Module_3_-_Environmental_Economics.pdf

Module 3 Environmental

Economics

Environmental Economics Externalities How to value externalities Application in relation to Climate Change

Topics

I. What is Environmental Economics? Economics is the study of the allocation of scarce

resources. Note that the theories of economics can be applied to

any scarce resource, not just traditional commodities. Economics is not simply about profits or money. It

applies anywhere constraints are faced, so that choices must be made.

Economists study how incentives affect peoples behaviour.

Environmental Economics

Environmental and natural resource economics is the application of the principles of economics to the study of how environmental and natural resources are developed and managed. Natural resources resources provided by nature that

can be divided into increasingly smaller units and allocated at the margin.

Environmental resources resources provided by nature that are indivisible.

Natural resources serve as inputs to the economic system. Environmental resources are affected by the system (e.g. pollution).

Environmental Economics

Why do we use economics in environment policy? The main reason is that in our society the

environment has become a scarce resource. Since economics is about how to deal with scarce resources, it can often be useful when tackling environmental problems.

Economic and environmental objectives are often perceived as being contradictory. It is believed that a choice must be made between one and the other and that both cannot be achieved concurrently

Environmental Economics

One way of using economics is to ensure that the costs and the benefits of environmental measures are well balanced. Although it is difficult to estimate costs and benefits, there is an increasing demand that this is done before environmental policy is decided on a European level. With the use of market-based instruments, environmental goals can sometimes be reached more efficiently than with traditional command and control regulations.

Method of application of environmental economics is to value externalities

Value the full lifecycle of a product And express it all in terms of money

Environmental Economics

What are externalities? An externality is a consequence of an industrial or

commercial activity which affects other parties without this being reflected in market prices, such as the pollination of surrounding crops by bees kept for honey.

Air pollution is an externality Spraying insecticides or herbicides both have external

consequences Externalities can be negative or positive

Externalities

A negative externality (also called "external cost" or "external diseconomy") is an economic activity that imposes a negative effect on an unrelated third party. It can arise either during the production or the consumption of a good or service.Examples of negative externalities include:

Air pollution from burning fossil fuels.Water pollution by industries that adds effluent, which harms plants, animals, and humans.Noise pollution during the production process, which may be mentally and psychologically disruptive.

Negative Externalities

Negative effects of Industrial farm animal production, including "the increase in the pool of antibiotic-resistant bacteria because of the overuse of antibiotics; air quality problems; the contamination of rivers, streams, and coastal waters with concentrated animal waste; animal welfare problems, mainly as a result of the extremely close quarters in which the animals are housed.

The depletion of the stock of fish in the ocean due to overfishing. This is an example of a common property resource, which is vulnerable to the Tragedy of the commons in the absence of appropriate environmental governance.

Negative Externalities

The cost of storing nuclear waste from nuclear plants for more than 1,000 years (over 100,000 for some types of nuclear waste) is included in the cost of the electricity the plant produces, in the form of a fee paid to the government and held in the nuclear waste superfund. Conversely, the costs of managing the long term risks of disposal of chemicals, which may remain permanently hazardous, is not commonly internalized in prices. The USEPA regulates chemicals for periods ranging from 100 years to a maximum of 10,000 years, without respect to potential long-term hazard.

Negative Externalities

A positive externality (also called "external benefit" or "external economy" or "beneficial externality") is an economic activity that imposes a positive effect on an unrelated third party.

Examples include: A beekeeper who keeps the bees for their honey. A side

effect or externality associated with such activity is the pollination of surrounding crops by the bees. The value generated by the pollination may be more important than the value of the harvested honey.

Positive Externalities

The construction and operation of an airport. This will benefit local businesses, because of the increased accessibility.

A industrial company providing first aid classes for employees to increase on the job safety. This may also save lives outside the factory.

A foreign firm that demonstrates up-to-date technologies to local firms and improves their productivity.

Positive Externalities

While it is relatively straightforward to assess the social costs of activities that affect marketable goods directlyfor example, the social cost of a factory whose smoke emissions harm the business of a nearby laundryit is much more difficult to determine social costs if there is uncertainty about the physical extent of the externality and the amount of harm that a specified extent of the externality causes.

