What is Environmental Economics

Environmental economics is a discipline of

economics that studies the economic effects of
environmental policies around the world.
Its main focus is on the efficient allocation of
environmental and natural resources and how
alternative environmental policies deal with
environmental damage, such as air pollution, water
quality, toxic substances, solid waste, and global
warming.
 Origin of Environmental Economics…
The origin of environmental economics date back to the
1960s, when industrialization was experiencing a boom,
particularly in the western world, and pollution from
industrial activity became an increasing concern.
Environmental activism also started to increase due to the
perceived negative consequences of environmental
degradation. The world became aware of rapid economic
growth and its consequences to the environment.
Environmental economists see the environment as a form of
natural capital that provides amenities and life support
functions to the earth’s inhabitants. Environmental economics
was premised on the neoclassical approach dealing with
issues such as inefficient natural resource allocation, market
failure, negative externalities, and management of public
goods.
 Contd…

As the movement developed over time, other intricate

details on the relationship between the environment
and the economy became apparent. The study brought
about powerful environmental arguments and
propositions, which gave rise to contemporary
environmental policies and regulations around the
world. It led to the establishment of new
environmental bodies – chief among them, the United
Nations Environment Programme (UNEP) in 1972.
 Scope
What causes environmental challenges in terms of
economic and institutional affairs?
The question explores the concept of market failure, which is
premised on the fact that there are either non-existence or
incomplete markets for environmental goods, such as
unpolluted air, clean environment, scenic nature views, etc.;
hence, there is likely to be no efficient allocation of
environmental resources.
What is the monetary value of environmental
degradation through pollution and other agents, as well
as the value of developments in the prevention and
eradication of environmental harm?
The methods of measurement and estimation of the variables
are an important aspect of environmental economics.
 Contd…

How can economic incentives and

environmental policies be effectively designed to
improve environmental quality and deter
environmental damage?
Critical evaluation of economic incentives and
environmental policies and regulations is crucial to
find out if they are yielding the intended
objectives.
 CONCEPTS
Sustainable Development
Sustainable development is defined by UNEP as
“development that meets the needs of the present
without compromising the ability of future generations
to meet their own needs.” The concept analyzes the role
of economic development in supporting sustainable
development.
The four basic components of sustainable development
are economic growth, environmental protection, social
equity, and institutional capacity.
 Contd…

Market Failure
Market failure occurs if the functioning of a perfect market
is compromised; hence, it is unable to efficiently allocate
scarce resources at a given price as conditions for laws of
demand and supply are not met.
An example can be an environmental good such as clean
oceans. It is difficult to price the value of clean seas and
oceans, and there exist no markets for clean water bodies
where it is traded depending on the degree of cleanliness. It
is a standard case of market failure.
 Contd…

Externalities
Externalities are inadvertent consequences of economic
activity that affect people over and above those directly
involved in it. Externalities are also another form of
market failure. They can either be negative or positive.
A negative externality creates unplanned outcomes that
are harmful to the environment or directly to the general
public. An example can be pollution through industrial
production, which results in unclean air and water and
other health risks. The polluting entities may not incur
any costs to address the pollution, even though their
activities harm the environment and negatively affect the
surrounding community.
 Contd…

A positive externality is a benefit to other people not

directly involved in its generation. A community nature
park can benefit people outside the community who visit
family and friends in the area and would not have
contributed to its development. People who benefit from
an economic resource without contributing to its
establishment are called “free riders.”
(A free rider is a person who benefits from something
without expending effort or paying for it. In other
words, free riders are those who utilize goods without
paying for their use.)
 Contd..

Valuation
Valuation is an important aspect of environmental
economics, as it helps to evaluate a variety of options in
managing challenges with the use of environmental and
natural resources. The valuation of ecological resources
is a complex process, as it is difficult to assign value to
intangible benefits, such as clean air and an unpolluted
environment.
Resources that offer multiple benefits are difficult to
value – for example, mountains may prevent flooding,
provide scenic beauty, direct river flow patterns, and
provide fertile soils for agriculture.
 Contd..

