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Cha 1
Cha 1
Cha 1
1.1 Introduction
Environment is defined as the complex of physical, chemical and biotic factors (as
climate, soil and living things) that act upon an organism or an ecological community and
ultimately determine its form and survival. It is the aggregate of an individual or
community.
In economics the environment is viewed as a composite asset that provides a variety
of services. It includes raw-materials, which are transformed into consumer products by
the production process, and energy, which fuels this transformation. These raw-materials
and energy return to the environment as waste products. Environment also provides
services directly to consumers; the air we breathe, the nourishment we receive from food
and drink, and the protection we derive from shelter and clothing and all benefits we
receive either directly or indirectly from the environment.
If the environment is defined broadly, the relationship between the environment and
the economic system can be considered a ‘closed system’. Here it means no inputs
(energy, matter, and so on) are received from outside the system and no outputs are
transferred outside the system. In contrast, an ‘open system’ is one in which the system
imports or exports matter or energy (Figure 1.1).
Figure 1.1
Economic system and the Environment
Firms
(Production)
Household
(Consumption)
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1.2 Emergence of Natural Resources and Environmental Economics
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phenomenon of externalities. The problem of environmental pollution entered economics
as a particular example of the general class of externalities.
1.4.1 Efficiency
One way of thinking about efficiency is in terms of missed opportunities. If
resource use is wasteful in some way then opportunities are being squandered;
eliminating that waste (or inefficiency) can bring net benefits to some groups of people.
An example is energy inefficiency. A substantial part of environmental economics is
concerned with how economies might avoid inefficiencies in the allocation and use of
natural and environmental resources.
1.4.2 Optimality
Optimality is related to efficiency, but is nevertheless conceptually distinct from it.
To understand the idea of optimality we need to have in mind:
a. A group of people taken to be the relevant society.
b. Some overall objective that this society has and in terms of which we can measure
the extent to which some resource use decision is desirable from that society’s
point of view.
Resource use choice is socially optimal if it maximizes the objective given any
relevant constraints that may be operating.
1.4.3 Sustainability
The third theme is sustainability. It involves taking case of posterity. Al allocation
of resources is socially optimal and then surely it must also be sustainable. If
sustainability matters, then presumably it would enter into the list of society’s objectives
and be taken care of in achieving optimality. The pursuit of optimality as usually
considered in economics will not necessarily take care of posterity. If taking care of
posterity is seen as a moral obligation, then the pursuit of optimality will need to be
constrained by a sustainability requirement.
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1.5 Fundamental features in the economic approach to natural resources and
environmental economics
There are three important features of economic approach to resource and
environmental issues.
1.5.1 Property rights, efficiency and government intervention
Regarding allocative efficiency the central issue is the role of markets and prices.
It is expected that the markets will bring about efficiency in allocation. However, well-
defined and enforceable private property rights are one of the necessary conditions for
efficiency. Many environmental resources fail to allocate efficiently, because there are no
clearly defined property rights. In such circumstances, price signals fail to reflect true
social costs and benefits, and a prima facie case exists for government policy intervention
to seek efficiency gains.
1.6 Assignment
A wood pulp mill is situated on the bank of Abaya lake nearer to the Nech Sar
National Park. The private marginal cost (MC) of producing wood pulp (in $ per ton) is
given by the function MC = 10+ 0.5Y; where Y is tons of wood pulp produced. In
addition to this private marginal cost, an external cost is incurred. Each ton of wood pulp
produces pollutant flows into the lake which cause damage valued at $ 10. This is an
external cost, as it is borne by the wider community but not by the polluting firm itself.
The marginal benefit (MB) to society of each ton of produced pulp (in $) is given by
MB= 30 - 0.5Y.
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Answer the following questions using diagrams or algebra.
(Note: Profit maximization requires selection of an output level that equates marginal
revenue and marginal cost. Maximization of social net benefits should be taken to imply
equating marginal social benefits with marginal social costs)
1. Draw a diagram illustrating the marginal cost (MC), marginal benefit (MB),
external marginal cost (EMC) and social marginal cost (SMC) functions.
2. Derive the profit maximizing output of wood- pulp, assuming the seller can obtain
marginal revenue equal to the marginal benefit to society derived from wood
pulp.
3. Derive the pulp output which maximizes social net benefits (Social net benefit =
Gross social benefit – social cost)
4. Explain why the socially efficient output of wood pulp is lower than the private
profit- maximizing output level.
5. How large would external marginal cost have to be in order for it to be socially
desirable that no wood pulp is produced?
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