Topic 4

Externality correction, emissions trading,

taxes versus quotas, environmental Kuznets
curve, ecological resilience, trade and
environment, measuring health impacts of
pollution
 Concept
• Relationship between economic growth and
environmental pollution
 Environmental Pollution and Remedies
• Does pollution decline with economic growth?
• Why do some countries have higher environmental
preferences?
• Can we say something based upon empirical
evidence?
• Can the government regulate pollution and how
effectively?
Environmental Kuznets Curve (EKC)
• An inverted U-shaped relation between pollution
and income may exist
• As income increases for countries, initially the
pollution level increases, but after a threshold of
income is crossed, pollution starts to decline
Shape of the Environmental Kuznets Curve
(EKC)

Pollution

Income
Draw a Biodiversity-Income Curve based
upon the previous slide
 EKC
• EKC believers argue that economic growth is important
for environmental quality improvement
• But, economic growth leads to environmental
degradation. However, environment could improve due
to:
– Possible changes in technology in the future, people’s
preferences, etc.
– Firms using a different input mix, which is less polluting
(switch from coal to gas)
– Production efficiency gains (more output per unit of energy
consumed)
 Empirical Evidence over EKC
• EKC may not exist
• Most indicators of environmental degradation
increase with income
• EKC has not been found to exist for all pollutants
• Local pollutants exhibit an EKC, global
pollutants do not
• Global pollutant=> carbon
• Local pollutant—sulfur dioxide
 EKC
• Grossman and Krueger (1991) derived the first
EKC for Sulphur dioxide and SPM
• At $4000 per capita GDP, SO2 concentrations
start to decline (Stern 2003)
 Two Effects Causing EKC
• Time Effect=>over time, pollution levels will
decline
• Scale Effect=> If economic growth is higher,
pollution will increase.
• Scale effect dominates time effect in
developing countries
• Developed countries: Growth rate is low, time
effect dominates scale effect (Stern 2003)
 Read EKC
Review Paper by Alstine and Neumayer

