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EC532 Environmental
Economics, Institutions
and Policy
Lecture 1 - Introduction

Introductory Comments
Provide overview of env econ.
Explain why the discipline is important

the origins/development env econ;

and the scope of the discipline.

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Examine linkages between economy and environment;

Briefly review key economic issues and concepts

Lecture Structure

Part 2 - Origins and Scope of Environmental

Economics
Part 3 - Introduction to Market Failure and
Government Failure

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Part 1- Consider links economy and the

environment

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Part 1
Links Between Economy
and the Environment

Defining Terms
A dictionary definition of economics would be
something like

Economics - the allocation of scarce resources

amongst competing uses.

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the science of the management of the material resources of an

individual, community or country.

What about environment?

Define environment to include flora and fauna,
aquatic ecosystems, energy and material
resources, and the atmosphere (Hanley et al,
2007).

And the Economy

There is no mystery of what an

economy is. An economy is just a
group of people interacting with
one another as they go about
their lives.

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According to Harvards Prof.

Mankiw,

.the economy is not separate from the environment in

which we live. There is an interdependence both because
the way we manage the economy impacts on the
environment, and because environmental quality on the
performance of the economy. (Pearce et al, 1989,
Blueprint for a Green Economy)
1. Our society, economy and individual wellbeing
depends upon a healthy natural environment. It underpins
everything we collectively produce and consume. We rely
on it for food, energy, minerals, clean air and clean water
as well as countless other inputs into the production
process. (State of Natural Capital Report, NCC, April
2013, page 10).

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Economy-Environment
Relationship

 Many examples economy-environment interact/

interdependent

Eg Tourism competing land use, congestion, pollution

(local and global), etc.

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Eg Agriculture pretty landscape, soil erosion, water

pollution, greenhouse gases, etc.

Eg Leisure competing land use, congestion, pollution

(air, water, noise) etc.
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E1 Energy and Materials

E2 Waste Sink
E3 Environmental
Amenity
E4 Global life-support
services
R1 and R2 Recycling
(Source: Hanley et al. 2007)

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Economy-Environment
Interactions

Example - Biodiversity

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Example Greenhouse
Gases

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Example - Tourism

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Example - Recreation

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Example Gulf of Mexico Oil

Spill

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Example Acid Rain

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What Nature Can do

for You! DEFRA, 2010
Globally, estimated degradation of planets ecosystems
costing 50 bn p/a could rise to equivalent of 7% of
global GDP by 2050

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The value of natural resources extracted for use in the UK

economy in 2007 - 41 bn

Air pollution reduces life expectancy of UK population on

average 6 months costing 15 bn p/a
If you live within 500m of accessible green space you are
24% more likely to meet recommended levels of physical
activity. Reducing sedentary population by just 1% reduce
UK morbidity/mortality rates valued at 1.44 bn

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Typical characterisation (many textbooks)

Assume economy - divided into two sectors:

production and consumption.

Use the environment in three main ways:

1.
2.
3.

As supplier of natural resource inputs

As supplier of environmental or amenity goods
A waste sink

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Links between the economy

and the environment

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1.Supplier Resource
Inputs
Land, water and stocks of raw materials

Renewable (eg trees)

Non-renewable (eg crude oil)

Distinction important - influences way

resources managed

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Natural resources:

Uses creation goods and services, inputs

Generate waste

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 Economic benefits (ie increased utility)

derived by consumption of environmental
goods.

Examples
Beautiful landscape
Recreational opportunities

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2. Supplier Environmental
Goods

Example

Climatic regulation trees/sea absorb carbon

dioxide

Example

Enjoyment (use and non-use) from biodiversity

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3. Waste Sink Capacity

(i)
Capacity of the environment to assimilate waste
products (production and consumption) - fixed

Environment also impacted by intentional

releases of chemicals

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Convert into harmless or ecologically useful

products

Eg, pesticides, wood preservatives, paints and

lubricants
But what happens if no longer able to absorb?

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3. Waste Sink Capacity

(ii)
Since 1750, pre-industrial period, carbon
dioxide concentrations - 280 parts per
million to 380 parts per million in 2000.

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Impact human activity on the composition

of chemicals in atmosphere.

Significant increases in methane and

nitrous oxide.
There are serious concerns - increasing
concentrations in the atmosphere and
associated climate change (Stern, 2007).

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3. Waste Sink Capacity

(iii)
Physical assimilative capacity of the environment.

Determined by physical factors eg, climate,

rainfall, wind patterns and geographical location.

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Ability of land, water and atmosphere to absorb

wastes.

Waste:
Degradable pollutants
Cumulative pollutants.

With cumulative - important thresholds

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Pollution Damage Function 3 possible functions

C

B
A

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Damages
(physical units)

Threshold

Pollution

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3. Waste Sink Capacity

(iv)

Key issue Function C point beyond which

pollutant seriously increased impact the
environment

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Function A simple linear damage function

Function B exponential damage function
Function C damage function with a threshold

Example
Level of oxygen in water (BOD) - falls below
particular level extremely dangerous aquatic
species.

