1. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 1 ECON Designed by Amy McGuire, B-books, Ltd. McEachern 2008-2009 17 CHAPTER Externalities and the Environment Micro

2. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 2 Renewable Resources LO 1  Used conservatively –Can be drawn on indefinitely  Some are open-access  Common-pool problem –People exploit a resource Personal marginal benefit > personal marginal cost –Personal marginal cost Ignores costs imposed on others

3. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 3 Renewable Resources LO 1  Not owned as private property  Open-access resources –No private property rights –Negative externalities

4. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 4 Resolving the Common-Pool Problem LO 1  Open-access resources  Government regulation –Output restrictions –Taxes –Use resource: socially optimal rate –Improve allocative efficiency

5. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 5 Optimal Level of Pollution LO 2  External costs with fixed technology –Fixed-production technology Cut emissions: cut production –Marginal social cost Marginal private cost Marginal external cost

6. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 6 Optimal Level of Pollution LO 2  Socially efficient production –Demand (marginal benefit) intersects marginal social cost curve –Government regulation Limit production Tax = marginal external cost –Marginal social cost = marginal benefit –Total social gain Total social cost (firms ignore external cost)

7. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 7 Exhibit 1 LO 2 Negative Externalities: The Market for Electricity in the Midwest 0.10 $0.14 Dollars per kilowatt-hour Marginal social cost Marginal private cost; 50 million kilowatt-hours of electricity are produced per month. The marginal external cost of production is imposed on society. 350 Millions of kilowatt-hours of electricity per month 50 Marginal private cost D a c Marginal social cost; only 35 millions kilowatts-hour are produced, which is the optimal output. Marginal social cost curve includes marginal private cost and marginal external cost. Total social gain b

8. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 8 Optimal Level of Pollution LO 2  External costs with variable technology –Variable technology Reduce emissions: alter the production process Cleaner technology –Production of cleaner air Diminishing returns

9. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 9 Optimal Level of Pollution LO 2  Reducing greenhouse gases –Marginal social cost curve Upward-sloping –Marginal social benefit curve Downward-sloping Diminishing marginal benefit to society –Optimal level of air quality Marginal social benefit = marginal social cost –Higher than optimal level of air quality Social waste

10. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 10 Exhibit 2 LO 2 The Optimal Reduction in Greenhouse Gas Emissions Dollars per unit Total social gain Marginal social cost Marginal social benefit AHigh Greenhouse gas emissions A’Low a b c Optimal level of greenhouse gas emissions: point a; marginal social benefit of reducing such emissions = the marginal social cost If some lower level of emissions were dictated by the government, the marginal social cost would exceed the marginal social benefit, and social waste would result.

11. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 11 Optimal Level of Pollution LO 2  Shift in marginal social cost curve –Technological breakthrough: Lower marginal cost of cutting greenhouse gas Downward shift of MSC curve Lower optimal level of emissions  Shift in marginal social benefit curve –Higher marginal benefit of reducing emissions Upward shift of MSB curve Lower optimal level of emissions

12. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 12 Exhibit 3 LO 2 Effect of Changes in Costs or Benefits of Reducing Greenhouse Gas Emissions Marginal social benefit Marginal social cost Dollars per unit A 0 A’ Higher quality air Marginal social benefit Marginal social cost Dollars per unit A 0 A’’ Higher quality air MSC’ (a) Lower cost of reducing emissions(b) Greater benefit of reducing emissions MSB’

13. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 13 LO 2 Case Study The Lungs of the Planet  Tropical rainforests = open-access  Recycle carbon dioxide: oxygen and wood  6-7% of Earth’s land surface  Half of world’s plant and animal species  In relatively poor countries  Burn forest  Pasture  Farmland  Growing demand for timber

14. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 14 LO 2 Case Study The Lungs of the Planet  ‘Slash and burn’  Add greenhouse gas to atmosphere  Reduces atmosphere’s ability to clean itself  Flash floods  Mud slides  Soil erosion, lost nutrients  Lost ecosystem

15. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 15 LO 2 Case Study The Lungs of the Planet  Tropical rainforest  Benefits around the globe  Little immediate personal cost  Costs of deforestation: around the globe  Solution  Property rights

16. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 16 Optimal Level of Pollution LO 2  The Coase theorem –For low transaction costs –Efficient solution Least cost solution Assign property right to one party One side bears the externality cost –Inefficient outcome If high transaction cost If large number of parties involved

17. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 17 Optimal Level of Pollution LO 2  Market for pollution rights –Government Sells pollution rights Limits maximum level of pollution per day –Firms D = marginal value of pollution Buy pollution rights –Value of pollution permits Fluctuates

18. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 18 Exhibit 4 LO 2 Optimal Allocation of Pollution Rights 100 0 250 Tons of discharge per day Dollars per ton 25 $35 D’ D S Suppose the demand for a river as a discharge service is D. No environmental controls: polluters dump 250 tons per day, where the marginal benefit of discharge is zero. Regulatory authorities: establish 100 tons as the maximum daily level of discharge and then sell the rights, the market for these pollution rights clears at $25 per ton. If the demand for pollution rights increases to D’, the market-clearing price of pollution rights rises to $35 per ton.

19. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 19 Pollution Rights and Public Choice LO 2  Pollution regulation –Special interest of polluters  Before 1990 –Command-and-control environmental regulations Particular technologies to reduce emissions  Market for pollution rights –Economic efficiency approach Reduce emissions: Cost-effective

20. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 20 Environmental Protection  Environmental Protection Agency EPA  Clean Air Act of 1970  Clean Water Act of 1972  Resource Conservation and Recovery Act of 1976  Superfund Law of 1980 LO 3

21. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 21 Air Pollution  Atmosphere  Economic resource  People value clean air; willing to pay more  Smog  40% from automobile emissions  40% from consumer products  15% from manufacturing LO 3

22. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 22 Air Pollution  Clean Air Act of 1970  90% reduction in auto emissions  By 1990, average emissions fell  Lead: 97%  Monoxide: 41%  Sulfur dioxide: 25%  U.S. air quality: good  U.S. – major source of fossil-fuel carbon dioxide emissions LO 3

23. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 23 Exhibit 5 LO 3 Fossil-Fuel Carbon Dioxide Emissions per Capita: The 25 Worst Nations

24. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 24 LO 3 Case Study Makesicko City  Mexico City  Population increase  From 3 million in 1950  To 20 million today  More industry; More vehicles  High pollution; Low oxygen, Tropical sun  Average commuting time: 4 hours/day  Low incomes  Environmental quality = luxury

25. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 25 Water Pollution  Sources  Sewage  Chemicals  Sewage  Dumped into waterways; no cleaning  Negative externality  Federal money: treatment plants LO 3

26. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 26 Water Pollution  Chemicals  10% from point pollution  Factories, industrial sites  Two thirds – from nonpoint pollution  Agricultural pesticides and fertilizers  In most states: pesticides have fouled some groundwater LO 3

27. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 27 Hazardous Waste and the Superfund  Before 1980  Firms  Pay others to haul and dispose  Not responsible for cleaning  Superfund Law of 1980  Companies  Pay others to haul and dispose  Pay for clean up LO 3

28. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 28 Solid Waste: “Paper or Plastic?”  U.S. households  4 pounds of garbage per resident per day  Mostly packaging  200 million tons per year  70% of garbage - landfills  Recycled: 15% of garbage  75% paper products  15% - incinerated  Trash-to-energy plants LO 3

29. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 29 Exhibit 6 LO 3 Paper and Cardboard Recycling: Top 25 among Advanced Economies

30. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 30 Solid Waste: “Paper or Plastic?”  2 out of 3 aluminum cans: recycled  Returnable deposit laws  Increase recycling  Recycling: imposes environmental costs  Curbside recycling  Trucks  Newsprint  De-inked LO 3

31. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 31 Positive Externalities LO 4  Beneficial externalities  Education –Personal benefits –Benefits to society Positive externality  Public policy –To increase quantity beyond private optimum

32. Chapter 17Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 32 Exhibit 7 LO 4 Education and Positive Externalities No government intervention: equilibrium quantity of education (E); marginal private benefit of education equals the marginal cost as reflected by the supply curve. Education also confers a positive externality on the rest of society, so the social benefit exceeds the private benefits. At E, the marginal social benefit exceeds the marginal cost, so more education increases social welfare. In this situation, government tries to increase education to E’, where the marginal social benefit equals the marginal cost.