1. Chapter 14 Environmental Economics
Lecture Slides
Economics for Today Irvin B. Tucker
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2. What will I learn in this chapter?
Why competitive markets may fail to protect the environment
How we might correct the market failure
The pros and cons of government intervention
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3. What assumption is made in this chapter?
There is sufficient foreign and domestic competition to allow us to use the perfectly competitive model
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4. When does economic efficiency exist?
When marginal benefit equals marginal cost
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5. Who is a third party?
People outside the market transaction who are affected by the product
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6. What are private benefits and costs?
Benefits and costs to the decision maker, ignoring benefits and costs to third parties
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7. What are externalities?
Benefits or costs that are not considered by market buyers and sellers
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8. What is an example of a negative externality?
Pollution from cars
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9. What is an example of a positive externality?
The enjoyment you derive from your neighbor’s well-kept yard
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10. What happens when externalities are present?
Competitive markets are not likely to achieve economic efficiency
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11. What are social benefits?
The sum of benefits to everyone, including both private benefits and external benefits
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12. What are private costs?
Production costs of capital, labor, land, and entrepreneurship
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13. What are social costs?
The sum of costs to everyone, including both private costs and external costs
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14. When is social welfare maximized?
When marginal social benefit equals marginal social cost
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15. Why can’t businesses solve pollution?
The added costs of cleaning up the environment will make them less competitive in the market place
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16. The following graphs show the short-run marginal cost curves and the long-run average cost curves for two firms. One pays private costs (typical) and the other pays both private and external costs (green firm).
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17. Exhibit 1(a) Short-run Marginal Cost MSC (green) MPC (typical)
Price per unit
MPC (typical)
PSR=SRMPC QS QP
Quantity of Output (units per time period) 17
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18. Exhibit 1(b) Long-run Average Cost
ASC (green)
Price per unit
PLR=LRASC
PLR=LRAPC
APC (typical)
QLR
Quantity of Output (units per time period) 18
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19. Why should a firm minimize costs?
Only firms that choose the lowest cost method of production will survive the market
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20. What happens when external costs are ignored?
Competitive firms produce “too much,” and the market equilibrium price is “too low,” compared to a socially efficient industry
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21. What happens when there is no government intervention?
If left to the competitive market, profit-maximizing firms would have no reason to reduce emissions
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22. Quantity of Output (units per time period)
Exhibit 2 A Comparison of Equilibriums for Typical Competitive and “Green” Industries
SS =  MSC (green)
SP =  MPC (typical) PS
Price per unit PC D QS QC
Quantity of Output (units per time period)
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23. Who is a free rider?
A person who gets the same benefit from purchasing a good whether she or he pays for anti-pollution devices or not
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24. Do markets fail when externalities are present?
Externalities illustrate that private markets fail to produce society’s preferred outcome
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25. How can society achieve efficiency when markets fail?
Government has a potential role when there is market failure
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26. What is an example of government failure?
Government can fail to correct market failure by doing too little or too much about pollution
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27. What are government approaches to achieving environment efficiency?
Command-and-control regulations
Incentive-based regulations
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28. What is a command-and-control regulation?
Government regulations that set an environmental goal and dictate how the goal will be achieved
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29. What is an example of a command-and-control regulation?
Mandatory installation of catalytic converters on automobiles
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30. What is an incentive-based regulation?
Government regulations that set an environmental goal, but are flexible in how buyers and sellers achieve the goal
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31. What is an effluent tax? A tax on the pollutant
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32. Social efficiency Decrease quantity Increase price Effluent tax
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33. D PS PC QS QC t Price per unit
Exhibit 3 Using an Effluent Tax to Achieve Environmental Efficiency
SS =  MSC (green)
SP =  MPC (typical) PS
Price per unit PC t D QS QC
Quantity of Output (units per time period) 33
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34. What is emissions trading?
Trading that allows firms to buy and sell the right to pollute
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35. What is new-source bias?
Bias that occurs when there is an incentive to keep assets past the efficient point as a result of regulation
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36. Is the efficient amount of pollution typically zero?
No, the marginal social cost of achieving one more unit of clean air may be greater than the marginal social benefit
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37. What conclusion can be made?
Economists generally believe that incentive based regulations are more efficient than command-and-control regulations
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38. Allowance Price (dollars)
Exhibit 4 Monthly Average Price of Sulfur Dioxide Allowances under the Acid Rain Program
1,800
1,600
1,400
1,200
1,000
Allowance Price (dollars)
800
600
400
200
’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ‘11
Year
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39. What is the Coase Theorem?
The proposition that private market negotiations can achieve social efficiency, regardless of the initial definition of property rights
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40. How comprehensive is the Coase Theorem?
Only a small number of environmental problems qualify for Coase Theorem solutions
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41. Exhibit 5 Choosing the Efficient Amounts of Spark Trains and Farm Crops
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42. Which cases qualify for the Coase Theorem?
no transactions costs
no income effects
only two parties in the negotiation
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43. What is a transaction cost?
The costs of negotiating and enforcing a contract
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44. What is the free-rider problem?
If some people benefit while others pay, few will be willing to pay for improvement of the environment or other public goods
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45. What is the result of the free-rider problem?
Goods affected are underproduced
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46. What is Tragedy of the Commons?
Individuals will use an open access resource to the point of exhaustion, basing their use on private benefits while disregarding external costs to others.
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47. What is the conclusion to this chapter?
Neither government nor the markets can be asserted to be the best solution to environmental problems, although government is our best option
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48. END