environmental improvement

Summing up 16 Willingness to pay, cont. Using the indirect utility function  The consumer is willing to pay the compensating surplus and will remain on the old utility level Equivalent surplus  Difference in expenditure keeping the new utility level when the environment improves

Summing up 17 Willingness to pay, cont. Question to the consumer: what will you accept in payment for forgoing an environmental improvement Using the indirect utility function  To accept the old environmental service the consumer must have a compensation giving him the same utility level as the improved environment would have given

Summing up 18 Methods to find willingness to pay Revealed preferences  Utilising complementarity between environmental service and market goods  The travel cost method finding demand for visiting sites  Hedonic regressions; isolating environmental differences  Household production; household produce their own environmental services Stated preferences  Asking people; constructed markets and contingent valuation

Summing up 19 Environmental policy Is public regulation necessary?  Property rights; the Coase theorem  Market failure: public bads and externalities Regulating policy instruments for pollution  Command and control  Economic incentives Pigouvian fees, emission fees Marketable permits Regulation with unknown control costs Unobserved emissions, audits

Summing up 20 The Coase theorem e b’,d’ b’ d’ e* b’* = d’* d(e min )=0 eπeπ Property right polluter Property right pollutee Pollutee can pay Polluter to cut back Polluter can pay Pollutee to accept more pollution Bargaining solution

Summing up 21 Unknown costs: The Weitzman rule e D’(e) -E{c’(e)} e* t* -c H ’ -c L ’ e H (t*)eHeH eLeL e L (t*) Social loss if H using t* Social loss if L using t* Social loss using e* if L and if H

Summing up 22 International issues Transboundary pollution  Global warming  Stratospheric ozone depletion  Acid rain Type of pollutants  Uniformly distributed: deposition  Non-uniformly distributed: deposition  Deposition depends on location

Summing up 23 Policy models for economic efficiency Minimising costs for given environmental deposition targets  The RAINS model  Future projection e i o  Deposition target d j *

Summing up 24 Policy models for economic efficiency, cont. Ideal Kyoto protocol

Summing up 25 Tradable emission permits Trade in permits can be used when  The social solution is derived from setting environmental standards because the damage function is not known  Damage function known, but certainty of achieving the desired pollution level is preferred Trade in permits to a common trading price can only be socially optimal if the pollutant is uniformly dispersed

Summing up 26 Efficiency of tradable permits e1*e1* -c 1 ’ e1e1 -c 2 ’ -c 1 ’, -c 2 ’ e R = a(e 1 o +e 2 o ) e1oe1o e2oe2o e2e2 e2*e2*

Summing up 27 Stock pollution Damage from accumulated waste Cannot achieve an interior steady-state solution without decay of accumulated pollution  Decay:  Formulating a dynamic optimisation model for an infinite horizon and solving using optimal control theory. Steady state illustration by phase diagram