20 Externalities, the Environment, and Natural Resources Environmental taxes are perhaps the most...

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20Externalities, the

Environment, and Natural Resources

Environmental taxes are perhaps the most powerful

tool societies have for forging economies that protect

human and environmental health.DAVID MALIN ROODMAN, WORLDWATCH INSTITUTE

● Part 1: The Economics of Environmental Protection♦ Externalities: A Critical Shortcoming of the

Market Mechanism

♦ Supply-Demand Analysis of Environmental Externalities

♦ Basic Approaches to Environmental Policy

♦ Two Cheers for the Market

● Part 1: The Economics of Environmental Protection♦ Externalities: A Critical Shortcoming of the

Market Mechanism

♦ Supply-Demand Analysis of Environmental Externalities

♦ Basic Approaches to Environmental Policy

♦ Two Cheers for the Market

ContentsContents

● Part 2: The Economics of Natural Resources♦ Economic Analysis: The Free Market and

Pricing of Depletable Resources

♦ Actual Resource Prices in the 20th Century

● Part 2: The Economics of Natural Resources♦ Economic Analysis: The Free Market and

Pricing of Depletable Resources

♦ Actual Resource Prices in the 20th Century

Contents (continued)Contents (continued)

Part I: The Economics of Environmental

Protection

Externalities: Shortcoming of the Market MechanismExternalities: Shortcoming of the Market Mechanism

● Remember that the market tends to create an undesired abundance of damaging externalities.

● In this chapter we focus on one of the most publicized externalities--pollution.

● Remember that the market tends to create an undesired abundance of damaging externalities.

● In this chapter we focus on one of the most publicized externalities--pollution.

● The Facts: Is the World Really Getting Steadily More Polluted?♦ Our society faces serious environmental

problems.

♦ However, we should realize that many of our environmental problems have improved significantly in recent years.

● The Facts: Is the World Really Getting Steadily More Polluted?♦ Our society faces serious environmental

problems.

♦ However, we should realize that many of our environmental problems have improved significantly in recent years.

FIGURE 20-1 National Long-Term Air Quality Trends, 1975-1999

NAAQS 24-hour standard = 0.14 parts per million

NAAQS standard = 50 micrograms per cubic meter

NAAQS standard = 1.5 micrograms per

cubic meter

’95 ’90 ’85 ’80 1975 0

Old NAAQS 1-hour standard = 0.12 ppm

New NAAQS 8-hour standard = 0.08 ppm

’95 ’90 ’85 ’80 1975 0

Ozone (Smog)

Sulfur Dioxide

NAAQS annual standard = 0.03 parts per million

’99 ’95 ’90 ’85 ’80 1975 0

NAAQS 8-hour standard = 9 parts per million

’95 ’90 ’85 ’80 1975 0

Carbon Monoxide

NAAQS annual standard = 0.053 parts per million

’90 ’95 ’85 ’80 1975

Nitrogen Dioxide

Particulate Matter

’95 ’90 ’85 ’80 0

● The Facts: Is the World Really Getting Steadily More Polluted?♦ Not all pollution can be attributed to modern

industrialization■Medieval cities were littered w/garbage and stank

of rotting wastes■The automobile was hailed as an improvement in

cleanlines over problems regarding horse dung

● The Facts: Is the World Really Getting Steadily More Polluted?♦ Not all pollution can be attributed to modern

industrialization■Medieval cities were littered w/garbage and stank

of rotting wastes■The automobile was hailed as an improvement in

cleanlines over problems regarding horse dung

Externalities: Shortcoming of the Market Mechanism Externalities: Shortcoming of the Market Mechanism

● The Facts: Is the World Really Getting Steadily More Polluted?♦ Air quality in most U.S. cities has improved

over last 30 years

♦ 100% decrease in ambient concentrations of lead

● The Facts: Is the World Really Getting Steadily More Polluted?♦ Air quality in most U.S. cities has improved

over last 30 years

♦ 100% decrease in ambient concentrations of lead

● The Facts: Is the World Really Getting Steadily More Polluted?♦ Although environmental problems are neither

new nor confined to capitalist, industrialized economies, we continue to inflict damage on ourselves and our surroundings.

● The Facts: Is the World Really Getting Steadily More Polluted?♦ Although environmental problems are neither

new nor confined to capitalist, industrialized economies, we continue to inflict damage on ourselves and our surroundings.

● The Law of Conservation of Matter and Energy♦ Nothing can disappear completely.

