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Economics of the Environment Not blind opposition to progress, but opposition to blind progress ~ Unknown (Sierra Club’s slogan) The view of the average human as builder conflicts with the view of the average human as destroyer which underlies the thought of many doom sayers ~ Julian Simon (1932-1998) CHAPTER 16 The environment is not only the source of raw materials, but is also a sink for the wastes generated as a result of exploitation of those same resources. As the economy continues to expand and industrial output grows, we are generating more and more hazardous wastes and toxic chemicals which will eventually end up in the air, in the water supply, and on land. Because society requires many services and products, it is understandable that a certain amount of pollution must be tolerated. The question is where the balance lies and how much longer we can exploit our natural resources before the costs associated with environmental degradation outweigh the benefits of increasing production and material wealth. Economists differ in their approach to reducing environmental pollution but, at the same time, assure that society as a whole benefits from proposed cleanup strategies. Most economists measure the cost/benefit ratio of the environmental protection in monetary terms; there are some, however, who are not willing to put a figure on the natural capital and the ecological systems that support life. The dilemma is that, although sources are owned privately (either by state or private enterprises), the same entities have free access to the sink (atmosphere) which is owned by the public as a whole. In this chapter we will discuss various methodologies that are used by traditional and ecological economists to measure the cost of polluting the environment in both monetary and non-monetary terms and the role the government plays in regulating pollution.1 In particular we will address pollution generated from fossil combustion and the costs and benefits of environmental cleanup. Open Access and the Tragedy of the Commons One of the major problems with environmental cleanup is that most natural capitals are not (and cannot be) privately owned. In economic terms, this is called the open access problem, or the tragedy of commons.2 W hen a resource (such as a grazing land or a lake) is accessible to all, there is little incentive for individuals to protect it. A cattle herder or a fisherman will rationally argue that if they do not exploit the land for 1 2 For more detailed information, please refer to the list of books given at the end of this chapter. H ardin, G., “The Tragedy of Commons,” Science , vol. 168, December 13, 1968. more grazing, or use the lake for more fishing, somebody else will. It is therefore logical to exploit the land or to overfish the lake to its maximum limit and reap the benefits before somebody else does. Same can be said of natural sinks like the atmosphere. A factory owner or a coal company have little incentive to bear the high cost of cleaning the air even though their children and families living nearby may have to breathe the same air. In a way, in absence of environmental regulations, they reap the full benefit of avoiding the cleanup cost, although they have to pay only a fraction of the cost that air pollution will bring to the entire community. Is there a right amount of pollution? Although having a clean environment is desirable to almost anyone, there is a limit to how clean it can get and how much it can cost. There are two schools of thought on what constitutes an efficient amount of pollution. Traditional economics treats pollution as a good that follows the same law of supply and demand that governs all other goods; it is most efficient at a level where the marginal cost of pollution reduction (supply) is equal to the marginal benefit to the society, or what society is willing to pay (demand) to avoid it. Any measure that reduces or increases pollution beyond this level results in the reduction in total benefits to producers and consumers as a whole. The second group of economists, called ecological economists, rejects this view as inherently unethical and unfair. They point out that personal safety is the innate right of every individual, and, independent of how much it costs, pollution must be brought below a certain level of risk to its victims. The former group advocates an efficiency standard, whereas the latter group believes a safety standard must be the basis of pollution control. Not surprisingly, efficiency advocates consider the safety standard as inefficient, whereas safety advocates consider efficiency standards to be inadequate in safeguarding the public and the environment. Efficiency Standard As we saw in the previous chapter, an efficient market is a market in which demand and supply are in balance. The market demand curve represents the amount people are willing to pay for one additional unit of output at each price, i.e. what people pay for the pleasure of having one extra unit of the good (marginal benefit). Similarly, the market supply curve represents cost incurred by the firm to produce each additional unit of good (marginal cost). If the price rises above this equilibrium point, the quantity demanded for the good drops, but suppliers would be willing to increase their production and new suppliers are willing to enter the market. The imbalance between the supply and demand pushes the price down and equilibrium is achieved again. The opposite will be true when price drops, but the final result will be the same. Applying this concept to pollution control, we note that the marginal costs of reduction will be increasingly higher per unit reduction in pollution (easier cleanups 414 Chapter 16 - Economics of the Environment are done first) and marginal benefits of reduction are lessened as air gets cleaner and cleaner. For example, it is costlier to reduce nitric oxide concentrations from 100 to 99 ppm than it would be to reduce it from 1000 to 999 ppm. At the same time, the marginal benefit the society receives (in terms of lower health risks, for instance) with reduction in nitric oxide’s concentration drops (Figure 16-1). Figure 16-2 shows the estimated marginal costs of nitric oxide abatement (in Euros/ton) for OECD and the former Soviet Union in 2010. As the data shows the graph is highly nonlinear. With the current technology, the cost of emission reduction is fairly small for removal of up to 50% of the pollutants, rises rapidly up to 80% and becomes prohibitively expensive if the last 20% of the emission is to be cleaned up.3 That is, as the level of pollution in the atmosphere decreases, we reach a point where further cleanup effort requires costs too excessive for the society to bear. Coase Theorem Marginal costs of reduction Cost Efficient level Marginal benefit of reduction Amount of Pollution Reduction Figure 16-1 Efficient level of pollution control There is no question that a clean environment will benefit public health and reduce medical costs. It seems to be a no-brainer that whoever pollutes the environment has the moral responsibility to pay for cleaning the environment. From an economical standpoint, however, society as a whole does not care whether the polluter or the victim pays for the cleanup. As long as victims and polluters reach a mutual agreement, in the absence of any regulation and in a truly competitive market, it makes no difference whether the victim or the polluter pays for the cleanup. In other words, it does not require victims to necessarily be compensated. That is the equilibrium point is where bargaining between the two parties leads to efficient levels of pollution. Question: To protect the public, environmentalists propose strict environmental regulations that restrict the dumping of pollutants into the atmosphere. How does the efficiency standard address the concern for public safety? Answer: Victims always have the option of suing the polluters to recover the cost of cleanup and other damages. By doing so, the cost of production increases, which forces polluters to invest in cleaner technologies or acquire effective pollution control equipments. Consider, for example, the transportation of crude oil from Alaska to refineries in California.4 The suppliers ship Q* barrels of oil at a cost of P* that includes the price of the good and ordinary transportation expenses such as wages for the crew, the cost of the ship, port taxes, etc. This is shown along the supply line S (Figure 16-3). In addition to these expenses there are costs associated with the spillage of oil along the route used by the oil tankers. If these costs are internalized, the supply curve shifts from 3 Figure 16-2 Costs of Pollution Abatement [Ref. 2]. h Air pollution damage b S1 a P1 P c S=MC d g e f D=MC Q1 Q Figure 16-3 Effect of pollution on equilibrium H armelen, T., et al., “An analysis of the costs and benefits of joint policies to mitigate climate change and regional air pollution in Europe.” Soil and Water Pollution, 5 , pp. 349-365, 2 002. 4 Th is example is borrowed from E conomics Today, by Roger LeRoy Miller and Daniel K. Benjamin, Addison Wesley Educational Publishers, Inc, 2001-2002. 