1. Valuing the Environment: Concepts
Chapter 2
Valuing the Environment: Concepts
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2. Introduction
This chapter introduces the general conceptual framework used in economics to approach environmental problems.
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3. Objectives
Define the economic approach and distinguish between positive and normative economics.
Derive and define a demand curve and distinguish between individual and market demand, total and marginal benefits, total willingness to pay and marginal willingness to pay.
Define opportunity cost. Distinguish between a contemporaneous opportunity cost and an intertemporal opportunity cost.
Derive and define the marginal cost curve. Distinguish between marginal and total cost.
Define present value and the discount rate. Illustrate the basic discounting equations.
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4. Objectives
Calculate the present value of net benefits and show how benefit-cost analysis can be used to evaluate specific options.
Derive net benefits graphically. Define optimality and economic efficiency.
Distinguish between static efficiency and dynamic efficiency. Use the equimarginal principle to illustrate both efficiency and inefficiency.
Define pareto optimality.
Apply these concepts to real world examples.
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5. FIGURE 2.1 The Economic System and the Environment
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6. The Human Environment Relationship
The Environment as an Asset
Closed system vs. Open system
Closed system: A system where there are no inputs and no outputs of energy and matter from outside the system
Open system: A system which imports or exports energy or matter from outside
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7. The first law of thermodynamics
Energy and matter can neither be created nor destroyed.
The second law of thermodynamics
The amount of energy not available for work increases.
It is also called as entropy law.
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8. The Economic Approach Positive Economics Normative Economics
Describing what is, what was and what will be
Normative Economics
Attempting to answer what ought to be
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9. Example 2.1
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10. Example 2.1 (continued)
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11. Normative Criteria for Decision-Making
Evaluating Predefined Options
Let B be the benefits from a proposed action and C be the costs. Our decision rule would then be:
If B > C, support the action
Otherwise, oppose the action
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12. Total benefits are the value of total willingness to pay, which is the area under the market demand curve from the origin to the allocation of interest.
Opportunity cost is the net benefit lost when specific environmental services are forgone in the conversion to the new use.
Total costs is the sum of marginal opportunity costs, which is the area under the marginal cost curve.
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13. Example 2.2
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14. Example 2.2 (continued)
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15. FIGURE 2.2 The Individual Demand Curve
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16. FIGURE 2.3 The Relationship of Demand to Willingness to Pay
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17. FIGURE 2.4 The Relationship of Marginal Cost and Total Cost
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18. FIGURE 2.5 The Derivation of Net Benefits
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19. Comparing Benefits and Costs Across Time
Present Value of a one-time net benefit (Bn) received n years from now is
Where r is the interest rate.
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20. Where r is the interest rate.
The present value of a stream of net benefit {B0,…, Bn) received over a period of n years is
Where r is the interest rate.
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21. Table 2.1 Demonstrated Present Value Calculations
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22. Table 2.2 Interpreting Present Value Calculations
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23. Finding the Optimal Outcome
Static Efficiency
First Equimarginal Principle (the “Efficiency Equimarginal Principle”): Net benefits are maximized when the marginal benefits from an allocation equal the marginal costs.
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24. Finding the Optimal Outcome
Dynamic Efficiency
An allocation of resources across n time periods satisfies the dynamic efficiency criterion if it maximizes the present value of net benefits that could be received from all the possible ways of allocating those resources over the n periods.
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25. Applying the Concepts Pollution Control
Benefits include, not limited to, reduced death rate, lower incidences of chronic bronchitis and other diseases, better visibility, improved agricultural productivity and etc.
Costs include
1) higher costs passed to consumers such as installing, operating and maintaining pollution control equipment
2) administrative costs such as designing, implementing, monitoring relevant policies
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26. Does Reducing Pollution Make Economic Sense?
In its 1997 report to Congress, the EPA presented the results of its attempt to discover whether the Clear Air Act had produced positive net benefits over the period 1970 to The results suggested that the present value of benefits (using a discount rate of 5 percent) was $22.2 trillion, while the costs were $0.523 trillion. Performing the necessary subtraction reveals that the net benefits were therefore equal to $21.7 trillion, as shown in Table 2.3. According to this study, U.S. air pollution control policy during this period made very good economic sense.
Source: Created by the authors from information presented in U.S. Environmental Protection Agency, The
Benefits and Costs of the Clean Air Act, 1970 to 1990 (Washington, DC: Environmental Protection Agency,
1997): Table 18 on p. 56.
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27. TABLE 2. 3 Monetized Benefits and Costs of the U. S
TABLE 2.3 Monetized Benefits and Costs of the U.S. Clean Air Act, 1970–1990 (billions of 1990 dollars)
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28. Preservation Versus Development of Land
Benefits include improved economic welfare from increasing employment, rise of income and etc
Costs include degradation of ecosystem.
Example of mining in Kakadu Conservation Zone
(Insert example 2.4)
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29. Summary Environment: a composite asset
Positive versus normative economics
Benefit/cost analysis
Static versus dynamic efficient allocation
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