• Excerpts:
• In the 1980s large issues such as ozone layer
depletion, global warming and biodiversity loss
began to refocus the debate around the impacts
of environmental degradation on economic
growth. Interest was shifting away from natural
resource availability towards the environment as
a medium for assimilating wastes (i.e. from
‘source’ to ‘sink’) (Neumayer, 2003b: 47).
• Also, following the Brundtland Report (WCED,
1987), the discourse of sustainable
development largely embraced the economic
growth logic as a way out of poverty, social
depravation and also environmental
degradation particularly for the developing
world. Thus the relationship between
economic growth and the environment came
under increased scrutiny.
• In the 1990s the empirical literature on the link
between economic growth and environmental
pollution literally exploded (see Cole &
Neumayer, 2005; Stern, 2003; 2004 for
overviews).
• This curve is named after Kuznets (1955) who
hypothesized that economic inequality increases
over time and then after a threshold becomes
more equal as per capita income increases
• There are a number of theoretical explanations
that suggest the sink side of the environment
will be less impacted as incomes rise.
• First, environmental quality is often cited as a
normal good, if not even a luxury good. In other
words, the income elasticity of demand for
environmental quality is greater than zero,
possibly even greater than one, or as income
grows environmental concern rises as well,
perhaps even more than proportionally so
(Beckerman, 1992; World Bank, 1992).
• Second, it is likely that economic growth
increases the possibility that more modern and
less pollution intensive man-made capital and
technology are introduced (Grossman &
Krueger, 1995).
• While pollution per unit of output might go
down, absolute pollution levels might very well
go up as economic growth increases. Therefore
the effect of technological change on pollution
is in principle ambiguous (Lopez, 1992).
• Third, as economic development progresses
and income grows, the share of industry will go
down as services goes up, thus sectoral changes
may favor less-polluting sectors (e.g. Jänicke,
Binder, & Mönch, 1997).
• Yet if starting from low income levels, structural
changes in the economy will most likely have a
detrimental effect on the environment. Pollution
will increase as the share of agriculture goes
down and industry goes up. Also there may be
limitations in the scope of these changing
patterns of output, given that people’s revealed
preferences indicate that pollution-intensive
material goods are still highly valued
• It is also suspected that high-income countries
have become cleaner because they have
exported their pollution-intensive industry to
LDCs, also known as the “pollution haven
hypothesis”.
• Fourth, rising income brings population growth
rates down, therefore population pressure on the
environment decreases.
• Although not all agree population growth is
detrimental to the environment (Simon, 1996),
the evidence is clear: larger populations generate
more emissions (UNDP, 1999). However with
considerable variance in the data, it is clear that
population growth is determined by factors other
than a country’s income level as well (Neumayer,
2003b: 82).
Possible Shapes of EKC
 Econometric model
• Eit = (α + βiFi) + δYit + φ(Yit)2 + kt + εit (1)
• if δ is negative and statistically significant but
φ is statistically insignificant, then we get
pattern A.
• These are indicators that show an
unambiguous improvement with rising per
capita income, such as access to clean water
and adequate sanitation.
• If δ is positive and statistically significant but φ is
statistically insignificant, then we get pattern C.
These are indicators that show an unambiguous
deterioration as incomes increase. These include
per capita CO2 emissions.
• The pattern most often encountered is B, which
follows if δ is positive and statistically significant
and φ is negative and statistically significant. In
this case, the estimated EKC has a maximum
turning point per capita income level, calculated
as Y* = (-δ/2φ)
• Table 1, taken from Cole and Neumayer (2005),
provides the estimated turning points from a
large number of EKC studies. Examples include
suspended particulate matter, sulfur dioxide,
carbon monoxide and nitrogen oxide emissions,
fecal and total coliforms and the quality of
ambient air (Neumayer, 2003b: 83-84).
• The empirical literature has also examined a
range of factors that may influence environmental
quality, such as democracy, literacy, etc.
• Torras and Boyce (1998) define higher political
and civil liberties and increased literacy rate as
constituting a more equitable power distribution.
They find that a more equitable power
distribution tends to result in better
environmental quality and that literacy and rights
appear to be strong predictors of pollution levels
in low income countries.
• Barrett and Graddy (2000) using the same data find
that for air and water pollution, an increase in civil and
political freedoms significantly improves environmental
quality. They find, especially with SO2, that a low
freedom country with an income level near the peak of
the EKC can reduce its pollution at least as much by
increasing freedoms as it can by increasing income per
capita.
• In contrast, Neumayer (2002b) shows that democracies
exhibit stronger international environmental
commitment than non-democracies, but he finds that
there is weak evidence for a link between democracy
and environmental outcomes.
• Perkins and Neumayer (2008) examine the
claim that outward orientation helps countries
to reduce their pollution intensity, that is the
amount of pollution generated per unit of GDP.
They find that countries, which import a larger
share of their machinery and manufactured
goods from countries with lower pollution
intensity, manage to lower their CO2 and SO2
pollution intensity faster than others.
 Problems with EKC hypothesis
• Ignores feedbacks from the environment
• =>Environmental damage could reduce economic
activity
• Mix of pollutants has shifted from SO2 and NOx to
carbon and solid wastes
• Effect of Trade
– Polluting industries may shift to low income countries
• EKC ignores irreversible environmental
consequences
 EKC and Hysteresis

Flow of Pollution

Stock of Pollution
 Hysteresis
• The previous graph shows an equilibrium
relation between flow and stock of pollution
• At low levels of flow of pollution, the
equilibrium stock is low, at high levels it is high
• There is a shift in this relationship as stock of
pollution increases!
• Cost of reverting back degradation is higher than
the cost of avoiding shift into a degraded state
 Hysteresis in Physical Systems

Pressure

+ve Jump in Density- Gas

turning into Liquid

-ve Jump in Density-Liquid turning into

Gas

Density
 Hysteresis in a lake
Flow of pollution

C (5 tons/day)

F1* (3 tons/day)

K (2 tons/day)

F2* (1 ton/day)

F1** (100 tons) B* (300 tons)