415 S to S1 and the quantity shipped is reduced from Q* to Q1. Let’s consider two situations: a) the tanker operators have the right to spill without having to pay any penalties for environmental damage; and b) the fishing industries have the right to demand that tanker operators reduce the shipment or even stop it altogether. If tanker operators own the rights to shipping, then they would continue to ship Q* barrels instead of the optimum value Q1. In this case fishers have to convince the operators to reduce their shipment from Q* to Q1. If they succeed, damages would decline by the area shown as trapezoid abed . This requires fishermen to make two side payments, one to the tanker operators for forfeiting a profit equal to the triangular area bdg and another to the operators’ customers, the refineries, in an amount equal to the triangular area gde for compensating their losses from lower sales. The total payment to operators and refineries is therefore bde = bdg + gde . Fishers have an incentive to pay for these costs because they are still left with a net gain of abd = abed − bde . Overall, fishers are better off reducing environmental damage as a result of shipments being reduced from Q* to Q1, while there is no monetary impact on operators or refineries. We can therefore conclude that a side payment will be paid by fishers to operators and refineries, and only Q1 units of oil will be transported. If the fishers own the rights to clean water, then they can opt to insist on reducing the shipment or stop it altogether. In this case, the operators and refineries may choose to offer side payments to fishers for obtaining the rights. But how much are they willing to offer? If they manage to obtain the rights of shipping Q1 barrels of oil from fishers, they are to benefit with a profit as high as hbef , the difference between their revenues and costs. At the same time, fishers are willing to accept as low as cbef , an amount equal to the environmental damage to them. For any amount above Q1, fishers demand an amount exceeding the additional revenues by the tanker operators which therefore cannot be collected. We can conclude that a side payment will be paid by operators and refineries to fishers, and again, only Q1 units of oil will be transported. This example shows that, irrespective of whether the polluter or victim pays for the pollution, the result is exactly the same. This is named Coase Theorem after Ronald Coase, the 1991 Nobel Laureate in Economics. Question: W hat do advocates of the efficiency standard say about second-hand smoking? Answer: Smokers have as much right to enjoy smoking as nonsmokers have to enjoy clean air. We cannot discriminate against anybody on the basis of whose rights are more valuable. 416 Chapter 16 - Economics of the Environment Economic Efficiency The term “efficiency” means different things to different people. Engineers talk about efficiency as the ratio of the desired output from a device to necessary input. An energy-efficient refrigerator uses less electricity for the same amount of cooling than a less efficient refrigerator uses (See Chapter 5). An efficient worker performs more work in a shorter time, and an efficient programmer writes the same program with fewer instructions. Social scientists refer to efficiency as the cost that society as a whole will pay compared to the cost if certain actions were or were not undertaken. For example, the social cost if there are no energy conservation policies could include a rise in pollution, degrading health, social unrest, hunger, job loss, and a decline in the economy overall. Economists refer to efficiency in terms of the maximum profit that can be gained from a given transaction. The most widely accepted definition of economic efficiency is Pareto efficiency. A market is most efficient when it makes the public as a whole “better off.” As long as the market has not reached its most efficient point, the economic pie enlarges and, in principal, everyone can benefit by getting a bigger slice. Question: W hen does the market for a car sales reach its peak economic efficiency? Answer: As long as there are buyers who are willing to pay for the cost of owning a car and there are sellers who are willing to satisfy customers’ demands, the market has room for additional cars. That is, the market is Pareto efficient when demand balances supply. Question: Is a “zero pollution” solution compatible with the concept of economical efficiency? Answer: The zero pollution option will not make the outcome economically efficient. Although the public is willing to pay for certain amount of cleanup cost, at a certain point the increase in the marginal cost of cleanup does not justify the marginal benefits and brings enough economic hardship to a large number of people that the happiness of some would not make up for the unhappiness of the rest. Safety Standard Can one put a price tag on safety? Efficiency advocates, as we saw in the previous section, set price at the point where the market is at its Pareto efficiency. Safety advocates, however, believe that people have a right to protect themselves against unsolicited harm to their immediate environment and see safety as an essential human right that must be assured at an acceptable level no matter the cost. 417 Proponents of safety (or fairness) standards disagree with the Coase hypothesis and argue that polluters are the ones who must pay for the cost of cleaning the environment -- the public should not be victimized at the expense of profiteering by the polluting firms. In addition to being fair to the victim, the polluter-pays principle is superior on two main economic grounds. First, it removes the incentive for polluters to pollute (free-ride), as they, rather than the victim, would have to pay for the cleanup. Second, if polluters do not pay for the pollution, their production costs drop. This encourages even more polluters to enter the market, produce more goods, and create even more pollution. Furthermore, safety advocates refute the claims by efficiency advocates that suing the polluters can remedy the problem of environmental pollution by pointing out that victims often do not have the resources that large corporations have. Litigation is often quite costly and can take many years. Therefore it is very likely that victims tolerate the pollution damage, giving polluters a free hand to pollute with little fear of retribution. Another concern raised with this option is that there are always those who try to free ride on the outcome of the lawsuits of a few without exposing themselves to excessive costs associated with the lawsuits. For example, a noisy tenant blasting his stereo in the middle of the night might inconvenience more than a few neighbors. Although one or more victims may be inclined to sue and evict this neighbor, others may refuse to contribute to the effort and hope others carry the burden. Proponents of efficiency standards, for their part, point to a number of drawbacks in safety standards. The first criticism is that safety standards are by definition inefficient. Voters often tend to walk on the side of caution and overestimate the risks; thus the cleanup costs will be excessive. Furthermore, with budgetary constraints, the public will be best served if the money is spent on environmental projects that save the largest number of lives. Because we have limited financial resources for Point/Counterpoint ... Safety vs. Efficiency Standards P: Everybody has the right to a clean and healthy environment. Polluters have the responsibility to clean the environment, no matter the cost. CP: Of course, every human being likes to breathe clean air, drink clean water and live in an environment free of toxic chemicals. The question is: at what cost, and does the price justify the outcome? P: We owe it to our children and grandchildren to protect our environment and preserve our natural resources. CP: The resources are used for our wellbeing and that of future generations. The cleanup cost is justified as long as it does not impede progress. Our children will be collectively better off if the economy expands at a faster rate than resources deplete. P: Deciding on safety issues based purely on cost-benefit analysis puts a higher value on the health and comfort of the wealthy, and is therefore immoral. CP: The government has a limited budget to spend on safety and cleanup measures. The cost of cleanup might be too draining on the economy of low-income neighborhoods and may adversely affect them by incidentally increasing the violence, noise, drugs and pornography, rampant among poor and economically disadvantaged groups. More money spent on the environment leaves less money available to spend on other safety measures such as gun control, accident prevention, and police protection. 