Environment 134 Midterm 1

What are some major environmental issues identified by international organizations?

• Water issues, climate change, population issues, recycling, and gasoline tax

• Climate change issues: snowpack, water availability, agriculture, wildfires and changing landscapes, human health, sea level rise

What are the four core concepts of environmental economics?

1. The theory of environmental externalities

2. The optimal management of common property and public goods

3. The optimal management of natural resources over time

4. The economic valuation of environmental goods and services

What are externalities?

An effect of a market transaction that impacts, positively or negatively, those outside the transaction

What are public goods?

Public goods are commodities or services that every member of a society can use without reducing their availability to all others. Typically, a public good is provided by a government and funded through taxes.

What are some examples of common property resources?

Atmosphere and Oceans

What is included in the standard circular flow model? How are natural resources included in the model?

Firms, Goods and Services, Payments for them, Households, Land, Labor, Capital, Wages, Rents, Interest, Profits

• This closed-loop model does not recognize flows of natural resources and environmental pollutants/waste, except insofar as they are included in the general production factor of “land, goods, and services.”

What is sustainable development?

Maintaining the well-being of humans across time

Examples of Environmental Externalities

Pollution, Solar Power, Activities that result in CO2 emissions, Noise, Climate Change

What do we mean by “internalizing externalities”?

• Using approaches such as taxation to incorporate external costs into market decisions

• Including the cost of externalities in the equilibrium quantity and price of a product. Taking into account all the factors of production and the benefits to consumers and producers, we achieve the socially optimal point, with more benefits to the overall society.

How do we illustrate negative externalities in a market graph?

Negative externalities are illustrated by adding a new supply curve that includes externalities showing that the social optimal point of that product is in less quantity and higher price or vice versa for positive externalities.

What is a “socially optimal” outcome in the presence of negative externalities?

Socially optimal outcome for negative externalities is one where less quantity of the product is produced at a higher price. It is at the intersection of the social marginal costs and the demand curve.

What is a Pigovian tax?

A per-unit tax set equal to the external damage caused by an activity, such as a tax per ton of pollution emitted equal to the external damage of a ton of pollution-- reflects the polluter pays principle. Instituted so that the market shifts to the socially optimal point.

How would we illustrate a Pigovian tax in a market graph?

If we set the Pigovian tax exactly equal to the externality damage associated with each automobile, then the marginal cost of production shifts up so that it exactly equals the social marginal cost curve

What is welfare analysis? How is it used to measure efficiency?

• Welfare analysis measures the total welfare that is provided by economic activity such as CS+PS+tax- Ext.

• The most efficient measure of welfare is the one which provides the higher overall benefit to the society.

What is consumer surplus?

• Consumer surplus is how much a customer gains or benefits from a certain economic activity. It is the difference between the Willingness to Pay and the actual price of the product, in other words, what the consumer "saves".

• The difference between their benefits from the consumption of automobiles, as shown by the demand curve, and the price they pay

What is producer surplus?

• Producer surplus is what the producer gains from an economic activity. It is the difference between the lowest price they are willing to sell and the actual price of the product. It is what the producer "gains" from economic activity.

• The difference between their production costs, shown by the supply curve, and the price that they receive

How do we measure net social benefits on a market graph?

We can define the net social benefits of the market as the sum of consumer and producer surplus minus the externality damage or benefit. This measurement reflects the overall economic efficiency and welfare impact of market transactions.

What do we mean by “optimal” pollution? Why shouldn’t pollution levels be zero?

Optimal pollution is the pollution level that maximizes net social benefits. The only way to achieve zero pollution is to have zero production.

What is the Coase theorem? What does it say about the relationship between property rights and efficiency?

• If property rights are well defined and there are no transaction costs, an efficient allocation of resources will result even if externalities exist.

• If we could clearly assign property rights to all environmental externalities, further government intervention would not be required. The clear assignment of property rights appears to promise efficient solutions to problems involving externalities.

What is the free rider effect?

The free-rider effect is when you receive benefits from a public good or service without contributing to the cost of provision. It results in the undersupply of public goods.