K* (50 tons) F2** (250 tons) Stock of pollution
 Read ‘Scheffer et al. 2001’
• Read the article in Nature Journal on
“catastrophic shifts in ecosystems”
Vol. 413, October 2001, pp. 591-596
 Shallow Lakes and Eutrophication
• Shallow lakes flip from a clear state into a
greenish turbid state as flow of nutrients, such
as phosphorous, increases.
• Phosphorous increases the growth of
phytoplankton
• Turbidity prevents light from reaching the
bottom of the lake
 Lake Hysteresis
• This leads to the disappearance of submerged
vegetation
• Waterfleas that graze on phytoplankton also disappear
as vegetation reduces
• To restore the lake the load of nutrients has to be
reduced way below the level at which the lake turned
turbid
• This is hysteresis: Cost of reversal into the pristine
state is higher than the cost of preventing the system
from falling into a bad state
 Hysteresis
Flow of Phosphorous

Stock of phosphorous in shallow lakes

 How to Control Pollution (reduce carbon
emissions)?
• Key Instruments available are:
• Taxes
• Quotas
• Regulation/Incentives
• Next slide shows how much abatement would
be done by a pollution emitting firm when it
faces a carbon tax
Optimal Abatement by a Firm when Faced with Carbon Taxation

Marginal Cost of Abating Pollution

A’
Tax on emissions T
$/ton
Marginal Cost (AA’)=Tax (OT)

O A B

Pollution Abatement (or emissions reduction)

 Benefits of Trading in Abatement
• Countries can benefit by trading in emissions
abatement
• Countries differ in their abatement costs
• Trading leads to equalization of marginal
costs of abatement
• Next slide shows how two countries differing
in abatement costs can benefit from trading
with each other
 Pollution Abatement: Two Countries

Marginal Cost of Abating Pollution G

Cost
Country II

Country I

C’ D’
C C B’
E’
A’
Extra Abatement

A D A E B
B
Required Abatement Required Abatement
 Gains from Trading in Carbon Abatement

Both countries are required to abate an equal amount -- AB tons

of carbon
If the agreed price of carbon credit between the 2 countries is AC
Then country I will do some extra abatement =BD
The cost of this abatement is A’BDD’ to country I
The revenue from sale of credit is BC’DD’. Therefore, profit is
A’C’D’
For country II the cost saving is G E’B’
The idea behind trading is to equalize marginal costs for the
trading partners.
 How much Tax is Optimal to Correct an
Externality
• Taxation is costly to economic activity as it reduces producers’
profits and consumers’ surplus, as eventually the firms may pass
some or all of taxes to the consumers.
• Therefore, it is important to find the optimal level of taxation
• Think of a carbon tax on Australian electricity firms. When a
carbon tax is imposed, they can pass on most of the price increase
to the consumers.
• A carbon tax on the cement industry may not lead to a similar
pass-on effect as cement can be imported if domestic prices
become high (whereas, electricity cannot be imported).
• Not all sectors are adversely affected by carbon taxation, solar
energy, renewable energy may benefit (how?)
Using Taxes To Correct Externalities: What is the Optimal Taxation?

S
Social Marginal Cost

N Private MC after taxes OT

Private MC
Price/cost L after taxes OT’

Private MC
M without taxes

B’ Price of good
P
A’
T

T’
A Quantity produced
O
B
 Carbon Leakage
• When a country (say A) unilaterally imposes
carbon taxation, firms relocate to other
countries (say B) or import of carbon intensive
goods increases, thereby offsetting the initial
carbon emission reduction gained from higher
taxes in country A.
• This is called carbon leakage.
Next set of slides presents key
points from a policy article on
carbon leakage
 Options for avoiding carbon
leakage
Carolyn Fischer
Resources for the Future