418 Chapter 16 - Economics of the Environment environmental protection, accepting a small increase in a particular risk may release money to carry out other safety measures. For example, by allowing a higher risk of cancer from pesticide use and diverting funds to reduce cancer from tobacco smoking, investing in accident prevention measures, and educating the public about drug abuse, gun safety, and gang violence might in fact saves more lives overall. Ultimately, how strict the safety standards should be requires a cost-benefit analysis. Question: W ho should pay for hauling garbage and constructing new landfills, the government or private homeowners? Answer: W hen the government pays for the cost, individual households have little incentive to reduce waste, and landfills fill sooner. At any rate, in the long run, the cost will be distributed through all households by requiring them to pay higher taxes. The Benefits of Environmental Protection Depending on how one views the environment, different values can be placed on protecting it. The utilitarian considers the value of the environment only as long as it brings him happiness. Anything that does not affect him directly has little immediate value to him. Therefore, nobody can be easily persuaded to pay for expenses today even though he might eventually be rewarded by cheaper products, better health, and a more pleasant environment. The environmental ethicist, on the other hand, sees protecting the environment as a moral issue; the environment belongs not only to us, but also to all living organisms and to all future generations. Society should seek to protect it whether it directly benefits today’s humans or not.5 Environmental protection has both market benefits and non-market benefits and may be broken down into values for generating revenues, providing non-monetary services to the community (use value), presenting unknown potential benefits (option value), and preserving the environment even if it does not benefit us directly (existence value). An example of the use value of a lake is an increase in the number of water sport enthusiasts, swimmers, and fishermen who use the lake. An example of option value is its value to future generations and the possibility that saving the environment and its ecological systems may one day provide the key to a currently non-curable disease. The existence value of the lake is the value individuals place on simply saving the ecosystem because of our belief that other creatures -- animals and plants -- have the same inherent right to these resources as humans. Cost-Benefit Analysis The economical benefits of environmental protection can be divided The differentiation between utilitarians and environmentalists only makes sense when basic human needs are satisfied. The poor have not seen any point in protecting the environment, as they do not receive much of the benefits. When poor countries are given sufficient incentives, their attitude will necessarily change and they will see the value of environmental protection and conservation. 5 419 into its market and non-market benefits. Market benefits are measured in terms of increased efficiency and production, savings in the cost of energy expenditure, reduction in cost of health care, and in the creation of new jobs. For example, cleaning the water in a polluted lake can increase commercial fishing and tourism, reduce the rate of infectious disease, and appreciate the price of housing adjacent to the lake, all of which can be measured in dollars. One approach is to use a hedonic regression to estimate the utility or pleasure associated with an improved environment. This technique assumes the price of an item can be calculated by assigning certain characteristics to its constituents and obtains estimates of the value of each characteristic. In essence, it assumes that there is a separate market for each characteristic. For example, hedonic regression can be used to assess the value of real estate in the absence of specific market transaction data. Because one building is different from another, it is often difficult to find an identical building that was sold recently. Instead, it is assumed that a house can be decomposed into several characteristics such as location, number of bedrooms, size of a lot, quality of neighborhood schools, etc. Hedonic regression treats these attributes separately and estimates prices for each of them. This information can be used to construct a price index that can in turn be used to compare the price of housing in different cities or at different times. The non-market benefits of cleaner lakes are the enhanced diversity of marine life, more enjoyable swimming, recreational fishing and boating, and improved air quality. Non-market benefits cannot be measured directly but can be estimated by polling people on their hypothetical willingness to pay, to avoid incurring specific damage and for the benefit of enjoying a cleaner environment, or willingness to accept compensation for a certain amount of pollution and its associated actual or perceived risks (contingent valuation). Since different people value the benefits differently, the result is contingent upon the questions asked. Actual risk is often estimated as the probability that a certain pollutant causes a certain number of deaths every year, spread over the affected population. This is usually done by examining data from past cases of human exposure to the pollutant or by extrapolating laboratory data from animals exposed to various doses of pollutants to humans. Many times, however, actual risks do not represent the perceived risks of exposure to pollution. For example, people may perceive that the risk of radiation from nuclear reactors is much higher than the risk from coal reactors, even though data shows the actual health risks from exposure to radiation are far less than those of exposure to air toxins. Once the environmental benefits of environmental protection are evaluated, we need to evaluate costs of noncompliance by determining losses to property and to humans. Although placing a monetary value to human life seems highly insensitive, unfortunately it is the only 420 Chapter 16 - Economics of the Environment way the cost of environmental degradation and damage to humans can be measured. Perhaps a better way to view this approach is to look instead into the benefits of saving lives by investing in various pollution abatement strategies. Depending on age, education, and income, the US Environmental Protection Agency puts a number ranging from $475,000 to $8.3 million for the value of human lives.6 In contrast, the value of life in many poor countries has been estimated to be in tens of thousands of dollars. Question: Some propose using the discounted future earnings of an individual to estimate the damage resultant from a loss of life. Others suggest the best way to measure the value of a life is by the risk various people are willing to take to accept similar jobs. Comment! Answer: The first method is often used by the US court system to determine monetary damage for a loss of life. The main objection to this method is that lives of retired people or volunteers are greatly underestimated. The second method looks into how much people value their own lives when they participate in dangerous sports, volunteer for military service, or apply for risky jobs such as police officers and firefighters. The main objection to this approach is that, to support their families, many people have no choice but to accept high risk jobs. Secondly, very few people are adequately informed on the actual risks they are undertaking when they accept a new job or participate in a dangerous endeavor, and therefore their choice of the job or activity is not a true indication of the actual risk they may face. Finally, this method does not take into account the preference of many participants whom are inherently more risk-taking with no relevance to the proceeds they receive. One thing is certain; no matter which approach we use, we must face the ethical dilemma of valuing some lives more than others. Economic Impacts The economic impact of environmental protection can be studied in terms of the direct cost of cleanup, the potential loss of jobs, and the costs associated with monopoly power. Engineering cost estimates of environmental protection in the United States have been steadily increasing from 1% of the GNP in the early 1970s to 2.8% of the GNP ($224 billion) in 2000, much of which is for improving water quality and cleanup of old hazardous solid waste sites. The impact of environmental protection on employment has been minimal at best. Despite what many “pro-business” activists claim, environmental regulations have not resulted in a large number of plant shutdowns and massive job losses. In fact, labor statistics show that although some workers were forced to retrain and change jobs, environmental protection has probably led to a small net gain in US employment.7 In fact, in the past quarter of a century, 6 7 “Putting a Price Tag on Life,” Newsweek , January 11, 1988, p. 40. G oodstein, E., “The Trade-Off Myth: Fact and Fiction about Jobs and the Environment,” Washington, DC: Island Press, 1999. 