INTRODUCTION TO ENVIRONMENTAL ECONOMICS

Meaning of environmental economics

Economics is concerned with decision making by agents, which include consumers, firms,
government agencies, and non-profit organizations like environmental advocacy groups.
- One goal of economics is to understand what motivates particular decisions. This
knowledge is used to anticipate (or predict) what decisions agents will make in
particular contexts.
- Want to be able to predict behaviour in order to use agents’ incentives and
motivations to achieve social goals -- to conduct public policy when we think it is
appropriate.
Environmental economics is the study of agent’s decisions that have environmental
consequences and how to affect these decisions to achieve environmental quality goals.
Three fundamental issues:
1. What is environmental degradation and why do we have it?
2. What level of environmental quality should we strive for?
3. How do we design institutions to improve and/or protect environmental quality?

Institutions refer to the basic organizational structure of society like laws, social customs,
markets, firms, governments (at all levels), etc.

Why do we have environmental pollution?

a) Environmental degradation is the result of immoral or unethical behaviour.

b) Environmental degradation is the result of the profit motive.
c) Environmental degradation is the result of the lack of information.

Waste products are an inevitable consequence of consumption and production activities.

Once we accept that waste products are inevitable we have a very practical problem:

Again, why do we have pollution?

How to dispose of the waste that is generated by consumption and production activities?
And, agents will look for the cheapest way to get rid/clear of the waste.

Example: A household simply burned waste. That was the cheapest way to get rid of it. And,
it didn’t hurt anyone. This is typical. Individual decisions about waste disposal usually do not
change the environment at all. However, when lots of people burn their household trash it
becomes a problem.

The Design of Environmental Policy

Suppose we are faced with a pollution problem. What can society do to mitigate the problem?
As a matter of public policy, we would change the institutions that people operate under in
order to change the incentives they face.
Now think about a coal-fired power plant. And suppose we want to make sure that its
emissions into the air are limited. How do we do this?

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First, we have to decide how much emissions we are going to allow. Then we have lots of
options
a) Tell its managers, “If this plant emits more than __ tons of sulphur-dioxide a year,
you’ll face fines or jail terms.”
b) Require the managers of the plant to install a particular device that “scrubs” the
emissions as they leave the smokestack.
c) Tell the plant managers, “You can emit as much as you want but you must pay a tax
for every ton of emissions.”
Each of these policies changes the incentives that managers face, and if implemented
properly will result in lower emissions. But, how do we choose among these options?

Economic Criteria for Policy Evaluation

(1) Efficiency -- the social benefit minus the social cost of a regulation is as large as
possible.
(2) Cost-effectiveness -- an environmental target is reached at least cost.
(3) Fairness -- How are the costs and benefits of a policy distributed among income
classes, races, geographical locations, industries, etc.?
(4) Incentives for innovation -- we would like environmental policies to motivate
sources of pollution to look for better (cheaper) ways to control emissions and to
motivate victims to look for ways to protect themselves.
(5) Enforceability -- Everything else equal, policies that are easier to enforce are
preferred.

If a policy is efficient it must also be cost-effective. Sometimes it is not possible to determine

an efficient policy, but we can almost always design one that is a cost-effective. In general,
efficient or cost-effective policies are not necessarily fair.

The primary linkages among economic activity, human welfare, and the environment.

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The Trade-off Between “Economic Goods” and Environmental Quality

Often imagine a negative (or inverse) relationship between regular economics goods and
environmental quality. To get more economic production we usually need to degrade the
environment some. To get better economic quality we need to forego some economic
production. Illustrate this relationship with a Production Possibilities Curve between
economics goods and environmental quality.

The PPC gives us combinations of some index of economic goods consumption (e.g., Net
National Product) and environmental quality that are feasible. Feasibility refers to
technological capabilities for production and how production affects environmental quality at
a point in time. If we want economic output to be C1 we can achieve at best environmental
quality level E1.

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Although the PPC is determined by the state of technology, availability of raw materials, and
environmental process, the location on the PPC is a matter of social choice.
If society wants more economic output—say an increase from C1 to C2—the environment
must degrade from E1 to E2. This is what we mean by a trade-off between economic
production and environmental quality. Note that if an economy is operating at an inefficient
point, say point A, then we can rearrange production and consumption choices to have more
economic goods and environmental quality.

A particular PPC is drawn for a specific group of people in a specific time period. However,
the choices of the present generation often affect the opportunities available for future
generations. Suppose that to have more economic output now, we have to consume more
fossil fuels. Opportunities for economic goods consumption and environmental quality may
be less in the future because 1) less fossil fuel available in the future, 2) global climate
change.