♦ Once a material is used, it must be recycled or become a waste product.

● The Law of Conservation of Matter and Energy♦ Nothing can disappear completely.

♦ Once a material is used, it must be recycled or become a waste product.

FIGURE 20-2 Annual Mean Global Surface Air Temperature

2001 1980 1960 1940 1920 1900 1880 0

● The Role of Individuals and Governments in Environmental Damage♦ Firms create pollution, but so do private

individuals and governments.

● The Role of Individuals and Governments in Environmental Damage♦ Firms create pollution, but so do private

individuals and governments.

● Environmental Damage as an Externality♦ Environmental damage is usually an

externality because people do not pay directly for the damage they impose.

♦ Therefore, the unconstrained market system generates too much pollution.

● Environmental Damage as an Externality♦ Environmental damage is usually an

externality because people do not pay directly for the damage they impose.

♦ Therefore, the unconstrained market system generates too much pollution.

Supply-Demand Analysis of Environmental ExternalitiesSupply-Demand Analysis of Environmental Externalities

● Supply and demand curves for pollutants can be constructed.

● The supply curve represents the real costs to society.

● The problem is that since the cost is external, people behave as if it were zero.

● Supply and demand curves for pollutants can be constructed.

● The supply curve represents the real costs to society.

● The problem is that since the cost is external, people behave as if it were zero.

FIGURE 20-3 Free Dumping of Pollutants

0 25 20 15 10

5 Quantity of Garbage

Basic Approaches to Environmental PolicyBasic Approaches to Environmental Policy

● Voluntarism--this has proved to be unreliable

● Direct controls --these have been the chief instruments of environmental policy in the U.S.

● Taxes on pollution emissions--imposing penalties on polluters

● Voluntarism--this has proved to be unreliable

● Direct controls --these have been the chief instruments of environmental policy in the U.S.

● Taxes on pollution emissions--imposing penalties on polluters

Industrial Discharge of Heavy Metals, Netherlands, 1976-1994

Mercury

Cadmium

Copper

1994 1992 1988 1984 1980 1976 0

Lead 120

00) Zinc

● Emissions Taxes versus Direct Controls♦ Problems of direct controls:

■Enforcement issues■Inefficiencies in the clean up

● Emissions Taxes versus Direct Controls♦ Problems of direct controls:

■Enforcement issues■Inefficiencies in the clean up

Basic Approaches to Environmental PolicyBasic Approaches to Environmental Policy

●Enforcement Issues♦ Enforcement of direct controls requires

vigilance and enthusiasm by the regulatory agency.

♦ It also requires speed and rigor on the part of the court system.

●Enforcement Issues♦ Enforcement of direct controls requires

vigilance and enthusiasm by the regulatory agency.

♦ It also requires speed and rigor on the part of the court system.

Emissions Taxes versus Direct ControlsEmissions Taxes versus Direct Controls

●Enforcement Issues♦ Direct controls work only if the legal system

imposes significant penalties on violators.

♦ In contrast, pollution taxes are automatic and certain.

♦ The only sure way for the polluter to avoid paying pollution charges is to pollute less.

●Enforcement Issues♦ Direct controls work only if the legal system

imposes significant penalties on violators.

♦ In contrast, pollution taxes are automatic and certain.

♦ The only sure way for the polluter to avoid paying pollution charges is to pollute less.

●Efficiency in Cleanup♦ A second important advantage of emissions

taxes is that they tend to cost less than direct controls.

♦ Only polluters who can reduce emissions cheaply and efficiently can afford to take advantage of the built-in loophole--the opportunity to save on taxes by reducing emissions.

●Efficiency in Cleanup♦ A second important advantage of emissions

taxes is that they tend to cost less than direct controls.

♦ Only polluters who can reduce emissions cheaply and efficiently can afford to take advantage of the built-in loophole--the opportunity to save on taxes by reducing emissions.

●Advantages and Disadvantages♦ An emission is so dangerous that it must be

prohibited altogether

♦ A sudden change in circumstances calls for prompt and substantial changes in conduct

♦ Where effective and dependable pollution metering devices have not been invented or are too costly to install and operate.

●Advantages and Disadvantages♦ An emission is so dangerous that it must be

prohibited altogether

♦ A sudden change in circumstances calls for prompt and substantial changes in conduct

♦ Where effective and dependable pollution metering devices have not been invented or are too costly to install and operate.

● Another way for the government to control pollution is to sell or auction emissions permits.