421 the majority of US jobs lost have been due to increased competition from newly emerged industrial powerhouses like China, Korea, India, and Brazil, or due to the transfer of much of the US manufacturing capability offshore, where labor is cheaper and taxes are lower. In the few cases that there has been some loss of income due to environmental regulation, the utility derived from a cleaner environment compensated for the drop in utility from additional material goods. Probably the most direct impact of environmental protection has been the consolidation of major environmental firms and an increase in the monopoly power that these firms exercise. The main reason for these mergers is that the cost of equipment required for cleanup is quite high and cannot be afforded by many small businesses. As we discussed in the previous chapter, monopolies may not be as efficient as a competitive market and prices charged are somewhat higher. Question: The costs for many of new and clean energy technologies such as photovoltaic and wind have already dropped below the social cost of older and polluting technologies such as coal and oil. Why haven’t these technologies been promoted more aggressively or been adopted by the public in great volume? Answer: It is true that renewable energy technologies are the socially preferred option; however, their private costs are still above those of the non-renewable energy sources. Unless they have a substantial profit advantage, no government promotion or subsidy can make clean technologies succeed. It should be noted that being competitive in the market is not enough for public transition to cleaner technologies. For example, in many instances it can be shown that it makes economic sense to switch from electric and gas heating to solar heating and geothermal heat pumps. Nonetheless, many people are reluctant to invest in upfront costs to install new technologies because they lack knowledge about advantages of clean technologies and have a strong perception that oil and coal are well-established, mature, and proven technologies. Clean technologies have another major barrier to overcome. That is, they are offering consumers a service that they already have. Furthermore, unless services are offered by financially secure, well-established firms, they often do not have necessary resources to counteract advertising campaigns by existing firms. In the absence of such incentives it is reasonable to assume that, without government action (regulation and elimination of subsidies to conventional technologies), clean technologies will, for now, serve only niche markets. Environmental Legislation Many economists consider the public ownership of resources (land, water, air) and free access to the environment as the main causes of environmental pollution; therefore, the only remedy for the abuse 422 Chapter 16 - Economics of the Environment is through environmental regulations, pollution taxes, and fines. Regulations are usually mandated by Congress and implemented by the government. Depending on their political affiliation, different people see the government’s role differently.8 The regulative systems of most governments involve complicated and lengthy processes that leave doors open to abuse, political maneuvering, and industry influence. In the United States, after a particular problem is identified, Congress acts to pass a bill that requires the government to study the problem and take necessary actions. The task of risk assessment and safety regulations is delegated to the EPA who may then study the problem in-house or hire consultants. During this process, the EPA seeks input from the industry, the public, and environmental groups. The agency then drafts a regulation which it refers to the state governments for enforcement. It is taken for granted that no matter how insignificant the ruling is, numerous lawsuits by various interest groups will stall the process. Many of the dirtiest industries such as petroleum, chemical, and manufacturing firms have huge financial and technical resources that they spend on advertising, promotion of the election of friendly candidates, and utilization of a large lobbying staff and legal firms that can represent them in every step of the way. Even the EPA’s top managers are influenced by high-ranking government officials who may hold the key to their promotions and job security and by industries who may, at some point in the future, hire them with very generous benefit packages. The best solution to reduce conflicts-of-interest is to eliminate or at least greatly reduce the role of money in legislative and regulatory processes. This may require banning or limiting political advertising, restricting or limiting contributions of industry lobbying groups to political campaigns, eliminating tax deductible benefits to lobbying expenses, and disallowing government officials to accept employment at firms whom may have benefited from rulings during the tenure of those officials for a certain number of years (let’s say 3-5 years after they leave their government posts). The same can be said about top-level industry managers who may be appointed to sensitive government posts. Finally, to implement political reform we must assure that the principles of democratic government are taking hold. The collapse of the Soviet Union demonstrated that the centrally planned economy in socialist countries was even less effective in preventing environmental disaster than market-based economies. The point is that democracy is a necessary ingredient to assure the free flow of information and to empower citizens Depending on their political affiliation, different people see the government’s role differently. Conservatives want to limit the government’s role as much as possible, accusing the government of being run by politicians and “special interests.” The environmental pollution, they insist, will be resolved only when industries agree to reduce emissions voluntarily. The public as a whole will decide what steps to take to force polluters to cut their emissions by boycotting, suing, or switching to more environmentally friendly competitors. Progressives see t he “good” government as necessary to serve the interest of the public by providing health care and assuring their welfare. They object, however, to the role of the big businesses that – t hrough their vast financial and intellectual assets – can influence the government and rally the public to support only those environmental measures that benefit them directly no matter w hat the short- and long-term costs to consumers. 8 423 and institutions to challenge the policies of the government when it is practicing erroneous environmental initiatives. There is no single approach to reduce the harmful effects of environmental pollution. Three approaches -- command-and-control regulations, incentive-based regulations, and process-based regulations (or a combination of them) -- are often used to address a variety of environmental problems. Control-Based Legislation Control-based legislation (also called command-and-control legislation) relies on directives (commands) on how polluters should reduce their pollution and by how much. These policies are enforced by imposing fines, penalties, and taxes for non-compliance. Under commandand-control (CAC) plans, firms are required to deploy the Best Available Control Technology (BACT) to control emissions. Although this approach dictates a fair and balanced regulation to all players irrespective of their size, it is not necessarily an efficient one. For example, consider two firms A and B producing essentially the same product and residing in the same geographical area. Because of its size and the cleaner technology it employs, A has a lower cost per unit of pollution reduced than B. From a fairness standpoint, A and B must reduce emission per unit output by the same amount. From an efficiency standpoint, it is best if A reduces emission by a greater amount than B, keeping the combined emission the same. The combined cost of emission abatement by the two firms will be lower. In the United States, environmental regulations are largely based on the CAC approach for most pollutants and are administered by the EPA through such statutes as the 1990 US Clean Air Act, which imposes penalties for those entities that violate the federal and state guidelines on the type and amount of toxic substances, handling, use, and disposal. The rules are imposed uniformly for all polluters without considering costs and circumstances. The problem with this approach is that it is, by definition, “not cost efficient” and can sometimes be outright ridiculous. For example, EPA regulation requires that 30 percent of the organic matter must be removed from inflows to sewage treatment plants. Although this regulation makes sense most of the time, it does not make sense in Alaska, which has some of the purest waters in the world. To comply with regulation, Alaska had to build a new $135 million treatment plant to remove 30% of almost nothing. Alaskan officials requested a waiver but were turned down. As a result, Alaskans had fish guts dumped into the water just to be removed again downstream before it entered the treatment plant. Although the EPA mandate was satisfied, the water was more polluted than it would have been if nothing had been done at all.9 The one exception to CAC legislation is the distinction it makes between 9 Dilorenzo, T. J., “Unfunded Federal Mandates: Environmentalism’s Achilles Heel?” Contemporary Issues Series 62, Center for Study of American Business, December 1993. 