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3. Waste Sink Capacity

(v)

We can describe the assimilative waste capacity

of the environment mathematically.
Stock of degradable pollutant (S) at time t is
given by S = F A
Stock of cumulative pollutant (S) at time t* is
given by S = F
where F is the positive flow in a year

A is the amount assimilated in a year

May need to take environmental management to
prevent further pollution so we dont pass a
threshold

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S ta

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The Precautionary
Principle

What this means do not keep on with the

status quo just because we do not have full
information about potential consequences

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Actions preventing or restricting

environmental damage should not be
delayed just because there are scientific
uncertainties about level of

Current policy example climate change

and carbon emissions
No longer treat environment as a waste sink

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Two Laws of Thermodynamics

These are the natural laws which govern the
environment

Strictly speaking earth is not a closed system

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They relate to closed systems

Why?
Receives energy from the sun
But almost closed

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First law of
thermodynamics
Whenever energy is converted in form, its total quantity
remains unchanged.

Common and Stagl (2005) example of coal-fired

electricity generating plant.
The coal is heated which produces electricity.

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Energy (or matter) can be neither created nor destroyed.

A by-product is waste heat that is transported away as cooling

water or gases.
Also various waste gases are emitted into the atmosphere,
which cause pollution, such as acid rain.
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Second Law of
Thermodynamics

What is Entropy?
A measure of the disorderedness of
energy.

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In a closed system, entropy does not

decrease.

Ordered energy is useful

Disordered energy is not

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Entropy
Entropy is a thermodynamic property of matter.

Entropy ranges from zero to a maximum.

If at its maximum - amount of work that can be
transferred is equal to zero

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Relate amount of energy that can be transferred

from one system to another in the form of work.

If entropy is zero - amount of work that can be

transferred is equal to the energy of the system
During irreversible process entropy of a system
always increases.

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Key Issues from

Entropy

The key points to remember:

2. there is a limit on the substitutability of inputs

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1. increased extraction of minerals by the production

process leads to an increase in wastes

3. since production and consumption lead to the

dissipation of matter, scarce energy is needed for
recycling
. The importance of these two laws relates to the
use, re-use and recycling of the environment after
interactions with the economy.

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Recycling

Hierarchy of resource use includes recycling - the 3Rs

Final option dispose

We recycle/reuse eg, glass bottles paper, metal, glass,

plastic, textiles, and garden waste

But there are limits re-use and recycling

Partly dictated by the laws of thermodynamics but

also the costs associated with re-using and recycling

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1. Reduce
2. Re-use
3. Recycle

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Part 2
Origins of Environmental
Economics

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Origins Environmental Economics

Environmental economics started developing
1960s

Increased pollution, heightened public awareness

about the environment
A Sand County Almanac (1949) by Aldo
Leopold.
Silent Spring (1960), by Rachel Carson.
Economists indefinite economic growth
sustainable - economic system must take account
of environmental uses:
Many natural resources finite
Other resources not to be depleted

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Why?

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Types of Capital
Environmental economists define two types of capital:
Natural
Man-made

The cannot (in general) be supplied by man-made

capital.

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Natural performs life support, amenity and other

functions

Growth environmental economics 1970s - NeoClassical paradigm

Main issues (micro) market failure, inappropriate
resource allocation and management public goods.
Less concern underlying relationships economy
-environment.

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Ecological Economics
Concerns limits economy-environment lead some
environmental economists develop ecological
economics

Distinction sustainable development

Weak and strong sustainability.

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Ecological economics - relationship economyenvironment central

Strong sustainability - not all forms of capital (i.e.,

human and natural) are perfectly substitutable.
Much of the distinction of less practical relevance
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Ecological Economics (the journal) publishes papers

that are more radical

Scope of the discipline

Essentially, environmental economics revolves around
three broad questions (relate to three uses).

1. What are the economic and institutional causes of

environmental problems? That is, how do the
economic and social systems shape incentives in
ways that lead to environmental degradation as well
as to improvements?

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2. How can we assess the economic importance (i.e.,

monetary value) of environmental
degradation/improvements?
3. How can we design economic incentives to slow or
halt environmental degradation and bring about
improvements in the quality and management of the
natural environment?

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EC532 Lec 1

Part 3
Market Failure and Govt
Failure

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What is Market Failure?

You cannot go out and buy a cubic
metre of clean air!
As air is free we over-use - an
example of market failure in this
context is global warming
So a possible solution is to create a
market in air pollution rights
transferable discharge
permits/Kyoto/EU ETS

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Consumers are unable to express

preferences

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Market Failure
All breathing the air

Unable to express preferences for

breathing clean rather than dirty air
through the market

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We do not pay for air no market

This is an example of market failure

Why does market failure occur?

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Market Failure
When specific condition not satisfied market failure can
occur.
Eg, A negative externality

MPC - short-run market supply curve

Negative externality - short-run market supply curve too
low

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Marginal Private Cost (MPC) < Marginal Social Cost (MSC).

Difference - Marginal Damages (MD)

MDs - quantity negative externality output increases
MDs - inflicted on society not internalised

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Effect of a negative externality

Price

MSC = MPC + MD
MPC

= supply
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P*

demand

Q*

Quantity

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 A - equilibrium position with negative externality.

Price is P and Q quantity supplied.
B - Pareto optimum - P* Q*

This is an example of market failure.

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Negative externality - too much good at low price

Why?
No market for the MDs produced by this activity.
To solve? Eg. EU Emission Transfer Scheme (ETS)

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UK NEA
(2011)

This is the key word here

undervalued!
This is driving the policy

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Government Failure
Many reasons why government failure can occur
Government under pressure from certain groups

Lack of information resulting in best policy

decisions not being taken

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Acts in their interest not societies

Politicians/bureaucrats may not have the goal of

maximising societys welfare (eg, CAP).

agricultural policy in Europe

paid farmers to produce output
excess supply
serious forms of environmental degradation

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