Externalities in Climate Change

As an example, while there is considerable agreement that todays emissions of CO2 have social costs that deserve attention, there is much less agreement about the magnitude of these costs, partly because of uncertainty about the impact of emissions of CO2 on climate and partly because of uncertainty about the economic costs of Climate Change.

Externalities of Climate Change

The economic cost of climate change is high: an annual $12 billion increase in electricity bills due to added air conditioning; $66 billion to $106 billion worth of coastal property damage due to rising seas; and billions in lost wages for farmers and construction workers forced to take the day off or risk suffering from heat stroke or worse.

By the end of the century, these costs and others put a combined price tag of hundreds of billions of dollars on climate change in the United States alone.

Externalities of Climate Change

This is not the case in the worlds poorest countries where climate change is projected to dramatically reduce incomes for the most affected. As just one measure, research has shown that the effect of very hot days on mortality in India is nearly 20 times as greater as in the United States where people simply turn up the air conditioning on hot days.

Other developing countries, like Bangladesh, are expected to lose substantial fractions of their land mass due to rising water levels. For these people, confronting climate change is quite literally a matter of life or death.

Externalities of Climate Change

We know the looming costs of climate change will weigh heavily on every country around the world in the coming decades.

The question is, what do we do about it? How do we rationalize making investments to prevent future

threats to society when so many investments need to be made to prevent current threats?

While complex politically, the economic case for reducing greenhouse gas emissions has always been simple: put a higher price on things that cause harm.

As previously discussed we now know what negative externalities are.

Climate change is the ultimate negative externality. That is, when someone anywhere in the world drives their car or turns on their lights they are causing damages for everyone else in the world.

Externalities of Climate Change

A very simple solution to this problem, which economists recognize and teach, is to penalize activities that cause damages to others.

To date, lawmakers around the world have largely chosen to ignore this basic economic insightthe result is that we are subsidizing the activities that cause climate change by failing to put a price on carbon emissions.

As a consequence, polluters all over the world are causing the climate to change in ways that pose risks to the well-being of our children, their children, and on and on.

Possible Solution

Fortunately, in the last several years, the United States has taken significant steps in the right direction, most notably through the U.S. Environmental Protection Agencys recent carbon rules.

Other countries are also signalling their willingness to take climate change seriously, such as, importantly, China, which has incorporated pilot cap-and-trade programs into their next five-year plan.

Finally there is a price on carbon.

Carbon Pricing

Carbon pricing the method most favoured by economics for reducing global-warming emissions charges those who emit carbon dioxide (CO2) for their emissions.

That charge, called a carbon price, is the amount that must be paid for the right to emit one tonne of CO2 into the atmosphere.

Carbon pricing usually takes the form of a carbon tax or a requirement to purchase permits to emit (also called "allowances").

Because such permits are privately tradable and emissions are limited to the total number of available permits (the cap), this system is known as cap-and-trade.

Carbon Pricing

A classic cap-and-trade design works in one of two ways. First, the government establishes an emissions cap, for

example 1000 tons/year, and prints 1000 permits to emit 1 ton.

Then it either (1) gives the permits to stakeholders in some politically or administratively determined way, or (2) auctions them off to the highest bidder.

After the permits have been distributed one way or the other, they can be traded privately.

Since emitters must have permits to cover their emissions (or face a penalty that would cost more than buying permits), emissions will be limited to the cap.

If the cap is low, permits will be in short supply (scarce) and the price of permits will be high

Cap and Trade

Like a carbon tax, a cap is generally applied to fossil fuel in proportion to its carbon content.

Generally, coverage is partial, for example it may be limited to the electric industry.

The main difference between the two systems is that the market for permits automatically adjusts the carbon price to a level that insures that the cap is met, while under a carbon tax, the government and not the market sets the price of carbon.

Cap and Trade

There is a very real need to accurately value the true cost of climate change.

A way of doing this is to value the externalities of climate change.

The carbon price and cap and trade mechanisms certainly go towards that end.

But, it is dependent on market mechanisms Will that be a true reflection of the damage of climate

change? If the market floods with carbon credits, the price reduces.

Conclusion

Carbon Pricing: Early Experience and Future Prospects, edited by John Quiggin, David Adamson, Daniel Quiggin

Carbon Emissions Pricing Policy: Technical Backgrounder. Canada Government.

Building a Low-carbon Economy: The Uk's Contribution to Tackling Climate Change, Committee on Climate Change, Great Britain.

Further Reading