What are some of the limitations of the Coase theorem?

• Does not work for multiple parties

• Free-rider effect

• Holdout effect: when one party possesses significant bargaining power and makes disproportionate demands

• Equity concerns: poorer communities may accept compensation for activities that are bad for the community and environment because of the need for money

• In reality, there are transaction costs associated with getting to a consensus.

What is a common property resource? What are some examples?

A resource that is available to everyone (nonexcludable), but use of the resource may diminish the quantity or quality available to others (rival). Examples: groundwater, ocean fishery.

What are the three phases of a total product curve for a common property resource?

• The first is a period of constant returns to scale: a proportional increase (or decrease) in one or more inputs results in the same proportional increase (or decrease) in input → each boat catches the same amount of fish per trip, throughout this period the fishery is not subject to rivalry

• The second phase is a period of diminishing returns (resource is rival with more competition): a proportional increase (or decrease) in one or more inputs results in a smaller proportional increase (or decrease) in output.

• The third phase is a period of absolutely diminishing returns: an increase in one or more inputs results in a decrease in output. → having more boats decreases total catch

How do we calculate total revenue, average revenue, and marginal revenue?

• Total Revenue = Price × Quantity

• Average Revenue = TR/Q = total revenue/units sold

• Marginal Revenue = ΔTR / ΔQ = change in total revenue/change in units

When does the efficient outcome occur? When does open-access equilibrium occur?

• efficient outcome —> MR=MC

• open-access equilibrium —> AR=AC

What is the tragedy of the commons? How might this problem be avoided?

• The tendency for common property resources to be overexploited because no one has an incentive to conserve the resource, while individual financial incentives promote expanded exploitation.

• This problem can be solved by imposing a license fee so that the market moves toward the social optimum point, by imposing quotas, or by getting an agreement between all parties. Individual transferable quotas (ITQs) are another option: tradable rights to harvest a resource, such as a permit to harvest a particular quantity of fish.

How can a license fee be used to improve economic efficiency? How can the price of the license fee be determined?

Imposing a license fee forces the market to move to the social optimum point, making overexploitation unprofitable. The price of the license fee is equal to the average revenue minus the average cost at the social optimum point.

How can transferable permits be used to improve economic efficiency? What is the advantage of using tradable permits instead of a license fee?

Tradable permits give individuals specific quotas to harvest the resource, so no one can overexploit. An advantage would be that people do not have to pay the government, allowing for more flexibility between the entities.

What are global commons? What special considerations might be required for managing a global commons?

• Global commons refer to shared resources or areas that are not subject to national sovereignty and are accessible to all countries and individuals.

• These resources typically include the atmosphere, oceans, outer space, and Antarctica. Special considerations for managing global commons include addressing the tragedy of the commons through effective governance and regulations, ensuring equitable access and benefit sharing, protecting the environment, promoting scientific research and monitoring, adhering to international law and cooperation, and fostering multilateral cooperation to address the complex environmental, social, and economic issues associated with these resources.

What is the total economic value?

Total Economic Value (TEV) is a concept used in environmental economics to quantify and assess the overall value of natural resources or environmental goods and services to society. TEV encompasses both direct and indirect contributions of ecosystems and environmental resources to human well-being, including both market and non-market values.

What are nonmarket benefits?

Nonmarket benefits are benefits provided by the environment that are not sold or bought in the market. Some examples are recreational areas, cultural significance, clean water and air.

What is the difference between willingness to pay and willingness to accept?

Willingness to pay is what a person is willing to pay for a service, while willingness to accept is how much compensation a person is willing to accept for decrease in environmental benefits.

What is the difference between use and nonuse values?

• Use values are those that people place on the tangible or physical benefits of a good or service → can be classified into direct-use value and indirect-use value

• Nonuse values are those that people obtain without actually using a resource (i.e., psychological benefits); nonuse values include existence, option, and bequest values.

What is the difference between direct use value and indirect use value?