424 Chapter 16 - Economics of the Environment new and old sources. Under this ruling, older sources (such as cars) do not have to meet the same stringent standards as newer equipment. The reasoning behind this decision is both technical (higher costs are associated with cleaning the older sources) and political (it is much easier to pass regulations restricting firms that are not yet around or are in infancy). The problem with this approach is that it promotes the use of older and dirtier equipment for much longer, reduces the incentive for putting additional resources into research and development (R&D) work, and slows down investments in costlier, newer, and cleaner technologies. This is a serious objection that has been raised against any technology-based regulations for both new and old sources. The fear of developing better technologies is that, under BACT, firms may then be legally obligated to upgrade their pollution control equipment at existing and newer facilities. Over the long run, this approach becomes less costeffective as the pace of technological innovation slows, and the cost of pollution abatement becomes higher. Question: Examples of the CAC approach are the imposition of gasoline taxes and CAFÉ standards discussed in Chapter 14, both of which were designed to increase fuel efficiency. Comment on the viability of these approaches. Answer: The main problems with gasoline tax are that both clean and dirty cars are taxed at the same rate and taxes must be quite high to be effective. The main concern raised against CAFÉ standards is that higher gasoline efficiencies promote more driving, and as a result total vehicle-miles traveled may increase. Incentive-Based Legislation To counteract many problems associated with control-based legislation, many economists propose developing incentive-based (IB) regulations in the form of emission credits, allowable tax deductions, and other incentives. Likewise, those who are not complying will be penalized by paying higher taxes with fewer emission credits. Two schemes have been proposed: 1) to enact pollution tax proportional to the amount of pollutants discharged into the air; and 2) to issue pollution permits (emission credits) that can be auctioned off or freely traded in a pollution market. Both systems are designed to put a price on pollution and provide incentives to firms and others to seek less polluting alternatives or better cleanup strategies. With taxing, the cost is direct – more pollution means more taxes. As an incentive, some tax breaks may be given to those industries that have met and exceeded the requirements set by law or have invested in research and development of cleaner technologies. With pollution permits (also called emission trading or cap and trade system), a regulatory body--usually the government-- sets an overall cap on the country’s carbon emission that drops annually; less pollution offers the 425 opportunity to free permits for sale, whereas more pollution requires additional permits to be bought from the government or from less polluting competitors. This encourages companies to invest in cleaner technologies or find efficient ways to cut emissions and sell the unused portions of their permits to others. There are, however, sharp differences on how the pollution permits should be allocated. Some economist favor allocating higher number of permits to industries which produce more pollution. The rationale is that as the overall cap tightens each year, the biggest polluters face the largest challenges in cutting emissions. Other economists, propose allocating permits through an auction. Under this system, every company – large or small - would have to buy rights to pollute. As a result, the biggest polluters would have to pay the most thereby providing them with the greatest incentive to cut emissions right from the start. 10 IB regulations applied to automotive emissions can take several forms that encourage both the fuel efficiency and, at the same time, lower the vehicle-miles traveled. One possibility is an auto emission tax that is adjusted based on the total emission the car has produced over the period of one year since the last smog check. Congestion tax (higher toll-charges for single-occupant cars or during rush hours) discourages traveling alone or during peak traffic. Another solution is to charge auto insurance on a pay-by-the-mile system; less would be charged to smaller cars and to people who drive less. Insurance rates will be higher for bigger cars and individuals that drive higher mileages. The final solution is the imposition of a revenue neutral scheme referred to as feebate; this system penalizes gas-guzzling cars by charging higher tax rates while rewarding high fuelefficient cars by giving them rebates. Example 16-1: Suppose a city ordinance requires a reduction in total particulate emissions in an industrial area by 100 tons. There are only two polluting firms, A and B, each responsible for producing 150 tons of particulates or one-half of all of the particulate emission in that area. What is the best strategy to achieve the required results in two scenarios in which firms can and cannot trade pollution permits? The cost of pollution abatement is $50 per ton for firm A and $200 per ton for firm B. What is the total cost of reduction in each case? Solution: Firm B has a much higher cleanup cost than A. If emission trading is permissible, it makes sense for firm B to buy 100 tons of emission by paying firm A $50 per ton for a total cost of $5,000. If emission trading is not allowed or firms do not reach an agreement, then firms must cut emissions by 50 tons each. The cost of pollution abatement is 50x$50 = $2,500 for A, and 50x$200 = $10,000 for B resulting in a total cost of $12,500. The main objections raised against incentive-based regulations are hot 10 R obert Reich online blog, “Why McCain’s “Cap-and-Trade” Won’t Work Nearly as Well as Obama’s,”, May 27, 2008 ( 426 Chapter 16 - Economics of the Environment spots, monitoring, and enforcement. Hot spots refer to the elevated concentration of pollution near firms who find it economically advantageous to avoid or defer cleanup by paying a tax penalty or purchasing additional permits. This is particularly important for concentrated pollutants that are not uniformly mixed. Examples are nuclear wastes, toxic wastes, and sulfur dioxide or particulate emissions that can easily buildup in the vicinity of power plant smokestacks. The IB strategies on pollutants like carbon dioxide and chlorofluorocarbons are less important because their impact on the overall air quality depends on the total volume of their emission, not on local concentration of these pollutants. To correct for this problem, it is often suggested that penalties and permits are issued such that the maximum concentration of different pollutants within a given geographical area is not to exceed the state and federal ambient air and water quality standards. Another problem raised by IB regulation is monitoring and enforcement. Unlike a CAC system where firms are required to install and maintain certain air quality abatement equipment, in incentive-based approaches, no such requirement exists so constant monitoring and precise measurement of concentrations of pollutants in multiple monitoring locations is required to assure compliance. This can be quite complicated and the cost, except under special circumstances, may not be warranted. Process-Based Legislation Unlike control-based and incentive-based statutes that regulate the amount of pollutants that an industry is allowed to release into the atmosphere, process-based legislation looks at the process or technology itself. Depending on technology, different regulations can be enacted during different stages of development from R&D to prototyping, field testing, and commercialization. Process-based legislations are usually devised by various federal and state agencies that are charged with the administration of environmental policies. When Does Noncompliance Pay Off? Not all polluting industries choose to comply with regulations. From a purely economical standpoint, if polluters’ marginal cost of compliance outweighs its marginal benefit, polluters are better off ignoring regulations. They may instead opt to pay fines and accept other punishments such as adverse public relations, potential losses in sales, and possibly even jail time. Costs of compliance are related to the cost of new pollution reduction equipment and the additional resources that are ultimately diverted to pollution control efforts. Benefits associated with compliance can be measured as the money saved due to reductions in the amount of fines and other penalties, improved public relations, and a potential for higher sales volume. The marginal cost of compliance increases as a firm decides to comply more and more with the regulations. The marginal benefit of compliance is highest when a firm does not comply with any 427 MC of compliance MB of compliance Degree of Compliance regulations and thus is most vulnerable to being fined. As a firm complies more, often its chances of being caught and so its marginal benefit falls (Figure 16-4). The point where MB and MC of noncompliance cross is where the firm can afford to avoid compliance. For any additional incidence of non-compliance, the firm will have to pay fines that exceed its marginal benefits. From the discussion above, it can be concluded that to reduce non-compliance, either the marginal cost of noncompliance must be increased (such as stiffer fines or longer jail time) or its marginal benefits reduced. Example 16-2: A power generating station is considering reducing the total particulate emission from its smoke stacks. Reducing the particulate emission is easiest for the larger particles with the biggest mass, and therefore a large portion of particulate mass can be removed with filters at a relatively low cost. The medium-sized particles can be removed by bag houses at somewhat higher costs, whereas the smallest particles require very expensive electrostatic precipitators. A cost analysis is made to calculate the marginal cost (cost for an additional unit of reduction) of particulate cleanup. The result is tabulated below: % reduction in total mass 10 50 90 95 99 Total costs in millions of dollars 1 11 33 61 96 Figure 16-4 Efficient level of pollution control Cost of Compliance To promote a cleaner environment, the government is offering polluters a tax credit that varies depending on the degree of reduction that is made. The most benefit can be reaped if the largest, more massive particles are eliminated because these particles most effectively reduce visibility, form fog, and soil buildings. The amount of tax credit reduces as particle sizes become smaller. The table of tax credit is shown below: % reduction in total mass 20 40 60 80 100 Tax Savings (Revenues) in millions of dollars 30 52 68 80 9 What is the Pareto efficient point for pollution reduction? 