Diksha Mission Economics No.

1
Environmental Economics
Environmental economics
 Environmental economics is a sub-field of economics concerned with environmental issues.
It has become a widely studied subject due to growing environmental concerns in the twenty-
first century.
 Environmental Economics undertakes theoretical or empirical studies of the economic effects
of national or local environmental policies around the world. Particular issues include the
costs and benefits of alternative environmental policies to deal with air pollution, water
quality, toxic substances, solid waste, and global warming.
Market failure
 Air pollution is an example of market failure, as the factory is imposing a negative external
cost on the community.
 Central to environmental economics is the concept of market failure. Market failure means
that markets fail to allocate resources efficiently.
 As stated by Hanley, Shogren, and White (2007 "A market failure occurs when the market
does not allocate scarce resources to generate the greatest social welfare.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
 A wedge exists between what a private person does given market prices and what society
might want him or her to do to protect the environment. Such a wedge implies wastefulness
or economic inefficiency; resources can be reallocated to make at least one person better off
without making anyone else worse off."
 Common forms of market failure include externalities, non-excludability and non-rivalry
Externality
 An externality exists when a person makes a choice that affects other people in a way that is
not accounted for in the market price.
 An externality can be positive or negative but is usually associated with negative externalities
in environmental economics. For instance, water seepage in residential buildings occurring in
upper floors affect the lower floors.
 Another example concerns how the sale of Amazon timber disregards the amount of carbon
dioxide released in the cutting. Or a firm emitting pollution will typically not take into account
the costs that its pollution imposes on others.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
 As a result, pollution may occur in excess of the 'socially efficient' level, which is the level that
would exist if the market was required to account for the pollution.
 A classic definition influenced by Kenneth Arrow and James Meade is provided by Heller and
Starrett (1976), who define an externality as "a situation in which the private economy lacks
sufficient incentives to create a potential market in some good and the nonexistence of this
market results in losses of Pareto efficiency". In economic terminology, externalities are
examples of market failures, in which the unfettered market does not lead to an efficient
outcome.
Common goods and public goods
 When it is too costly to exclude some people from access to an environmental resource, the
resource is either called a common property resource (when there is rivalry for the resource,
such that one person's use of the resource reduces others' opportunity to use the resource)
or a public good (when use of the resource is non-rivalrous). In either case of non-exclusion,
market allocation is likely to be inefficient.
 These challenges have long been recognized. Hardin's (1968) concept of the tragedy of the
commons popularized the challenges involved in non-exclusion and common property.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
 "Commons" refers to the environmental asset itself, "common property resource" or
"common pool resource" refers to a property right regime that allows for some collective
body to devise schemes to exclude others, thereby allowing the capture of future benefit
streams; and "open-access" implies no ownership in the sense that property everyone owns
nobody owns.
 The basic problem is that if people ignore the scarcity value of the commons, they can end up
expending too much effort, over harvesting a resource (e.g., a fishery).
 Hardin theorizes that in the absence of restrictions, users of an open-access resource will use
it more than if they had to pay for it and had exclusive rights, leading to environmental
degradation. See, however, Ostrom's (1990) work on how people using real common property
resources have worked to establish self-governing rules to reduce the risk of the tragedy of
the commons.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
Solutions
 Solutions advocated to correct such externalities include:
1. Environmental regulations
 Under this plan, the economic impact has to be estimated by the regulator. Usually, this is
done using cost-benefit analysis. There is a growing realization that regulations (also known
as "command and control" instruments) are not so distinct from economic instruments as is
commonly asserted by proponents of environmental economics.
 E.g.1 regulations are enforced by fines, which operate as a form of tax if pollution rises above
the threshold prescribed. E.g.2 pollution must be monitored and laws enforced, whether
under a pollution tax regime or a regulatory regime.
 The main difference an environmental economist would argue exists between the two
methods, however, is the total cost of the regulation.
 "Command and control" regulation often applies uniform emissions limits on polluters, even
though each firm has different costs for emissions reductions, i.e., some firms, in this system,
can abate pollution inexpensively, while others can only abate it at high cost.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
2. Quotas on pollution
 Often it is advocated that pollution reductions should be achieved by way of tradable
emissions permits, which if freely traded may ensure that reductions in pollution are achieved
at least cost. In theory, if such tradable quotas are allowed, then a firm would reduce its own
pollution load only if doing so would cost less than paying someone else to make the same
reduction, i.e., only if buying tradable permits from another firm(s) is costlier. In practice,
tradable permits approaches have had some success, such as the U.S.'s sulphur dioxide
trading program or the EU Emissions Trading Scheme, and interest in its application is
spreading to other environmental problems.
3. Taxes and tariffs on pollution
 Increasing the costs of polluting will discourage polluting, and will provide a "dynamic
incentive," that is, the disincentive continues to operate even as pollution levels fall.
 A pollution tax that reduces pollution to the socially "optimal" level would be set at such a
level that pollution occurs only if the benefits to society (for example, in form of greater
production) exceeds the costs.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
 This concept was introduced by Arthur Pigou, a British economist active in the late nineteenth
through the mid-twentieth century. He showed that these externalities occur when markets
fail, meaning they do not naturally produce the socially optimal amount of a good or service.
 He argued that “a tax on the production of paint would encourage the [polluting] factory to
reduce production to the amount best for society as a whole.
 These taxes are known amongst economists as Pigouvian Taxes, and they regularly
implemented where negative externalities are present. Some advocate a major shift from
taxation from income and sales taxes to tax on pollution - the so-called "green tax shift.“