Environmental resources can be assigned values

depending on use and non-use methods. It’s easier to
assign value to a product in use by observing what
consumers are willing to pay.
Opportunity cost pricing, replacement cost, and
hedonic pricing techniques can be employed in the
“use” method. The contingent valuation technique is
used for the “non-use” method by measuring what
consumers are willing to pay for a product they do
not use or enjoy.
 Opportunity cost pricing
Opportunity cost is a key concept in economics
(Buchanan, 1987; Crowards, 1998). The opportunity cost
is the net benefit forgone, because the resource providing
the service can no longer be used in its next-most-
beneficial use. As an example, suppose a farmer cuts
down a forest to expand his cropland.
suppose a farmer cuts down a forest to expand his
cropland. If the consequent loss of timber, firewood and
water purification function is the next best use of the
land, then the value of timber, firewood and water
purification is the opportunity cost of the expanded
cropland.
 Contd..

In the case of non-renewable resources (oil, metals, etc)

the opportunity cost is the value of the ecosystems that
will be harmed throughout the lifecycle of the raw
material (extraction, processing, use, disposal).
Replacement cost
The replacement cost method uses the cost of replacing
an ecosystem or its services as an estimate of the value
of the ecosystem or its services.
Similarly, the substitute cost method uses the cost of
providing substitutes for an ecosystem or its services as
an estimate of the value of the ecosystem or its services.
 Contd..

Hedonic Pricing
A hedonic pricing model is often used to estimate
quantitative values for environmental or ecosystem
services that directly affect market prices for homes.
This method of valuation can require a strong degree of
statistical expertise and model specification, following a
period of data collection.
The hedonic approach to economic assessment can be
used for evaluating the economic value of environmental
goods such as noise, air or water quality, landscape and
similar goods
 Contd.

Cost-Benefit Analysis
Cost-benefit analysis (CBA) involves weighing the benefits arising
from a policy against the perceived benefits. Hence, the best policy
is one in which there is the greatest surplus of benefits over costs.

CBA starts with a base policy where no changes are made to the
status quo. A time horizon is selected where the perceived costs and
benefits are expected to be realized. Benefits are instances where
human well-being is improved, and costs decrease human well-
being.

Costs and benefits to be realized in the future are discounted using

a discount factor to cater to the time value of money. Benefits
include extra income, improved quality of life, clean water, and
beaches, and costs include opportunity costs, internal and external
costs, and externalities.
 Pollution
Physically, pollution occurs because it is virtually
impossible to have a productive process that involves no
waste; economically, pollution occurs because polluting
is less expensive than operating cleanly. ... Additionally,
pre-existing market distortions influence the nature of
efficient pollution abatement strategies.
 PRECAUTIONARY PRINCIPLE
This is a moral and political principle which states that
if an action or policy might cause severe or irreversible
harm to the public, in the absence of a scientific
consensus that harm would not ensue, then the action
should be stopped
The principle implies that there is a social
responsibilities to protect the public from exposure to
harm, when scientific investigation has found a
plausible risk. These protections can be relaxed only if
further scientific findings emerge that provide sound
evidence that no harm will result
 contd..

The burden of proof falls on those who would advocate

taking the action.
These protections can be relaxed only if further
scientific findings emerge that provide sound evidence
that no harm will result.
For example, a large ground-water body that many
people use for drinking water is contaminated by
bacteria and the source of contamination is strongly
suspected to be dairy cows but the exact science is not
yet able to provide absolute proof, the cows should be
removed from the environment until they are proved,
by the dairy industry, not to be the source or until that
industry ensures that such contamination will not recur.
 Contd…