428 Chapter 16 - Economics of the Environment Crime and Punishment Digging Deeper ... I n every society, there are always those who become involved in illegal or criminal activities for various reasons: to reduce costs (avoiding buying and installing pollution-control devices), to increase revenue (illegal commercial fishing, and logging), or to increase utilities (illegal hunting or swimming). An economic analysis of the situation shows however, that there is a point where the risk of detection and punishment does not justify the benefit reaped from such activities. The main task of regulatory and law-enforcement agencies is to impose a high level of monitoring and enforcement, or create enough deterrence (for example, large fines or long jail times) to convince the criminals (the environmental polluters in our discussion) that crime does not pay. Example: Suppose you are given the option of receiving a guaranteed $1,000 or have a 50% chance to receive double or nothing. Which one do you take? Solution: Mathematically, both options have the same expected value of $1,000. The conservative takes the $1,000 payoff; the risk taker will gamble hoping for the $2,000. Both options are exactly the same for a risk-neutral person. The majority of firms are risk neutral by definition. Example: Suppose a firm determines that there is only a 20% chance of being caught dumping its hazardous waste into a nearby river and if caught there is a 50% chance of being punished. Furthermore, the firm estimates a savings of $100,000 from noncompliance. How large a fine would create sufficient deterrence against noncompliance by the firm? Solution: The penalty, X, should be large enough to washout the potential (expected) gain from noncompliance. i.e., 0.2*0.5*X = $100,000, or X = $1 million dollars. Solution: The optimum pollution reduction level is at the point where MC and MB of pollution abatement are equal. The marginal benefits and costs are calculated and shown graphically. The two curves cross at a percent reduction where MC = MB = $14 million, for a reduction of 68% in total particulate mass. Global Issues During the past few decades, our environment has undergone changes unforeseen by our predecessors. Global population has nearly doubled and the gap between rich and poor nations has widened. International conflicts have escalated, many of them because of competition for control of limited natural resources. We discovered that the sky over Antarctica (and to a smaller degree all over the world) has been losing ozone rapidly. Acid rain has damaged millions of acres of land and has adversely affected marine life and other species. More than half of the tropical forests have been destroyed or greatly degraded. The damage incurred by properties alone is estimated at billions of dollars. Many valuable species of plants and animals are now extinct or endangered. Our ever-increasing dependence on petroleum has not only affected our health, but has also resulted in global warming, the full consequences of which are yet to be determined. The environmental issues associated with fossil combustion were discussed in some detail in Chapter 8. Until relatively recent times, most of our activities that affected the environment were local in scope. Cleanup required taking small steps over small geographical areas and short times. Today, the rapid 429 rise in consumption of both materials and energy has made many environmental issues global in nature. Nuclear testing by one nation can have environmental repercussions thousands of miles away. The burning of fossil fuels, use of non-biodegradable products, and dumping of toxic wastes in rivers can impact the environment globally. One feature that separates global and local issues is their scale, both in magnitude and duration. Global issues are persistent; they cannot be solved overnight by one nation or one country alone. Resolving these issues may require long-term planning. Global issues are interconnected; solving one may in fact solve many other problems, or we may need to solve a multitude of other problems simultaneously. For example, reducing greenhouse gases will reduce both global warming and ozone depletion, while narrowing the gap between rich and poor nations can also solve many health, hunger, employment, and security issues. Global warming, ozone depletion, and acid rain are among the most severe problems we are facing worldwide. Global warming has rightly received the most attention, as we may have to face consequences that last hundreds of years as a result. The Kyoto Treaty was a positive step that required cooperation between industrial and poor countries. Under this plan, rich countries would reduce their emissions of greenhouse gases and at the same time provide incentives for poor countries to follow suit. Unfortunately, the United States and Australia, two of the most industrialized countries and the largest contributors of greenhouse gases, cited economic hardship and pulled out of the treaty, weakening the agreement and reducing its likelihood of success. Despite this disappointment, the treaty was finally ratified in 2005. The impact of the treaty on curbing overall carbon emission is yet to be determined. Ozone depletion was recognized as a major environmental issue at the 1987 Montréal Protocol and later in the Rio Summit on biodiversity in 1992. Enforcement of the treaty required signatories to ban the import and export of products containing CFCs to and from nonmember countries. This provision not only provided incentives for member countries to find ozone-friendly substitutes, but the reduced trades with nonmembers also provided impetus for others to join the agreement. The two common substitutes for CFCs are hydrofluorocarbon (HFC), hydrochlorofluorocarbon (HCFC). The former is not an ozone depleting substance but neither is as efficient a coolant; the latter is a mildly ozone depleting substance slated to be phased out by 2030. Acid rain is formed when the sulfur and nitric oxides emitted from the stacks of coal and oil power plants react with the humid atmospheric air. The “UN Convention on Transboundary Air Pollution” drafted the “Protocol to Abate Acidification, Eutrophication, and Ground-level 10 U N Environmental Commission for Europe ( 430 Chapter 16 - Economics of the Environment Ozone.”10 This protocol sets ceilings for emissions of four pollutants, sulfur dioxide (SO2), nitrogen oxides (NOx), volatile organic compounds (VOCs), and ammonia (NH3), to be reached by 2010. The protocol also sets limits for specific emission sources (power plants, refineries, farms, etc.) requiring the best available techniques to keep emissions down. Globalization and the Environment As discussed in the previous chapter, globalization has removed many of the trade barriers to allow freer movement of capital. Proponents of globalization argue that an increase in trades stimulates investment, reduces poverty, allows transfer of cleaner technology, improves health, creates jobs, and provides environmental benefits in the form of greater investment in air and water quality. Critics contend that globalization encourages ever more economic growth and production with no real concern about unequal and unsustainable pattern of consumption.11 To promote globalization, international agreements are made that removes tariffs and other barriers to trade. As a result of such agreements, subsidies for many essential goods are eliminated and, because they cannot effectively compete with well-developed highly automated agricultural and manufacturing practices of developing countries, many thousands of small farmers, artisans, and independent workers lose their livelihoods. Another charge against globalization is that, since environmental laws are less strict and corruption is more rampant in some of the developing countries, many developed countries have moved their manufacturing sectors to these countries. Weaker environmental laws in the developing countries have given governments and large corporations an effective argument to lower their own environmental laws, thus leveling the playing field to the detriment of the global environment. Environmental Issues in Developing Countries Many of the environmental problems in developing countries are directly related to poverty (See box “Poverty and Wealth”). For people who lack safe drinking water, have inadequate sewage systems, and live in unsanitary conditions, conservation measures and environmental issues are one of the last things on their minds. Only when they achieve simple means of subsistence and have sufficient resources to afford thinking about other problems do they become interested in long-term health issues and consequences of environmental pollution. Most of these countries are heavily in debt and therefore any attempt at conservation and environmental protection must be linked to economic development and debt relief. Unless richer countries are willing to subsidize poorer countries to carry out environmental programs, the situation will deteriorate even further and the environment will suffer. Debt relief does not have to come as a handout, however, and could require the debtor country to spend equivalent money in their local currency on environmental programs 11 Dauvergne, P., Handbook of Global Environmental Politics, Edward Elgar Publishing, 2005. 