• Carbon leakage – the increase in foreign

emissions that results as a consequence of
domestic actions to reduce emissions – is of
particular concern for countries seeking to put
a substantial price on carbon ahead of their
trading partners.
• Carbon leakage occurs through multiple
channels. The largest one, as indicated by the
modelling literature, is the energy market
channel. The idea is that if a major economy on
its own withdraws a lot of demand for fossil
fuels, the global prices for those fuels become
depressed. As a consequence of cheaper
prices, other countries consume more fossil
fuels and their economies become more
carbon intensive.
How Carbon Leakage occurs through Energy
Channel

A
B P

E
D
 Instructor’s Explanation of the previous
figure
• Global demand, given by the thick blue line, shifts
leftwards to dashed line A after a carbon tax, as there
is a reduction in demand from the country unilaterally
imposing a carbon price.
• The new price of fuels is given by point C. The original
price was P.
• Rest of the world (ROW) demand is given by line B.
• At price C, ROW demand increases to point E (from
previous ROW demand D at the original price P). This
change in demand (E-D) is the leakage.
• The channel for carbon leakage that causes the
greatest concern for policymakers, however, is
the ‘competitiveness’ channel
• This channel relates to policies – like carbon
pricing – that pass on higher energy costs to
energy-intensive, trade-exposed (EITE)
industries, making manufacturing in carbon-
pricing countries less competitive. This causes
economic activity, market share, and, in the
longer run, investments in those sectors to shift
abroad to jurisdictions with lower energy costs.
• Modelling results indicate that one-quarter to
one-half of carbon leakage occurs through
competitiveness effects. This channel is
somewhat narrower than the energy market
channel, as it primarily affects specific
industrial sectors that represent a small share
of the economy, but they have outsized effects
on emissions leakage, and may also wield
outsized political influence.
• A third channel, the induced innovation channel,
has the potential to create negative leakage in the
long term. If carbon mitigation policies induce
innovation in clean energy technologies, lowering
their costs globally, all countries will find them
more attractive. Greater adoption of clean
technologies in countries with low or no carbon
prices will help displace fossil fuels and further
reduce global emissions.
• Currently, about 12% or less of global CO2
emissions is subject to a carbon price (World
Bank 2015). With the exception of some carbon
taxes in Scandinavian countries, current prices
are well below $40 – the US Environmental
Protection Agency’s central estimate of the
global social cost of carbon (SCC) – and all of the
largest systems have prices below $15 (see also
the contribution by Wang and Murisic in this
book).
• There are three main options for addressing leakage
among identified EITE sectors: exemption from
carbon pricing, output-based rebating, and border
carbon adjustments.
• A straightforward option is to exempt qualified EITE
industries from the broader GHG reduction policy,
in whole or in part. For example, in Sweden,
industrial consumers pay no energy tax and only
50% of the general carbon tax; in Germany, heavy
industry is exempt from the surcharges for
renewable energy and EITE sectors can request
exemptions from most energy taxes.
• By differentiating carbon prices among industries,
some cost-effective options for reducing emissions
will be left untapped, which will either limit overall
reductions or leave a greater burden on the
remaining non-exempt industries.
• As a result, exemptions would likely increase the
total cost of achieving a given emissions target,
unless leakage effects are very strong.
• Sectors like aluminium may see larger
competitiveness impacts from the pricing of
carbon in electricity than from their direct
emissions.5
• A second, common option is to use rebates to
relieve some, or all, of the burden from the price
on embodied carbon. The idea is to keep all
energy-intensive industry under the carbon-pricing
system, but to offer rebates for the EITE sectors in
proportion to their output, based on a benchmark
of sector-wide performance. For example, the EU
chose a benchmark of the performance of the top
10% of firms (i.e. those with lowest emissions
intensities) in a sector, while New Zealand uses up
to 90% of average emissions intensity, based on
recent historical data.
• Since more output generates more rebates, the
rebate functions like a subsidy to output of EITE
firms, signalling that emissions reductions
should not be sought through reductions in
output (since that would result in leakage). The
advantage relative to exemptions is that OBR
retains the carbon price incentive to reduce
emissions intensity. However, it does come at a
cost of muting the carbon price signal passed on
to consumers, who then have less incentive to
consume less energy-intensive products or find
cleaner alternatives.
• The third option is border carbon adjustment (BCA)
of a domestic carbon price, which would levy
charges on imports of EITE products to ensure that
consumers pay the same price for embodied
carbon, regardless of the origin. A recent Energy
Modelling Forum modelling exercise on carbon
leakage (summarised in Böhringer et al. 2012)
found that BCA for EITE sectors for reduced carbon
leakage from actions taken by OECD countries by
25% to 50% across most models
• At its logical limit, if BCA were applied to all products,
it would convert the carbon pricing regime from one
that taxes carbon arising from production to one
that taxes carbon embodied in consumption (much
like a value-added tax is a destination-based tax).
While calling on consumers in developed countries
to take responsibility for their carbon consumption
sounds appealing, full BCA causes a strong shift in
the terms of trade to the detriment of developing
countries. For example, China’s exports are eight
times as carbon-intensive as those of the EU and
three times those of the US (Atkinson et al. 2011).
 Sources of Emission and Ways of Managing
them
• Point Sources
– Electric power plants
• Emissions taxes
• Emissions quotas