4. Better defined property rights.

 The Coase Theorem states that assigning property rights will lead to an optimal solution,
regardless of who receives them, if transaction costs are trivial and the number of parties
negotiating is limited.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
 For example, if people living near a factory had a right to clean air and water, or the factory
had the right to pollute, then either the factory could pay those affected by the pollution or
the people could pay the factory not to pollute. Or, citizens could take action themselves as
they would if other property rights were violated.
Coase Theorem
 Coase Theorem is a legal and economic theory developed by economist Ronald Coase that
affirms that where there are complete competitive markets with no transactions costs, an
efficient set of inputs and outputs to and from production-optimal distribution will be
selected, regardless of how property rights are divided.
 Further, the Coase Theorem asserts that if conflict arises over property rights under these
assumptions, then parties will tend to settle on the efficient set of inputs and output.
 The Coase Theorem states that under ideal economic conditions, where there is a conflict of
property rights, the involved parties can bargain or negotiate terms that will accurately reflect
the full costs and underlying values of the property rights at issue. In order for this to occur,
the conditions conventionally assumed in analysis of efficient, competitive markets must be in
place, particularly the absence of transaction costs.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
 Information must be free, perfect, and symmetrical. Bargaining must be costless; if there are
costs associated with bargaining, such as those relating to meetings or enforcement, it affects
the outcome.
 Neither party can posses market power relative to the other; bargaining power between the
parties must be equal enough that it can not influence the outcome of the settlement.
 Markets for all final goods and productive factors economically related to the property at
issue must be efficient so that the market prices of the property in question can be accurately
ascertained.
 The Coase Theorem shows that, where property rights are concerned, involved parties do not
necessarily consider how the property rights are divided up if these conditions apply and they
care only about the division of flow of current and future incomes and rents without regard
issues such as personal sentiment, social equity, or other non-economic factors.
 The Coase Theorem is applied to situations where the economic activities of one party impose
a cost on or damage the property of another party. Based on the bargaining that occurs
during the application of the Coase Theorem, funds may either be offered to compensate one
party for the other's activities or to pay the party who's activity inflicts the damages to forgo
that activity.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
MAJOR CONFERENCES ON ENVIRONMENT
Stockholm Conference (1972)
 Conference on human environment for creating formal international awareness regarding the
need for maintaining the quality of the environment.
Our Common Future (1987)
 Concept of sustainable development introduced in Brundtland Report.
Global Environment Fund (GEF): 1992
 It is a global alternative asset manager established in 1990 to invest in high-growth clean
energy, energy and resource efficiency
Convention on Biological Diversity: 1993
 The Convention on Biological Diversity (CBD) is the international legal instrument for "the
conservation of biological diversity, the sustainable use of its components and the fair and
equitable sharing of the benefits arising out of the utilization of genetic resources" that has
been ratified by 196 nations