431 Did You Know That ...? Poverty and Wealth: The Factsi • The world’s 200 richest individuals put together own as much as 41% of the world population. • 1.2 billion people in the world, roughly one in five, live on less than US$1 a day. Another 2.8 billion on less than $2 a day. Over a billion do not have access to clean water. • 17-40% of the world’s population are hungry or suffer from malnutrition. 40 million people die each year as a result. • In India, only 4% of people reach the age of 65, and nearly 4 out of every 10 people are less than 15 years old. • The richest fifth of the countries account for 86% of total consumption, 45% of all meat and poultry, 58% of all energy, and own 87% of all vehicles and 74% of all telephone lines. The poorest fifth of the countries account for miniscule 1.3% of total consumption, 5% of all meat and poultry, 4% of all energy, and own less than 1% of all vehicles and 1.5% of all telephone lines. Singh, D. N., “Population Growth and Development Relationship,” in Strategies and Development Planning, Edited by Ashok Kumar Rai, 1977, pp. 368-388. ISBN: 81-7100-905-0. i such as family planning, water sanitation, land remediation, air quality improvements, etc. This is particularly important, in light of the fact that, as developing countries become more affluent and undoubtedly emulate the living standards of the developed countries, their environmental footprints becomes larger. Another powerful tool to promote environmental protection is international marketable permits. Under this plan, once the target for reduction of a certain pollutant is set, a fixed number of permits are issued and distributed among developing and developed countries. Developing countries have incentive to maintain their environment and, by doing so, they will have additional permits that they can exchange for cleanup equipment or upgrade their old and dirty technologies with newer clean technologies. Developed countries can buy the permits to avoid penalties and find new markets for shipping clean technologies. For example, a country can trade one million tons of carbon dioxide (for example by switching from coal to natural gas) for a shipment of wind turbines, photovoltaic cells, or consulting expertise for increasing crop yields without the need for additional fertilizers. The same goes for population control. In many poor countries, larger families provide a safety net that can help at times of sickness and old age. Children can provide labor and bring in additional income. Because the infant mortality rate is higher, parents seek to have more children – especially males – to assure enough of them survive to maintain minimal living standards and to carry on their genes. It might be argued by some that a reduction in infant mortality rate will increase population which will, in turn, exacerbate the problem. This is what happened in 1950s and 60s when improved health conditions, better nutrition, and vaccinations saved the lives of millions of babies, resulting in a population boom in many poor countries. The data also shows that after the initial surge in population the growth rate declined. This is attributed to better access to education, less pressure to have larger families, and an increasing allocation of family resources to improving the quality of life of fewer 432 Chapter 16 - Economics of the Environment children. It now appears that proper family planning is one of the best strategies and is an economically sensible way to address a wide range of global environmental problems in poorer countries. Due to the absence of popular and democratic governments in many developing countries, especially in Africa, Asia, and the Middle East, environmental problems continue to become increasingly severe. International businesses have great incentives to collaborate with corrupt officials to pass laws that are inherently in conflict with the principal of conservation of these countries’ natural capital. It is therefore fair to conclude that protection programs are possible only if they involve the full partnership of the host countries monitored by international teams of economic ecologists and consultants. Only those technologies that result in a more equitable distribution of wealth, eliminate or reduce poverty, make education and health services accessible, result in the least damage to the environment, and produce work can benefit these countries and are sustainable. Summary Benefits of environmental protection and optimum amounts of pollution are difficult to measure. Economists are divided over the economic merit of pollution abatement, although they generally agree that some degree of environmental protection will benefit overall human wellbeing. Because the environment is a public good, it is subject to the same open access problem as other goods. Individuals have less inclination to engage or invest in long-lived environmental protection measures than if they had ownership of the good. Poor countries are also banking on receiving the benefits of environmental protection actions taken by more developed countries and, in that sense, on getting a free ride. Greenhouse gases, ozone, and acid rain are public goods because measures taken to reduce them by one country benefit all the others. Within a country or municipality, the government can overcome the free riding problem by imposing taxes and fines. At the international level, imposition of environmental laws requires international cooperation, ratification of treaties, and the financial commitment of rich and industrial nations. Since the United Nations does not have the power or authority to force any member states to comply with the laws, the terms for enforcing the laws must be clearly spelled out in the treaty itself. There is no clear strategy to ensure public health while at the same time maintaining optimal efficiency. When a command-and-control system is used, firms are required to install cleanup equipment. However, the government must ensure that the cost of abatement is not prohibitive and the economic welfare of the firm is also considered. Two incentive-based 433 approaches were discussed. Permits can be issued by the government, auctioned off, or traded between firms to achieve an efficient level of pollution. Alternatively, fines and taxes can be imposed to reach the same results. Unfortunately, both approaches also provide incentives for polluters to lie. In a tax system, firms are encouraged to underestimate pollution as taxes will be imposed per unit volume or weight of emission. With permits, firms have an incentive to overestimate emission, because they can get more permits. Process-based regulations are effective in assessing the total amount of waste in a given process, differentiating among various manufacturing technologies and helping firms in their initial planning stages of development. What is clear is that neither safety nor efficiency alone can be used to set standards, and some risk/benefit analysis is needed to decide on the most effective approach. Additional Information Books 1. Chapman, D., Environmental Economics: Theory, Application, and Policy,” Addison-Wiley, 2000. 2. Goodstein, E. S., Economics and the Environment, 4th Ed., John Wiley & Sons, 2002. 3. Siebert, H., Economics of the Environment: Theory and Policy, Springer Verlog, 2004. 4. Dauvergne, P., Handbook of Global Environmental Politics, Edward Elgar Publishing, 2005. Periodicals 1. Journal of Environmental Economics and Management ( JEEM), the journal of Association of Environmental and Resource Economics. 2. Ecological Economics – Direct Science Elsevier Publishing Company, the journal of the International Society for Ecological Economics (ISEE). 