• Mobile Sources
– Cars
• Fuel taxes
• Subsidies on hybrid cars

• Non-Point Source
– Agricultural runoffs into rivers
• Taxes on inputs—fertilizers, pesticides
 Concept
• Relationship between trade and environment
 Trade and the Environment
WTO Study
http://www.wto.org/english/res_e/booksp_e/special_study_4_e.pdf

• World population doubled from 2.5 B in 1950

to 6 B in 2000
• Integration of world economy
• Reduction in trade barriers
• 14-fold increase in trade since 1950
• Trade has strained the environment
 Consequences
WTO Study

• Environmental Degradation
• Deforestation
• Loss in biodiversity
• Ozone layer depletion
• Overfishing
• Global warming
 Other Problems
WTO Study

• Relaxed Environmental regulations

• WTO rules prevent environmental law making
• Provide legal cover to countries to challenge
domestic policies that interfere with trade.
• Political economy argument: competitive
pressure from world markets
 Trade and the Environment
WTO Study

• ‘Between 1960 and 1990, some 20% of all

tropical forests in the world were cleared. In the
Amazon alone, some 20,000 square kilometers
are cleared every year’
• ’20% of all endangered species are threatened
by so-called "exotic invaders“’
• ‘Some 58% of the world's coral reefs and 34% of
all fish species are currently at risk from human
activities.’
 Trade and the Environment
WTO Study

• Composition effect
– Leads to specialization=> countries can import
goods and produce those they have a comparative
advantage over
– If export goods are cleaner, then it reduces
pollution in the exporting country
– Merely redistributes pollution globally
 EKC Revisited
• Scale effect
– Enhanced economic activity will increase pollution
• But increase in income will lead to higher
preferences for cleaner environment
– People will have a higher willingness to pay for
cleaner goods
 General Equilibrium Effects
WTO Study

• ‘Some sectors are more polluting (or pollution

intensive) than other sectors’
• ‘Polluting industries are capital intensive’
– Chemical industries
– Pulp and paper
– Oil refining

• Developed countries have comparative

advantage
 Class Exercise
Class Exercise 1
 
A country has unilaterally decided to implement a uniform carbon tax of $25/ton. Discuss
what are the potentially beneficial or adverse impacts of this tax on the firms, consumers and
the overall economy. Suggest what would be a good way of using the revenues generated
from carbon taxation. Familiarize yourself with the idea of double dividends.
 It refers to the notion that environmental taxes can both reduce pollution (the first dividend) and
reduce the overall economic costs associated with the tax system by using the revenue generated to
displace other more distortionary taxes that slow economic growth at the same time (the second
dividend)
 
 
 