Advantages
 Provide policy makers with simple common-sense
approach to evaluating actions
 It allows for greater protection of the consumer and
environment
 it requires decision-makers to explain the rationale
behind their decisions, to quantify the risks, and to
provide objective information.
 Allows government to create appropriate plans of
action giving good information
 Allows regulators the chance to examine the far
reaching effects of proposed action prior to that action
being undertaken
 DISADVANTAGES
Blocking innovation and progress generally because
applications of strong formulations of the principle can be
used to block innovation, a technology which brings
advantages may be banned by PP because of its potential
for negative impacts, leaving the positive benefits
unrealized
Internal inconsistency – (applying strong PP risks causing
harm)
Vagueness and plausibility
Given the increased rate of regulatory demands for prove of
limited to no risk, many health related products may be kept
from market.
The principle does not stand firmly on its own but would
function best when coupled with the sustainability approach
 CONCLUSION
Though this principle has a lot of advantages and
seeks to protect the interest of the public, it also
generates internal inconsistency and therefore
applying the principle in absolute terms actually
contradicts the principle in its self.
 POLLUTER PAYS PRINCIPLE
It is a principle in the international environmental law
where the polluter pays for damage done to the natural
environment. It is also known as the extended polluter
responsibility. Whoever is responsible for damage to
the environment should bear the cost associated with it.
Its purpose seeks to shift the responsibility in dealing
with waste from governments to the entities producing
it.
 burden of proof
 The burden of proof lies on the environmental
regulators
 A straight forward interpretation of the polluter pays
principle would suggest that if the consumption or
production activities of one group of consumers or
producers have harmful effects on others then the
perpetrators of the harms should be held liable for the
damages.
 A simple example is tax on petrol, when consuming
petrol we create pollution so the tax means the price
will pay more closely reflect the social cost.
 ADVANTAGES
It is a simple extension of the principle of fairness
and justice
It enhance economic efficiency that is it helps to
protect the environment without sacrificing the
efficiency of a free market economic system
The additional revenues are used to cut payroll,
income and corporate taxes
Revenues collected can help to achieve other social
goals
It is a way of internalizing externalities
 DISADVANTAGES …
Ambiguity still exists in determining ‘who is a
polluter’
It can be difficult to measure how much pollution is
produced e.g. firms may hide the extent of their pollution
A large number of poor households, informal sector
firms, and subsistence farmers cannot bear any
additional charges for energy or for waste disposal.
Small and medium-size firms from the formal sector,
which mainly serve the home market, find it difficult to
pass on higher costs to the domestic end-users of their
products.
 Contd…

Pollution can be shifted to countries with weak

environmental legislations Exporters in developing
countries usually cannot shift the burden of cost
internalization to foreign customers due to elastic
demand
CONCLUSION
The idea that polluters should be made to pay for
damages that they cause to the health and property of
others is sound and, in a free society based on personal
responsibility, should be the guiding principle for all
environmental policy.
 Labour Economics
Labour economics is the study of the labour force as an
element in the process of production. The labour force
comprises all those who work for gain within the labour
market, whether as employees, employers, or as self-
employed, but also the unemployed, who are seeking
work.
It helps economists to understand labour related
problems e.g Issues on fair wage or salaries workers,
welfare of workers, labour productivity, workers safety,
gender related matters, job security and Job satisfaction
 Labour Markets
A labour market is the place where workers and
employees interact with each other. In the labour
market, employers compete to hire the best, and the
workers compete for the best satisfying job.
Description: A labour market in an economy functions
with demand and supply of labour.
 Characteristics of Labour Markets
A commodity market refers to a physical place where
buyers and sellers of a particular commodity gather
for engaging in transactions while a labour market is
viewed as a process by which supplies of a particular
type of labour and demands for that type of labour are
balanced.
unlike a commodity market, the relationship between
a seller and a buyer in a labour market is not
temporary and as such personal factors, which can be
ignored in a commodity market, become important in
a labour market.
 Contd…

unlike a commodity market, in a labour market there is

a lack of perfect mobility which gives rise to a
diversity of wage rates for the same type of work and
we do not find a normal wage rate to which the market
rate naturally tends. In other words, labour market is
essentially an imperfect market.
wage fixing is an essential characteristic of the labour
market, where (in the absence of unions) the buyer of
labour normally sets the price but in the commodity
market, it is normally the seller who sets the price. In
labour market the price that is set tends to be fixed for
some length of time. Employers do not want wage
rates to fluctuate with every change in demand and
supply conditions.
 Contd…

the labour market is far more complex than the

commodity market. It makes little difference whether a
potato is sold in Calcutta or in Bombay to the seller.
But this is not true of a human being. Whatever is the
occupation or monetary reward of a person, each
individual feels that he is entitled to a decent treatment
and that the dignity of his person must be respected..
The essential characteristic of the labour market of an
expanding economy is that the vast majority of
individuals are employees while relatively small
minorities function either as employing persons or as
employed managers of employing units. As the vast
majorities are labours, they are interested in short-run
wage-levels, working hours and working conditions.
 Contd…

As a result of industrialisation the average employing

unit has become larger in size, its bargaining power has
expanded while at the same time, the bargaining power
of the individual worker has shrinked and become almost
meaningless for all practical purposes.