• Direct use value: the value one obtains by directly using a natural resource, such as harvesting a tree or visiting a national park → can obtain a direct-use benefit even if we leave a natural resource relatively untouched

• Indirect-use value: ecosystem benefits that are not valued in markets, such as flood prevention and pollution absorption → benefits obtained from nature but without any effort on our part, also known as ecosystem services

What are the three types of non-use values?

Option value: preserving it because you want to visit it later

Bequest value: preserving it for future generation use

Existence value: value given by simply knowing the natural resource is preserved and exists.

What are the 5 categories of environmental analysis?

1. Market valuation

2. Cost of illness method

3. Replacement cost methods

4. Revealed preference methods

5. Stated preference methods

What is the cost-of-illness method?

• An approach for valuing the negative impacts of pollution by estimating the cost of treating illnesses caused by the pollutant

• Monetizes the direct and indirect costs associated with illnesses attributed to environmental factors

What are replacement cost methods? Why are these not measures of WTP or WTA?

• An approach to measuring environmental damages that estimates the costs necessary to restore or replace the resource, such as applying fertilizer to restore soil fertility.

• These approaches consider the costs of actions that provide human-made substitutes for lost ecosystem services

Not WTP or WTA because the cost of restoration is not determined by humans– it is determined precisely by the cost of materials and labor needed to replace a resource whether the market is willing to pay or accept that price is a different thing entirely

What are revealed preference methods? What are the three revealed preference methods?

Methods of economic valuation based on assumptions and market behaviors

1. Travel cost model

2. Hedonic pricing

3. Defensive expenditures

How can a travel cost model be used to estimate consumer surplus?

The travel cost can tell us what the minimum willingness to pay is for a person to consume a resource ex: go to a national park.

Travel cost models (TCMs): use statistical analysis to determine people’s willingness to pay to visit a natural resource such as a national park or river; a demand curve for the resource is obtained by analyzing the relationship between visitation choices and travel costs → one type is a zonal model

In order to estimate consumer surplus, we need an estimate of how the quantity demanded varies with price. The key insight of TCMs is to note that the cost to travel to a park or other recreation site varies for different visitors primarily based on their distance from it → CS area of triangle

Limitation of TCMs is that they can only estimate recreational use values, can’t provide the total economic value for a natural area because it cannot estimate indirect-use or nonuse benefits

How can hedonic pricing models be used to estimate economic values?

The use of statistical analysis to explain the price of a good or service as a function of several components, such as explaining the price of a home as a function of the number of rooms, the caliber of local schools, and the surrounding air quality

Based on the idea that environmental quality can affect the market prices of certain goods and services, hedonic pricing attempts to relate the price of a marketed good to its underlying characteristics. The most common application involves studying residential housing prices

For example, it obsoletes the relationship between housing and these environmental variables to extrapolate how much buyers are willing to pay for improved environmental quality.

How can the defensive expenditures approach be used to estimate economic values?

A pollution valuation methodology based on the expenditures households take to avoid or mitigate their exposure to a pollutant

Collects data on actual expenditures to obtain a lower-bound WTP for environmental quality changes, the most common application is drinking water quality

For example, the price they pay for water bottles when water is not suitable for drinking.

What are stated preference methods?

Economic valuation methods based on survey responses to hypothetical scenarios, including contingent valuation and contingent ranking, can be applied to any situation to determine the WTA or WTP for a hypothetical scenario.

What is contingent valuation?

An economic tool that uses surveys to question people regarding their willingness to pay for a good, such as the preservation of hiking opportunities or air quality/their willingness to accept compensation for loss of these goods. Can be used to find WTP and WTA.

What are some of the problems associated with contingent valuation?

Endowment effect, strategic bias, yea-saying, range bias, protest bids, nonresponse bias

Getting people to answer

WTA>WTP

What did the NOAA panel conclude about contingent valuation? What were some of the recommendations of the panel?

Best to ask WTP than WTA

Best asked in person

Yes/No questions

Follow-up questions

What is contingent ranking?

A survey method in which respondents are asked to rank a list of alternatives

• also a stated preference method, but respondents are not directly asked about their WTP

What is cost-benefit analysis (CBA)?

A tool for policy analysis that attempts to monetize all the costs and benefits of a proposed action to determine the net benefit.