Difference between Environmental Economics and Resource Economics

Environmental economics primarily deals with the study of the overall impact of
economic activities on the environment and how environmental policies and regulations can
be designed to address environmental issues such as pollution, climate change, and ecosystem
degradation. It often looks at the economic costs and benefits associated with environmental
protection and sustainable practices.
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Environmental economics is concerned with issues like externalities (e.g., pollution

and negative spillover effects), market failures, valuation of environmental goods and
services, and the design of policies such as carbon pricing, emissions trading, and subsidies
for renewable energy sources.
Resource economics addresses topics related to the sustainable use and management
of finite resources. This includes analyzing optimal extraction rates, property rights, the
tragedy of the commons, and the economic incentives for conservation and sustainable
resource management.
Resource economics, on the other hand, specifically focuses on the management and
allocation of natural resources. It examines the economic aspects of resource extraction,
utilization, and conservation. This field is focused on issues related to the use and depletion
of natural resources like minerals, forests, fisheries, and water.

The disciplines of environmental and resource economics have been developed over decades
as a substantial specialisation of economic theory and application. Environmental economics
evaluates environmental goods while resource economics analyses scarce resource allocation.
Given that climate change, biodiversity loss, water crisis and other aspects of environmental
change are clearly evident to society, it is only natural that economists should also focus on
economic sustainability. Therefore, nowadays environmental economics has become a more
integrated sustainability science with a focus on resources and resource productivity and the
part it plays in the circular economy.

Nowadays, the enactment of national environmental policies and the involvement of

international bodies in environmental issues are providing a major input to policy debates and
discussions and in particular those of the Intergovernmental Panel on Climate Change (IPCC)
and the Intergovernmental Platform on Biodiversity and Ecosystem Services (IPBES, 2018).

Environmental and resource economics is therefore growing rapidly as an important

specialisation in economic theory and practice. Researchers first used the term
’environmental economics’ in the 1960s although those studies were widely influenced by
18th and 19th century economists who focused on natural resource economics. What should
be also noted is that in the 18th and 19th century resource economics was primarily focused
on agricultural production (Sandmo, 2015). For instance Malthus’ theory on population
growth (Malthus, 1798) was largely based on agricultural productivity, while a study by
Jevons (1865) focused on the scarcity of coal — a non-renewable resource. Marshall (1890)
discussed potential inefficiencies of a common property resource. More recently research has
focused on all parts of the production process relating to both physical products and services
and in terms of both renewable and non-renewable resources.

The literature on environmental and resource economics has been developed to better
understand wellbeing as represented through internalising the value of nature (e.g., natural
capital) for which valuation techniques have been developed over decades (see Khanal et al.,
2018). Environmental and resource economics is based predominantly on the economic
neoclassical paradigm, namely the potential of the market to use environmental resources
efficiently and in a socially optimal way (Beder, 2011). The efficiency of using natural
resources to produce goods and services in the economy is a measure of resource productivity
and is now considered a key factor in economic development. Thus, natural resources have
become a priority area of economic activity reflecting four key developments (Bleischwitz,
2010):
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1. Global demand for natural resource exploitation continues to grow.

2. Environmental constraints to using resources are increasingly apparent throughout
their whole life cycle.
3. Access to critical metals and minerals is a potential barrier to a low carbon economy.
4. Uneven patterns of resources use will potentially cause resources conflicts.

A number of environmental policy measures has been recently developed and introduced. At
the macro level, measuring qualitative variables is seen as important given gross domestic
product (GDP) is liable to be misleading as a proxy for wellbeing. This is to say that the
environment can no longer be considered separately from the economy. The former is a
fundamental life-support system as it does not only have amenity values but also is a resource
base for economic activities. The environment brings to the economy raw materials, which
are turned into consumer products through various production processes and energy. But such
raw materials and energy inputs are habitually returned to the environment in the form of
waste.

Most contemporary environmental studies have focused on the notion of sustainable

development which calls for a long-term horizon for policy making. At the same time, the
economy is also studied through an evolutionary perspective which takes into account the
mechanisms of biological evolution. This involves acceptance of the environment as a life
support system which is essential for economic stability and the quality of human life (van
den Bergh and Gowdy, 2000). What should be noted here is that our knowledge of most
environmental problems is far from comprehensive, creating much uncertainty regarding the
framing of policies that take into account both the relevant costs and benefits (Pindyck,
2007). A major challenge in managing environmental external effects is related to the fact
that today’s policies and research have to be interdisciplinary and combine data and
knowledge from various areas (Andersen, 2007). Such fields of research can still gain
influence or dominance even when interdisciplinarity does not occur: but the solving and
understanding of environmental problems is thereby hindered (Beder, 2011).

In the 21st century considerable attention is being directed across system hierarchies and
space and time. Therefore, environmental economists are at the heart of these developments
and recognise the risks and opportunities for sustainable development and for the
development of a circular economy (Ruth, 2006). Overall, environmental policies need to
have a long-term orientation, provide important information and economic incentives as well
as facilitating international cooperation (Bleischwitz, 2010).

The following sections refer to the main current issues arising from recent environmental
economics studies research. These include, but are not limited to, addressing issues such as
water, waste, energy and air pollution challenges, as well as creating economic tools to
measure environmental phenomenon. A further issue is the combining of environmental
economics with social sciences such as psychology and behavioural economics. Then we
consider the topical issue of capital stock measurement and the crucial role investments play
(Tolliver et al., 2019). Finally, this special issue progresses the understanding of the way in
which appropriate policies and investments may be interrelated in measures designed to
further sustainability.

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