Class Exercise 2
Discuss the advantages of cap and trade compared to carbon taxation with respect to
mitigating the global warming problem.
Both cap and trade and carbon taxation are effective policy tools for mitigating the global warming problem.
However, there are some advantages that cap and trade has over carbon taxation.
Market-based approach: Cap and trade is a market-based approach, whereas carbon taxation is a direct tax.
Cap and trade creates a market for emissions permits, and firms can buy and sell permits, depending on their
needs. This creates a more efficient market where the price of the permits will reflect the supply and
demand for them. In contrast, carbon taxation directly imposes a cost on firms and may not create the same
level of market efficiency.
Certainty of emissions reduction: Cap and trade ensures a certain level of emissions reduction. The
government can set the cap on the amount of greenhouse gas emissions that can be released by firms. This
guarantees a certain level of reduction in emissions. Carbon taxation, on the other hand, does not guarantee
any specific level of emissions reduction. Firms may simply pay the tax and continue to emit greenhouse
gases at the same level.
Flexibility: Cap and trade allows firms to choose how they want to reduce their emissions. Firms can choose
to reduce their own emissions or purchase permits from other firms that have reduced their emissions. This
gives firms more flexibility in how they want to reduce their emissions. Carbon taxation, on the other hand,
does not offer the same level of flexibility. Firms are simply taxed on their emissions, and they must pay the
tax regardless of how they reduce their emissions.
Incentivizes innovation: Cap and trade incentivizes innovation in emissions reduction technologies. Firms
that develop new technologies that reduce emissions can sell their permits for a higher price, thereby
generating a financial incentive for innovation. Carbon taxation does not have the same effect, as firms may
simply pay the tax rather than invest in new technologies.
In conclusion, both cap and trade and carbon taxation are effective policy tools for mitigating global
warming. However, cap and trade has several advantages over carbon taxation, including its market-based
approach, certainty of emissions reduction, flexibility, and incentivization of innovation in emissions
reduction technologies.
 Concept
• Comparative Advantage
• Two Students, S1 and S2, can do two types of
assignments in certain number of hours as
given in the table
Assignment 1 Assignment 2
S1 20 hours 10 hours

S2 5 hours 7 hours
• Student 2 has an absolute advantage, still they
can both gain from trading as the opportunity
costs of the assignments (wrt each other) are
different for the two students.
• S1 can do Assign 2 cheaper (in terms of time
spent) compared to Assign 1
• S2 can do Assign 1 cheaper than Assign 2
 Number of hours spent with and without
trade
• When Students do not trade Assignments:

Assign 1 Assign 2 Total hours

s1 20 10 30
s2 5 7 12

• When S1 does Assignment 2 (twice) and S2 does Assignment 1 (twice) (assume doing assignment twice takes twice the time)

Assign 1 Assign 2 Total hours

S1 2*10 20
s2 2*5 10
 Theory of Comparative Advantage
• Countries trade goods and services in which
they have the comparative advantage
• What does comparative advantage mean?

Cloth Wine
USA 100 80
Australia 40 60
• In the USA-It takes 100 man-hours to make a shirt and 80 man-hours to make a bottle of wine
 Comparative Advantage Explained through a Production Possibility Frontier---
Find the opportunity costs of making cars in the two countries and determine
which country will specialize in making computers

100

computers Country 1
60

Country 2 Country 2

75 Cars 120
 Comparative Advantage Explained through a Production Possibility Frontier---
The two countries have similar opportunity costs, what happens now?

100

computers Country 1
60

Country 2

75 Cars 120
 Examples of comparative advantage

• Indian call centers

• Software programming??
• Examples from China, US?
 Theory of Comparative Advantage is an
obsolete idea, why?
• The theory of comparative advantage is not an obsolete idea, as it remains
a fundamental principle in the field of economics. The theory of
comparative advantage was first introduced by David Ricardo in the early
19th century, and it states that countries should specialize in producing
goods and services in which they have a comparative advantage, and then
trade those goods and services with other countries.

• The theory of comparative advantage is still relevant today because it

provides a framework for understanding the benefits of international
trade. It helps to explain why countries that produce certain goods or
services more efficiently than others can benefit from trading with each
other. By specializing in the production of goods or services in which they
have a comparative advantage, countries can increase their overall
efficiency and productivity.
While the theory of comparative advantage has been criticized by some economists
who argue that it does not take into account factors such as income inequality or
environmental concerns, it remains a fundamental principle in international trade and
has been supported by empirical evidence over time. In fact, it has been used to
explain the success of many countries in developing their economies through trade.