● Emissions permits in many ways work like a tax--they make it too expensive for firms to continue polluting as much as before.

● Another way for the government to control pollution is to sell or auction emissions permits.

● Emissions permits in many ways work like a tax--they make it too expensive for firms to continue polluting as much as before.

Financial Device to Protect the Environment: Emissions PermitsFinancial Device to Protect the Environment: Emissions Permits

● One advantage of the permit approach over taxes is that it reduces uncertainty about the quantity of pollution that will be emitted.

Financial Device to Protect the Environment: Emissions PermitsFinancial Device to Protect the Environment: Emissions Permits

Two Cheers for the MarketTwo Cheers for the Market

● Through appropriate legislation, the forces of the market can be harnessed to correct the market’s own failings.

Part 2: The Economics of Natural Resources

Economic AnalysisEconomic Analysis

● A reliable indicator of the availability of depletable resources is the price of the resource.

Past Petroleum Prophecies (and Realities)

● Scarcity and Rising Prices♦ Resource scarcity prices

♦ Hotelling theorem ■Shows that the price of a depletable resource must

rise at the rate of interest■Assumes perfect competition■Assumes the costs of transportation and extraction

are negligible

● Scarcity and Rising Prices♦ Resource scarcity prices

♦ Hotelling theorem ■Shows that the price of a depletable resource must

rise at the rate of interest■Assumes perfect competition■Assumes the costs of transportation and extraction

are negligible

The Price of Economite Over Four Years

$121 $133.10 $146.41

2 Years Later 3 Years Later 4 Years Later

1 Year Later

Initial Date

● Supply-Demand Analysis and Consumption♦ The ever-rising prices accompanying

increasing scarcity of a depletable resource discourage consumption (encourage conservation).

♦ Even if quantity demanded grows, it will grow less rapidly than if prices were not rising.

● Supply-Demand Analysis and Consumption♦ The ever-rising prices accompanying

increasing scarcity of a depletable resource discourage consumption (encourage conservation).

♦ Even if quantity demanded grows, it will grow less rapidly than if prices were not rising.

FIGURE 20-4 Consumption over Time of a Depletable Resource

(b) (a)

120 110

Quantity Demanded

100 95 88

Quantity Demanded

Actual Resource Prices in the Twentieth CenturyActual Resource Prices in the Twentieth Century

♦ In fact, the real prices of natural resources have grown much slower than the rate of interest, if at all.

FIGURE 20-5 Real Prices of Lead, Zinc, and Copper, 1900-2000

2000 1930 1940 1990 1980 1970 1920 1950 1910 1900 1960

Copper

● Interferences with Price Patterns♦ Unexpected discoveries of reserves whose

existence was previously not suspected

♦ Invention of new methods of mining and refining that may significantly reduce extraction costs

♦ Price controls that hold prices down or decrease them

● Interferences with Price Patterns♦ Unexpected discoveries of reserves whose

existence was previously not suspected

♦ Invention of new methods of mining and refining that may significantly reduce extraction costs

♦ Price controls that hold prices down or decrease them

FIGURE 20-6 Price Effects of a Discovery of Additional Reserves

After discovery

Before discovery

Quantity in Millions of Tons

● Is Price Interference Justified?♦ Market sets quantity demanded = quantity

supplied even if a finite resource is undergoing rapid depletion.

♦ Reason: price adjustments

♦ Any shortage must be artificial due to a decision to prevent the price mechanism from doing its job.

● Is Price Interference Justified?♦ Market sets quantity demanded = quantity

supplied even if a finite resource is undergoing rapid depletion.

♦ Reason: price adjustments

♦ Any shortage must be artificial due to a decision to prevent the price mechanism from doing its job.

FIGURE 20-7 Controls on the Price of a Resource

5 4 2 0

Quantity in Millions of Tons

● On the Virtues of Rising Prices♦ Rising prices help to control resource depletion

■Promote conservation■Stimulate more efficient use■Encourage the discovery of alternate resources and

techniques

● On the Virtues of Rising Prices♦ Rising prices help to control resource depletion

■Promote conservation■Stimulate more efficient use■Encourage the discovery of alternate resources and

techniques

Growing Reserves of Exhaustible ResourcesGrowing Reserves of Exhaustible Resources

● Over time, the known reserves of many resources have actually increased, probably because rising prices induced exploration and discovery.

20 Externalities, the Environment, and Natural Resources Environmental taxes are perhaps the most...

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