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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
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
● 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)
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Part I: The Economics of Environmental
Protection
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
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.
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
Externalities: Shortcoming of the Market MechanismExternalities: Shortcoming of the Market Mechanism
● 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
FIGURE 20-1 National Long-Term Air Quality Trends, 1975-1999
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
NAAQS 24-hour standard = 0.14 parts per million
NAAQS standard = 50 micrograms per cubic meter
’99
’99
’99
’99
’99
NAAQS standard = 1.5 micrograms per
cubic meter
’95 ’90 ’85 ’80 1975 0
0.4
0.8
1.2
1.6
Mic
rog
ram
s p
er
Cu
bic
Me
ter
Lead
Old NAAQS 1-hour standard = 0.12 ppm
New NAAQS 8-hour standard = 0.08 ppm
0.030
0.025
0.020
0.015
0.010
0.005
0.16
’95 ’90 ’85 ’80 1975 0
0.04
0.08
0.12
Par
ts p
er M
illi
on
Ozone (Smog)
Sulfur Dioxide
NAAQS annual standard = 0.03 parts per million
’99 ’95 ’90 ’85 ’80 1975 0
Par
ts p
er M
illi
on
NAAQS 8-hour standard = 9 parts per million
’95 ’90 ’85 ’80 1975 0
4
8
16
12
Par
ts p
er M
illi
on
Carbon Monoxide
NAAQS annual standard = 0.053 parts per million
0.08
’90 ’95 ’85 ’80 1975
1975
0
0.02
0.04
0.06
Par
ts p
er M
illi
on
Nitrogen Dioxide
Particulate Matter
80
’95 ’90 ’85 ’80 0
20
40
60
Mic
rog
ram
s p
er
Cu
bic
Me
ter
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
● 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
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
● 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
Externalities: Shortcoming of the Market Mechanism Externalities: Shortcoming of the Market Mechanism
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
● 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.
Externalities: Shortcoming of the Market Mechanism Externalities: Shortcoming of the Market Mechanism
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
● 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.
Externalities: Shortcoming of the Market MechanismExternalities: Shortcoming of the Market Mechanism
FIGURE 20-2 Annual Mean Global Surface Air Temperature
FIGURE 20-2 Annual Mean Global Surface Air Temperature
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
2001 1980 1960 1940 1920 1900 1880 0
13.4
13.6
13.8
14.0
14.2
14.4
14.6
14.8
Tem
per
atu
re (
°C)
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
Externalities: Shortcoming of the Market MechanismExternalities: Shortcoming of the Market Mechanism
● 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.
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
Externalities: Shortcoming of the Market MechanismExternalities: Shortcoming of the Market Mechanism
● 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.
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
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
FIGURE 20-3 Free Dumping of Pollutants
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
S
S
0 25 20 15 10
P
Pri
ce p
er T
on
per
Yea
r o
f G
arb
age
Rem
ove
d
5 Quantity of Garbage
T T
D
A
E
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
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
Industrial Discharge of Heavy Metals, Netherlands, 1976-1994
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Mercury
Cadmium
Copper
1994 1992 1988 1984 1980 1976 0
25
50
75
100
Lead 120
150
Ind
ex (
1976
= 1
00) Zinc
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
● 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
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
●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.
Emissions Taxes versus Direct ControlsEmissions Taxes versus Direct Controls
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
●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.
Emissions Taxes versus Direct ControlsEmissions Taxes versus Direct Controls
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
●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.
Emissions Taxes versus Direct ControlsEmissions Taxes versus Direct Controls
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
● 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
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
● One advantage of the permit approach over taxes is that it reduces uncertainty about the quantity of pollution that will be emitted.
● 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
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
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.
● 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
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
Economic AnalysisEconomic Analysis
● A reliable indicator of the availability of depletable resources is the price of the resource.
● A reliable indicator of the availability of depletable resources is the price of the resource.
Past Petroleum Prophecies (and Realities)
Past Petroleum Prophecies (and Realities)
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
Economic AnalysisEconomic Analysis
● 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
The Price of Economite Over Four Years
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
$121 $133.10 $146.41
2 Years Later 3 Years Later 4 Years Later
$110
1 Year Later
$100
Initial Date
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
Economic AnalysisEconomic Analysis
● 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
FIGURE 20-4 Consumption over Time of a Depletable Resource
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
(b) (a)
120 110
D1
D1
$121
A
100
100
110
0
Pri
ce p
er T
on
Quantity Demanded
100 95 88
100
110
D
D 0
Pri
ce p
er T
on
Quantity Demanded
$121
D2
D2
G
F
C
A
B
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
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.
♦ 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
FIGURE 20-5 Real Prices of Lead, Zinc, and Copper, 1900-2000
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Pri
ce
pe
r P
ou
nd
(in
Co
ns
tan
t 1
98
2 C
en
ts)
160
180
0
20
40
60
80
100
120
140
2000 1930 1940 1990 1980 1970 1920 1950 1910 1900 1960
Zinc
Copper
Lead
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
Actual Resource Prices in the Twentieth CenturyActual Resource Prices in the Twentieth Century
● 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
FIGURE 20-6 Price Effects of a Discovery of Additional Reserves
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
0
After discovery
Before discovery
Pri
ce p
er T
on
Quantity in Millions of Tons
S1
S1
P2
P1
S2
S2 D
D
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
Actual Resource Prices in the Twentieth CenturyActual Resource Prices in the Twentieth Century
● 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
FIGURE 20-7 Controls on the Price of a Resource
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
5 4 2 0
Pri
ce p
er T
on
Quantity in Millions of Tons
D
D
P*
P
S
S
A B
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
Actual Resource Prices in the Twentieth CenturyActual Resource Prices in the Twentieth Century
● 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
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
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.
● Over time, the known reserves of many resources have actually increased, probably because rising prices induced exploration and discovery.
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