Ch. 20 - Economics on the Environment

How economic activity affects the fragile biosphere of our planet, and how the resulting environmental problems can be addressed:

• Economic activities, such as the production and distribution of goods and services, inevitably alter the biosphere.

• Climate change, driven by economic activities, poses a significant threat to human well-being and presents challenges in creating effective environmental policies.

• Well-conceived environmental policies strive for cost-effective methods to minimize environmental damage and weigh the costs against the benefits of reduction efforts.

• Some policies implement taxes or subsidies to adjust prices, encouraging individuals to incorporate the environmental impacts of their consumption and production decisions; other policies may impose restrictions on harmful materials and practices.

• Certain environmental systems can undergo substantial and often irreversible damage, and prudent policies aim to prevent triggering such degradation processes.

• Assessing environmental policies raises complex questions regarding how to value natural resources and the welfare of future generations.

20.2 — Climate Change

• Key characteristics shared with other environmental issues include:

  • Stabilization of yearly emissions is insufficient.

  • Climate change is irreversible.

  • The worst-case scenario must be considered.

  • It is a global issue that necessitates international collaboration.

  • There are inherent conflicts of interest.

20.3 — Abatement of Environmental Damages: Cost-Benefit Analysis

• Climate change mitigation can be achieved through policies aimed at reducing environmental damage, including:

  • Discovering and implementing cleaner technologies.

  • Reducing the consumption of environmentally damaging goods.

  • Banning or restricting harmful substances or activities.

• Abatement policies reduce pollution and environmental damage, measured by the quantity of abatement, which can include emissions taxes and incentives for fuel-efficient vehicles.

• The global greenhouse gas abatement cost curve illustrates the costs associated with abatement efforts.

• A steeper cost frontier indicates lower opportunity costs for environmental improvements.

MRS (Marginal Rate of Substitution)

• The policymaker’s MRS reflects citizens' consumption values. It is high (steep curve) if citizens highly value consumption but do not prioritize further environmental improvements, and vice versa.

• If both marginal utilities (of consumption and environmental quality) remain constant, they do not fluctuate with the amount of consumption or abatement.

Cost-Benefit Analysis in Policy Decision-Making

• Ideal policymakers select abatement levels by considering:

  • Only those policies on the frontier of feasible options—avoiding higher-cost policies within shaded areas.

  • The combination of environmental quality and consumption that maximizes their indifference curve.

• Finding the point on the feasible frontier where the MRT (Marginal Rate of Transformation) aligns with the MRS is crucial.

• Variations in values or abatement costs can lead to different abatement choices.

20.4 — Conflicts of Interest

• Marginal Rate of Substitution for both citizens and business owners affects the bargaining dynamic influenced by:

  • Enforcement capacity.

  • Reliable information.

  • Citizen consensus.

  • Lobbying.

  • Legal recourse.

20.5 — Cap and Trade Environmental Policies

• The cap and trade system merges a regulatory emission limit with an incentive-based approach to allocate required abatement among firms.

  • Governments set total required abatement levels, create permits, and these permits are tradable.

  • Firms submit permits that cover their emissions.

• Determining the optimal price for carbon emissions presents advantages and disadvantages between cap and trade systems and carbon taxes.

  • A cap and trade method with a low cap is typically favored for its flexibility.

  • A high carbon tax could effectively offset external costs but may face political challenges.

20.6 — Measurement Challenges in Environmental Policy

• Two key methods for measuring abatement benefits are:

  • Contingent Valuation: A stated preference approach where individuals express their values via surveys.

  • Hedonic Pricing: A revealed preference method using economic behaviors to uncover preferences.

• Both methods aid in assessing how individuals value environmental changes based on their experiences.

Natural Capital and Green Growth

• Depreciation signifies the wear and tear of physical capital in production.

• In green growth accounting, the environment is treated as an asset subject to depreciation, making economic growth appear less favorable.

• Willingness to pay (WTP) reflects citizens’ valuation of environmental improvements, with a safe environment often regarded as a right—a merit good.

20.7 — Dynamic Environmental Policies

• Advancements in technology can enhance the marginal rate of transformation concerning the trade-off between consumption and abatement efforts.

20.8 — Environmental Dynamics

• Equilibrium plays a crucial role in predicting prices and unemployment levels.

• Stability in equilibrium signifies no change over time, while negative feedback processes counterbalance initial shocks, whereas positive feedback can amplify them, leading to tipping points.

• Prudential policies aim to avert the risks of irreparable environmental degradation.

• Planetary boundaries are established for critical ecological variables to prevent surpassing tipping points.

20.10 — The Importance of Policy Choices

• The Environmental Performance Index (EPI) measures country-level ecological health and ecosystem vitality, including wastewater management, fisheries, and forestry.

• The fairness of the 'polluter pays' principle is a fundamental consideration in environmental policy economics.