What are the basic steps for doing a cost-benefit analysis?

1. List all costs and benefits

2. Nonmarket valuation is used to estimate the values of nonmarket goods (such as human health and ecosystem impacts)

3. If actual nonmarket values cannot be estimated, consider transferred values or expert opinions.

4. Add up all the costs and the benefits.

5. Compare total costs to total benefits to obtain a recommendation.

What are the two main ways of presenting the bottom-line result of a CBA?

Net Present Value (NPV): This is the total benefits minus the total costs, both discounted to present value.

• If the NPV is positive, the project is generally considered worthwhile.

Benefit-Cost Ratio (BCR): This is the ratio of the present value of benefits to the present value of costs.

• If the BCR is greater than 1, the benefits outweigh the costs.

How do economists value future costs and benefits?

Discounting Rate

• Costs and benefits that occur in the future should be assigned less weight (discounted) relative to current costs and benefits

• Present value of $X in the nth year

  • PV(Xn) = X/(1+r)n

  • n: the number of years in the future

  • X: future value

  • PV: present (or discounted) value of $X in the nth year

  • r: discount rate (annual rate at which future values are reduced, expressed as a proportion)

Is a high or low discount rate inherently better for environmental protection?

It should be set equal to the rate of low-risk investment (government bonds). The market rate of return represents the opportunity cost of spending money now.

A low discount rate is generally better for environmental protection because it gives more weight to future benefits and costs. That means long-term environmental benefits (like cleaner air or less climate damage) look more valuable today.

A high discount rate, by contrast, makes future impacts seem much smaller and less important, which can justify short-term gains at the environment’s expense.

What is a social discount rate?

The social discount rate/social rate of time preference (SRTP) is a discount rate that attempts to reflect the appropriate social valuation of the future; the SRTP tends to be less than market or individual discount rates.

What is the pure rate of time preference?

The pure rate of time preference is the rate of preference for obtaining benefits now as opposed to the future, independent of income level changes.

What is the value of a statistical life?

The willingness of society to pay to avoid one death based on valuations of changes in the risk of death

A VSL estimate, in theory, indicates how much society is willing to pay to prevent one death from environmental pollution, without any specific reference to whose death will be avoided.

What is wage-risk analysis? How is it used to calculate a VSL?

A method used to estimate the value of a statistical life based on the required compensation needed to entice people to high-risk jobs.

Wage-risk analysis can determine the extra wage necessary to induce workers to undertake riskier jobs.

What is the difference between risk and uncertainty?

Risk: A situation in which all potential outcomes and their probabilities are known or can be estimated.

Uncertainty: A situation in which some of the outcomes of an action are unknown or cannot be assigned probabilities.

How do economists calculate an expected value? What is the problem with using expected values in cases where people are risk-averse?

EV = probability of X * net benefit (or cost)

If we are risk-averse, we may wish to give greater consideration to the possibility of a dam failure. In a quantitative analysis, we could give added weight to any significant negative outcomes. Or we may apply the precautionary principle. Essentially, even if EV analysis shows the same value for two outcomes, people might want one more because it has less uncertainty or perceived risk.

What is benefit transfer?

Assigning or estimating the value of a resource based on prior analysis of one or more similar resources.

What is sensitivity analysis?

An analytical tool that studies how the outputs of a model change as the assumptions of the model change. It helps identify which variables have the most influence on the results, allowing decision-makers to understand the robustness of their conclusions.

What are some of the limitations of cost-benefit analysis?

Nonuse values can only be estimated by the stated preference methods (CV)

The discount rate can affect the future predicted cost

What is cost-effectiveness analysis? How does it differ from cost-benefit analysis?

A policy tool that determines the least-cost approach for achieving a given goal

It is different from CBA because it goes directly for the cheapest approach instead of looking at whether the difference of cost and benefit to see if something is worth it in market terms and evaluates outcomes in terms of effectiveness rather than monetary benefits.

What is positional analysis?

A policy analysis tool that combines economic valuation with other considerations such as equity, individual rights, and social priorities; it does not aim to reduce all impacts to monetary terms.