Therefore, the individual worker loses control over the

determination of factors quite basic to him, such as
wages, his working hours etc. Thus, industrialisation is
producing divergent trends in the bargaining power of
buyers and sellers within the labour markets.
 Classical theory of wage determination
Generally, the prices of factors are determined by the
interaction of demand and supply, which should also
be applicable in determining the wages for labour.

However, the theory of demand and supply is not fully

applicable while determining wages for labour.

This is because labour as a factor of production is

distinct from other factors of production.

The following are the unique features of labour:

 Contd…

 The demand for labour requires a different treatment

in terms of demand. This is because the demand for
labour is not dependent on its utility, but its
productivity. However, the demand for products
depends on buyer’s satisfaction in terms of utility of a
product.
 Labour cannot be detached with labourers. Therefore,
while determining wages, human factors are taken into
account.
 The supply of labour is different from the supply of a
product. The supply of a product increases with
increase in its prices, whereas the supply for labour
decreases with increase in wage rates.
 Subsistence theory …

Subsistence theory was developed by Adam Smith.

According to subsistence theory, wages should be at the
level where a worker can satisfy his/her own needs as
well as the needs of his/her family. This level of wages
is termed as subsistence level.

In case, the level of wage rises beyond the subsistence

level, then the size of population would increase as the
worker may get married and have children. This
increase in population would increase the supply of
labour. As a result, the wage level would again come
down to the subsistence level.
 Subsistence theory …

On the other hand, if the wage level falls below the

subsistence level, then the worker may not think of
getting married. This would decrease the labour supply.
In such a case, the wage level needs to reach back to the
subsistence level so that the supply of labour can be
increased.
 Criticism
Provides a general rule for determination of wages for
all countries. However, the subsistence theory is
applicable in underdeveloped countries, but not for
developed countries.
Assumes that an increase in the wage level results in
increase of population. However, an increase in the
wage level may also increase the standard of living of
individuals as well as their real wages.
Focuses on the customs and habits of people for
determining the wage level. However, the taste and
habits of individuals is subject to change with time.
Presents a general view for all types of works.
However, in the real world, the level of wages differs
for different types of works
 Criticism
Takes into account only the supply of labour not the
demand for labour, which is a major component in
determining the wage level.
 WAGE FUND THEORY
Wages fund theory was advocated by J.S. Mills.
According to him, “wages depend upon the demand and
supply of labour, or, as it are often expressed, on the
proportion between population and capital.
By population here means the number only of the
labouring classes or rather of those who work for hire,
and by capital, only circulating capital and not even the
whole of that but the part which is expanded on the
direct purchase of labour.
Wages not only depend upon the relative amount of
capital and population, but cannot, under the rule of
competition, be affected by anything else.”
 Contd.

As per the wage fund theory, the wage level depends on

the quantity of the wage fund and the number of people
who are employed. Wage fund refers to the amount of
capital that an employer keeps for paying wages to
labour.
The level of wages can be determined with the help of
the following formula:
Level of wages = Wage fund / Number of employees
This equation implies that wages are directly
proportional to wage fund and are inversely proportional
to number of employees. Therefore, wages increases
when wage fund increases or number of employees
decreases.
 Contd.

However, according to the wage fund theory, wage fund

is constant. Therefore, the wage level would increase
only by reducing the number of employees. According to
this theory, trade unions do not have any control on the
level of wages.
Wage fund theory- is also criticized by many
economists on the following grounds:
 Does not provide a clear view whether the wages are
paid through capital reserved or from the revenue
generated by selling products. Generally, in short term,
wages are paid from the revenue generated by selling
products. However, in long term, wages are paid from
the capital reserved.
 Contd.