In summary, the theory of comparative advantage is not an obsolete idea, as it

continues to provide a valuable framework for understanding the benefits of
international trade and specialization.
Comparative Advantage and the Environment

• Countries need to remain competitive on the

trade front
• This influences environmental regulations
• Some countries may specialize in polluting
goods as they have a comparative advantage
 Phaneuf Article
The economics of Pollution Control
• Coal burning power plants in the US East emit
sulfur dioxide pollution
• Sulfur dioxide emissions cause acid rains,
destroy forests, affect human health, poison
lakes, etc.
• Who is to blame?
• Power plants or consumers?
 Phaneuf Article
• Marginal analysis approach:
• If the benefits from reducing sulfur emissions
marginally are higher than the costs, reduce
emissions
• Options:
1. Switch to low sulfur coal produced in the west
2. Install scrubbers on smokestacks
3. Shut down
 Phaneuf Article
• Option 1 is costly as it involves shipping coal
across the continent, but can reduce
emissions by 30-40 percent
• Option 2 is more costly as large capital
expenditure is required, but can reduce
emissions by 90 percent
• Option 3, will lead to no electricity being
produced
 Phaneuf Article
• In terms of benefits:
• Low levels of emissions can move societies
away from resilience thresholds
• High levels of acid rains kill forests and poison
streams
• Low levels can be absorbed with little impact
 Phaneuf Article
• So, what is the optimal level of sulfur
emissions
• Depends upon the society’s wtp
• Costs can fall over time
• Wind energy was costly in the beginning, but
costs fell by 90 percent
• Currently kilowatt-hour costs are comparable
for wind and electricity plants
 Phaneuf Article: Environmental policy

• Emission taxes: fixed tax for each unit of

pollution
• Firms are free to choose each unit of pollution
but larger pollution will mean higher
payments to the government
• Taxes give incentives for technological
development
 Phaneuf Article: Transferable Emissions Permits

• Government determines the target level of

permits
• Distributes a fixed number of certificates
amongst firms that sum up to to the total
target determined
• Each firm must return a certificate back to the
government for each unit of emission
 Phaneuf Article: Trading in certificates

• Firms that emit less can make profits by selling

certificates to firms with larger emissions
• This leads to a market for pollution rights
• This case also encourages development of
clean technology
 Health Impacts of Air Pollution
World bank group report

• How to measure the health impacts?

• Dose-Response Relationships

– Correlate mortality outcomes with ambient levels

of pollution
 Different ways to Measure Health Impacts
(world bank group report)

• Human capital approach=> Earnings forgone

due to premature death from exposure to air
pollution
• Cost of Illness=>Lost workdays +out of pocket
expenses
• Preventive and mitigative expenditure
– Purchase of bottled water, installation of air-
conditioning
 Measuring Health Impacts
• Wage differential=> reduced wages offered
from bad health but on similar jobs
• How much extra wages you want for an
increase in the risk of death?

• Contingent valuation method=> direct

questioning
Table 2. Human Capital and Mortality Cost
by Age, United States
Age group Life years Mortality cost
(years) lost (1992 U.S. dollars)
Under 5 75 502,421
5–14 68 671,889
15–24 57 873,096
25–44 42 785,580
45–64 25 278,350
65 and older 10 22,977
Note: The cost estimates are based on life expectancy at the
time of death and include labor-force participation rates, average
earnings, the value of homemaking services, and a 6%
discount rate.
Source: Institute for Health and Aging.
 Preventative measures
• Inferred from amount people are willing to
spend to avoid bad health
• Expenditure on bottled water

• (VOSL) in the range of US$1.9 million–$10.7

million (1990 dollars).
 The Value of a Statistical Life
Thomas J. Kniesner
Claremont Graduate School
W. Kip Viscusi
Vanderbilt Law School

Excerpts:

• Estimates of the VSL for the United States are

around $10 million ($2017), and estimates for
other countries are generally lower given the
positive income elasticity of the VSL.
• Suppose that p is the probability of an accidental
death at work and is measured by the number of
accidental worker deaths per 10,000 workers.
• Suppose further that the estimated hedonic locus
reveals that the typical worker in the labor market
of interest, say manufacturing, needs to be paid
$1,000 more per year to accept a job where there is
one more death per 10,000 workers.
• This means that a group of 10,000 workers would
collect $10,000,000 more as a group if one more
member of their group were to be killed in the next
year.
• Note that workers do not know who will be fatally
injured but rather that there will be an additional
(statistical) death among them. Economists call the
$10,000,000 of additional wage payments by
employers the value of a statistical life.
• It is also the amount that the same group of workers
would be willing to pay via wage reductions to have
safer jobs where one fewer of their group would be
fatally injured or ill. In that sense the VSL measures the
willingness of workers to implicitly pay for safer
workplaces and can be used to calculate the benefits of
life-saving projects by private sector managers and
government policymakers.
• The multivariate regression approach leads to the workhorse
regression equation in the literature that is typically referred to as
the Mincer equation in light of the contributions of Jacob Mincer
that is
• ln(𝑤𝑖,𝑗,𝑘)=𝛼+𝛽𝑝𝑖,𝑗,𝑘+𝑋𝑖,𝑗,𝑘Γ+𝑢𝑖,𝑗,𝑘,
• where for worker i in industry j and occupation k
• the dependent variable is the natural logarithm of the real wage,
• p is the work-related fatality rate,
• and X is a vector with both demographic control variables (such as
age and education) and other job characteristic variables (such as
non-fatal injury risk, workers’ compensation insurance coverage,
and industry and occupation indicators) with associated coefficient
vector Γ.
• Finally, ui,j,k is an error term whose stochastic properties are
reflected in regression coefficients’ estimated standard errors.
• In the typical semi-log wage equation above the
estimated coefficients are so-called rates of
return or the proportionate change in the wage
per one unit change in the independent variable
of interest, (𝜕𝑤/𝜕𝑝)(1/𝑤).
• So, in the case of the typical U.S. fatality risk
measure of deaths per 100,000 workers, a wage
rate that is average hourly earnings, and a typical
work year that is h hours, the value of a statistical
life is calculated as VSL = 𝛽(hat)×𝑤×ℎ×100,000. It
is common to compute the average value of the
VSL using 𝑤= average wages and h = 2000,
• Using the formula for the VSL just presented
the mean VSL for U.S. men is about $7 million
to $8 million in $2001 (Kniesner, Viscusi,
Woock, & Ziliak, 2012).
• Although other specifications may lead to
different VSL estimates, it is noteworthy that
even after these extensive controls the general
range of the VSL is similar to the levels
frequently used in U.S. policy contexts.
Self-Insurance (SI) versus Self-Protection (SP)

• Self Insurance: Amount wtp to reduce severity

of damage
• Self Protection : Amount wtp to reduce the
probability of damage
• Normally, people combine both SI and SP
when faced with an environmental hazard
 Exercise
• The government plans to install new traffic
management systems that would cost each
taxpayer 200 USD. City population is 0.4
million
• The new traffic system will reduce no. of
deaths by 10
• Calculate the VOSL
 Exercise
• Refer to previous slide.
• A tax of USD 200 per person reduces the
probability (p) of traffic accident related
deaths from .0001 to .00005. Where p is the
probability of accident faced by a commuter.
There are .4 million commuters annually.
• Find the VOSL
 What is Resilience?
• Conventionally, resilience has been defined in two ways in the ecology literature.

• The first, termed as the ‘engineering resilience’ defines it as the speed of bouncing
back of any perturbed system (Pimm 1984).

• The other, termed ‘ecological resilience’, is about the amount of stress that the
system can tolerate before flipping from its original state to another stable but
degraded state (Holling 1995, Carpenter and Cottingham 1997).
 What is Resilience?
Environmental Quality

Stock of Species