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
The Living Planet Index (LPI): 1998
 It is an indicator of the state of global biodiversity and the health of our planet. It was first
published in 1998. LPI tracks the population abundance of thousands of mammals, birds, fish,
reptiles, and amphibians around the world
 The Zoological Society of London manages the index in cooperation with the World Wide
Fund for Nature
ENVIRONMENTAL LAWS IN INDIA
Wildlife Protection Act: 1972
 Wildlife includes bees, butterflies, animals, fish and moths, crustacean and aquatic or land
vegetation. In other words, everything that forms a part of the habitat is included in the term
Wildlife.
 The basic objective of this act was the measures to protect the wildlife in the form of forming
national parks or sanctuaries, etc.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
Water (Prevention & Control) Act: 1974
 The basic objective was to prevent and control the level of water pollution.
 Besides this, it had the responsibility of maintenance and restoration of the water quality.
Air (Prevention and Control of Pollution) Act: 1981
 The basic objective is to prevent, control and abate the levels of air pollution, caused by
various establishments.
 The decision to formulate the act was taken at United Nations Conference on Human
Environment held in Stockholm, June 1972.
Environment (Protection) Act 1986
 Provides a framework for the protection and improvement of environment.
 Under this act, new/expanding projects need to obtain environmental clearances which are
addressed under “Environmental Impact Assessment Notification, 1994”.
 SJVNL takes up Environmental Impact Assessment for all projects as a mandatory standard
management procedure.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
 SJVNL also reviews projects taking into consideration the air quality standards and noise
levels, as decided by the national laws.
Ozone Depleting Substances (Regulation and Control) Rules (2000)
 The rules put a restriction on manufacturing, export-import commodities.
 The organisations, according to the rules, should aim at becoming the CFC free organisation
in near future.
Wildlife Protection (Amendment) Act 2002
 According to this act, “no alteration of boundaries/national park/ sanctuary shall me made by
the State Government except on recommendation of the National Board for Wildlife (NBWL)”.
 State Governments have to take the permission from the Supreme Court before submitting
the proposal for any kind of diversion in the forest land in National Park Sanctuaries.
The Biological Diversity Act (2002)
 Enacted by Ministry of Environment and Forests under the United Nations Convention on
Biological Diversity at Rio de Janeiro in June, 1992.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
 The basic objective under the act was “to provide for the conversation of biological diversity,
sustainable use of its components, and fair and equitable sharing of the benefits arising out of
the sued of biological resources, knowledge and for matters connected therewith or
incidental thereto.”
 Under this act, the areas which are rich in biodiversity are made biosphere reserve for
conservation purposes.
 The provisions under this act are applicable to National Parks and Sanctuaries as well.

Hazardous Wastes (Management and Handling) Amendment Rules: 2003

 The basic objective is the proper handling and disposal of used mineral oils considered to be
hazardous wastes.
 For the disposal of hazardous waste, every organisation needs to take permission from the
State Pollution Control Boards (SPCB) when required.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
ENVIRONMENTAL KUZNETS CURVE
 It shows the relationship between environment degradation and per capita income.

WEAK AND STRONG SUSTAINABILITY

Weak Sustainability: Substitute man-made and natural capital. Depletion of stock of natural
capital could be made good by investment in man-made capital.
Strong Sustainability: Natural and man-made capital are complementary to each other. They
cannot be substituted, either in production or consumption.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
SOCIAL BENEFIT
 Social benefit is a kind of a positive externality Total Benefit = Private benefit + Social
Benefit Similarly, we have social costs which too can be either private or social in nature.
THE TRAGEDY OF THE COMMONS
 The theory was given by Hardin and is related to the use of resources.
 This thesis explains that unregulated access to a common property resource creates a
decision making environment in which incremental benefits to an individual exceed the
incremental private cost associated with the resource.
TRAVEL COST METHOD
 It measures the amount of money that people are ready to spend and opportunity cost of
time are taken as a proxy for the willingness to pay for the visit
HEDONIC PRICING METHOD
 It is a method for estimating the implicit prices of the attributes that differentiates closely
related products in a product category.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
CONTINGENT VALUATION METHOD
 It is also known as survey method. Under this, we ask people about what value they place on
a particular change in environment.
HOTELLING RULE
 The concept was given by Harold Hotelling in 1931. His paper was based on non- renewable
resource economics. He suggested that arbitrage will remove any deviation in future prices.

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
 QUESTIONS FOR THE DAY

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
1. Which of the following is an example of tragedy of commons?
A) Over fishing B) Smoking in a public place
C) Excessive rain D) Common use of public toilet

2. The government levying taxes on polluters or charging a surcharge for pesticide use are
A) Examples of Coase theorem B) Internalization of negative spillover effects
C) Marginal abatement cost D) Examples of a free rider

3. According to Coase theorem, when property rights are well defined and legally
enforceable and transaction costs are not prohibitive
A) Population growth leads to rigid land rights
B) Participants will organize their transaction voluntarily to achieve efficient outcome
C) Violence, displacement, erosion and poverty are minimized
D) Individual’s overuse of the biosphere is curtailed

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
4. ------------------ method gives a minimum estimate of the benefits received from the
environment protection programme.
A) Delphi method B) Costless choice method
C) Preventive expenditure method D) None of the above

5. Which of the following characteristic is widely regarded as being an important aspect of

sustainable development?
A) Intergenerational equity B) Increasing consumer expenditure
C) Increased level of savings D) None of these

6. ---------------------- is a tax levied on a non market activity that generates

Negative externalities which is intended to correct the market outcome.
A) Specific tax B) Ad velorem tax C) Carbon tax D) Pigovian tax

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
7. Among the direct methods to evaluate environmental benefits, which method is used to
determine individual preferences among various outcomes?
A) Delphi Method B) Contingent Valuation Method
C) Trade Off Games Method D) Costless Choice Method

8. Which of the following agreement is related to protecting the Ozone layer by controlling the
release of CFCs?
A) Montreal protocol B) Kyoto Protocol
C) Rotterdam Convention D) Basel Convention

Answers:-
1) A 2) B 3) B 4) C 5) A 6) D 7) C 8) A

To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731