 Presents the concept of keeping a certain amount for

wage fund, which is not true in the real world. This is
because there is no as such fund, which is fixed for
providing wages.

 Calculates the level of wages by dividing wage fund

with number of employees, which is not an
appropriate method of determining the wage level.
 Residual claimant theory
Residual claimant theory was given by Walker, an
American economist. According to his theory, wages are
the residual part of the capital left after paying to the
other factors of production. Walker advocated that rent
and interest factors of production are based on the
contract among individuals, while profit is obtained by
adopting certain principles. However, the level of wages
is not determined by any such principles.
According to residual claimant theory, wages are paid
from the residual amount of total output left after paying
for the three factors of production, namely rent, interest,
and profit. As per this theory, the level of wages would
increase with an increase in the productivity of labour.
 criticism
There are certain criticisms against the residual claimant
theory. The theory fails to explain the role of trade
unions in increasing the wages of an employee.
Moreover, Walker did not explain the impact of supply
of labour on wages.
 Tausig’s Theory of Wages:
Tausig, an American economist, modified the marginal
productivity theory. According to him, the marginal output
generated by a worker is not completely provided to him
in terms of wages. This is because the manufacturing of a
product takes time and labour needs wages during the
manufacturing process.
In such a case, the employer pays wages to labour from
his/her own capital. Therefore, the employer does not
provide the actual amount of marginal product to the
labour. The employer deducts a certain percentage from
the total output to compensate the amount that he/she pays
to the labour during the production process. The amount is
reduced from the total output at the prevailing rate of
interest.
 Modern theory of wage determination

Modern economist opines that the price or

remuneration of labour i.e. wage is determined by
interaction of forces of demand and supply. Wage is
determined at the point where demand for and
supply of labour are equal to each other. This is why
the modern theory is known as supply and demand
theory of wages.
 Demand for labour:
Demand for the labourer is derived demand. Factors of
production are demanded because they have
productivity or efficiency. Productivity of a factor refers
to the addition made by it total productivity. Demand for
labourers depends on the demand for the goods they
produce.
The demand for a factor is affected the prices of other
factors. Labourers can be substituted for other factors of
production. Technical factors also affect the demand for
labour. When old techniques are applied there will be
more demand for labour. With the introduction of new
technique of production the demand for labour declines
 Demand for labour:
Besides the technique production and the prices of other
goods, there is a main factor earning the demand for
workers is their marginal productivity, original
productivity is stated in money forms. Stated in moneys
it is called marginal revenue productivity.
Workers are demanded up to the point where their
marginal revenue productivity also labour's wage.
Therefore an entrepreneur employs labour up to the part
where their wages are equal to their marginal activity.
With the increasing number of labourers the marginal
activity will go on diminishing. Thus the demand curve
for labour is downward sloping,
 Supply of labour:
Supply of labour means the number of workers ready to
at the existing wage rate. Unlike the supply of other
goods, the supply of labour can not be increased with
the rise in their demand. Under perfect competition, the
supply curve of a firm is perfectly elastic. A firm can not
influence price. It accepts market price as the given
datum. Thus the demand of an individual firm for
labourer cannot affect price (wage).
On the other hand the supply curve of an industry slopes
upward from left to right. This means that an industry
can get more labourers at higher wages. An upward
rising supply curve of an industry shows the more of
workers are employed at higher wages. Determination
of the Equilibrium wage level:
 Supply of labour:
Wage rate is determined by the supply of and demand
for labour. Equilibrium wage state is said be determined
at the point where supply and demand are equal. At
point F demand curve DD and supply curve SS cut each
other.
 Collective Bargaining
Collective bargaining is the process in which working
people, through their unions, negotiate contracts with
their employers to determine their terms of employment,
including pay, benefits, hours, leave, job health and
safety policies, ways to balance work and family, and
more.
The basic objective of collective bargaining is to arrive
at an agreement between the management and the
employees determining mutually beneficial terms and
conditions of employment.
The principles include the effective recognition of the
right to collective bargaining, along with freedom of
association and the elimination of forced or compulsory
 Collective Bargaining
labour, the effective abolition of child labour and the
elimination of discrimination in employment and
occupation.
 Collective Bargaining
Advantages
 gives workers a larger voice. ...
 can improve a worker's quality of life. ...
 creates enforcement consistency. ...
 encourages cooperation. ...
 creates a binding result.
 Different concepts of wage
A wage is monetary compensation (or remuneration,
personnel expenses, labour) paid by an employer to an
employee in exchange for work done.
According to Section 2(h) of the Minimum wages Act,
1948 the term wages means all remuneration capable of
being expressed in terms of money which would if the
terms of the contract of employment express or implied
were fulfilled be payable to a person employed in
respect of his employment or of work done in such
employment and includes house rent allowance but does
not include the value of ….
 any house accommodation supply of light water
medical attendance or
 Contd…

 any other amenity or any service excluded by general

or special order of the appropriate government;-
 any contribution paid by the employer to any person
fund or provident fund or under any scheme of social
insurance;
 any traveling allowance or the value of any traveling
concession;
 any sum paid to the person employed to defray
special expenses entailed on him by the nature of his
employment; or
 any gratuity payable on discharge
 Living Wages
Living wages are defined as that wages which are
consistent to provide certain facilities as well as some
basic necessities to the employee. So, it means that
wage level which is satisfactory to provide for the
basic necessities and such niceties that are advised
necessary for the betterment of the employee as well
as his family in accordance with his social status.
Thus, living ages has been defined as follows:
The living wage should enable the male earner to
provide himself and his family not merely the basic
essentials of food, clothing and shelter but a measure
of frugal comfort including education for the children,
 Contd..

protection against ill-health, requirement of essential

social needs and measures of insurance against old
age.
Article 43 of the Constitution of India states that the
state shall endeavour to secure by suitable legislation or
economic organisation or in any other way to all
workers, agricultural, industrial or otherwise work, a
living wage, conditions of work ensuring decent
standard of life and full enjoyment of leisure and social
and cultural opportunities. So, the government of India
has adopted as one of the directives of the principle of
state policy to ensure living wages.
 Contd..

Living wage is a wage sufficient to ensure the

workman food, shelter, clothing, frugal comfort,
provision for evil days etc. as regard for the skill of an
artisan, if he is one.

Thus, Living wages does not mean to fulfill only for

the basic necessities of life to employee such as
food ,shelter and clothing, but also it include for some
comforts, leisure and amenities estimated by current
human standards such as health, education of children,
travelling, old age, recreation and social needs etc.
 Contd..

Living wage is a wage sufficient to ensure the

workman food, shelter, clothing, frugal comfort,
provision for evil days etc. as regard for the skill of an
artisan, if he is one.

Thus, Living wages does not mean to fulfil only for

the basic necessities of life to employee such as
food ,shelter and clothing, but also it include for some
comforts, leisure and amenities estimated by current
human standards such as health, education of children,
travelling, old age, recreation and social needs etc.
 Minimum Wage
The term Minimum Wage has not been defined in the
Minimum Wages Act, 1948.
The minimum wage is the lowest wage in the scale
below which the efficiency of a worker is likely to be
inspired.
The minimum wage includes not only the bare physical
necessities but also conventional necessities. The
Minimum wages must, therefore, provide not merely for
the bare subsistence of life but also for the preservation
of the efficiency of the worker.
For this purpose, the minimum wage must also provide
for the same measure of education, medical
requirements, and amenities.
 Fair wage
Fair wage means which is something more than the
minimum wages. It is a mean between the minimum
wage and the living wage. So, the lower limit of the
fair wage must surely be the minimum wage
whereas the upper limit is the fair wage which is
capacity of the industry to pay further the
comparisons definitely with the average payment of
same work in other occupations or trades which
requires the same amount of ability. Basically, it is
economic position and its future prospects on which
fair wage depends.
 Labour market discrimination
Labour market discrimination is defined as a
situation where workers or groups of workers are
treated differently in terms of recruitment, pay,
benefits and promotion from other workers or
groups due to their non-economic characteristics,
including gender, race, religion and age. This means
that while workers may be equally productive, they
are not treated the same. Treatment may be positive,
where certain groups are favoured, or negative,
where groups are treated less favourably.