3. Environmental Economics and Policy Studies – Published by Springer-Verlog, New York is the official journal of the Society for Environmental Economics and Policy Studies. Government Agencies and Websites 1. US Agency for International Development ( 2. National Center for Environmental Economics (http://yosemite.epa. gov/ee/epa/eed.nsf/pages/homepage). Non-Government Organizations and Websites 1. United Nations Development Program ( 2. United Nations Environment Programme ( 3. Intergovernmental Panel on Climate Change ( 4. World Resource Institute ( 5. Union of Concerned Scientists ( 434 Chapter 16 - Economics of the Environment Exercises I. Essay Questions 1. Describe what economists mean by a. Existence value b. Safety standard c. Contingent evaluation d. Command-and-control legislation e. Economic efficiency 2. What are the differences between existence, use, and option values? Give examples for each. 3. According to one study, the maximum price elasticity for mpg is 0.21, meaning that a 1% increase in price leads to 0.21% increase in fuel economy. How much should the price of gasoline be increased if we desire to achieve a 10% increase in automobile fuel efficiency? 4. Jill and Jack are sharing an office in a manufacturing firm. Jack is a smoker and claims much more relaxed and productive if he smokes three cigarettes a day. Jill hates smoking and claims that she cannot handle the smell of even a single smoke. Assume that there is no regulation that bans smoking in the office, who is right? Is there a point where a compromise can be reached? 5. Should smoking be banned in public places? If yes, should imposing the ban be the responsibility of a government agency? Should it be decided through voting? 6. A new landfill in your neighborhood is expected to raise the cancer rate by 1 in 1000 during your life time. To reduce the risk to 1 in 10,000, new monitoring and safety equipments have to be installed which will cost $100 million. To pay for the cost, your property tax must be increased by $1 a month. Would you pay for it? What if higher costs necessitated an increase in property tax of $10 a month? $50 a month? $100 a month? 7. A wireless telephone company needs to install their high-frequency, high-voltage transformers on the rooftop of your building. They offer you a flat fee of $10,000 for the right to install their equipment. Would you take it? There is some research that indicates a 1% increase in the rate of cancer for people living nearby these transformers. Would your neighbors have the right to sue you if you accepted the company’s offer? 8. The same company wants to install a second unit in a poor neighborhood of the city. The company offers $2,000 for obtaining the right. Is this fair? W hat if the neighborhood voted to accept the offer? 9. Discuss three methods of encouraging automotive fuel efficiency. What are the advantages and disadvantages of each? 10. What is the globalization and its effect on the environment? Is the overall trend positive or negative? How has globalization affected your community? II. Multiple Choice Questions 1. On the basis of the traditional economic theory a. The cleaner the environment is, the more sustainable economy will be b. Cost of environmental cleanup is a major drag on economy c. Society must bear a certain amount of pollution d. Pollution is a good that follows the law of supply and demand e. Both c and d 2. When it comes to the environmental protection, efficiency standard advocates believe that a. Personal safety is the innate right of every individual, and no matter the cost, must be guaranteed b. The marginal cost of reduction drops per unit of reduction in pollution c. The marginal benefit of reduction increases as air gets cleaner and cleaner d. An efficient market is a market in which demand and supply are in balance e. All of the above 3. The unknown potential benefits of the 435 environmental protection are called a. Use value b. Option value c. Existence value d. Hidden value e. Contingent value 4. Which of the statements below is consistent with the operation of a profit-maximizing firm in a competitive market that does not penalize polluters no matter how much they pollute? a. Consumers pay the full social cost of production. b. Consumers pay only the external cost of production. c. Consumers pay only the external marginal cost of production. d. Consumers pay less than the socially efficient price since producers are subsidized by society. e. None of the above. 5. Which of the following is consistent with the command-and-control regulation? a. Taxing producers equal to the external cost created by their pollution. b. Requiring firms to lower their pollution level according to best available control technology. c. Requiring firms to reduce their pollution level to zero. d. Requiring firms to buy pollution permits to offset their pollution. e. Requiring firms to pay a penalty equal to the external cost of pollution. 6. Which of the following statements is not correct? a. The economical benefits of environmental protection can be measured only by its monetary benefits. b. Hedonic regression implies the pleasure one gets from an improved environment. c. Non-market benefits of environmental protection can be estimated by people’s willingness to pay for those benefits. d. The willingness to accept compensation for some level of pollution is called contingent evaluation. 436 7. Suppose two firms A and B each produce 10 tons of emission every month. The local city council passes a bill that requires total monthly emission to be reduced by 8 tons. It costs firm A $5 and firm B $20 to cut emissions by one ton. The most efficient way to comply with the ordinance is for emission trading that results in a. Firms A and B negotiating to trade emission permits b. Firm A cutting emission by 8 tons c. Firm B cutting emission by 8 tons d. Each of the firms A and B cutting emissions by 4 tons e. Both a and b 8. In the example above, assume that the law sets a maximum particulate emission of 12 tons per each firm. What is the optimally efficient cost of pollution abatement? a. $ 60.00 b. $ 90.00 c. $ 130.00 d. $ 240.00 e. Not enough data is given. 9. The main advantage of control-based regulations is that a. Because it excludes or relaxes fines on old sources, the cleanup costs are less b. Because regulation is based on imposing the best available control technology, there is great incentive for firms to spend money on R&D activities c. It allows old industries to survive and thus hire new employees d. It provides incentives to those who help improve air quality and reduce emissions e. All of the above 10. Which of the following statements is correct? a. Both control-based and incentive-based regulations provide incentives to firms to reduce emissions. b. Tradable pollution permits allow same amount of reduction in pollutant levels, but at a lower cost. c. The main problem with incentive-based Chapter 16 - Economics of the Environment regulation is the creation of hot spots. d. Tradable pollution permits encourage firms to invest in control abatement technology to make additional money by selling their permits to dirtier firms. e. All of the above. 11. The main objection raised against incentive-based regulations is that a. Penalties cannot discourage firms from polluting b. Localized hot spots may appear c. It is always possible to buy permits at a lower cost than it takes to install new pollution control equipment d. It offers the opportunity to sell permits given out free e. All of the above 12. Which of the following statement(s) is/are correct? a. Proponents of safety standards believe that polluters must pay for the pollution. b. Safety standards remove incentives for polluters to free ride. c. Safety standards are inefficient. d. All of the above. e. a and b, but not c. 13. Non-market value of the yet-unknown potential benefits of a resource is called a. Use value b. Option value c. Existence value d. Utility value e. A charity 14. ____________________ see protecting the environment as a moral issue. a. Hedonists b. Utilitarians c. Environmental ethicists d. Existentialists e. Environmentalists 15 On the basis of efficiency standards, which of the following can justify subsidizing the development of a hydrogen infrastructure? a. The funding for hydrogen research has been increasing in the last few years. b. The hydrogen sector has a strong lobbying presence in Washington D.C. c. Switching to hydrogen reduces our dependence to foreign oil and is therefore a positive externality. d. Hydrogen is a necessary component for fuel cell operation. e. All of the above. III. True or False 1. A competitive market is Pareto efficient. 2. The main drawback of traditional command-andcontrol regulation is that it is not economically efficient. 3. Incentive-based regulation is superior over command-and-control regulation because it benefits society by generating the same level of pollution at a lower cost. 4. A Pareto efficient market is one that assures the seller is better off than the buyer as a result of a trade. 5. Zero pollution is fundamentally in-compatible with an efficient market. 6. Environmental protection necessarily brings about a certain number of job losses. 7. In the last few years, the majority of US job losses have been due to increased competition from low wage foreign workers. 8. An environmental ethicist considers the environment valuable because it is the source of happiness to him and others. 9. An example of socially efficient practices is a subsidy to educational systems, because it promotes literacy which is a positive externality. 10. The environment of the Former Soviet Union was 437 considerably cleaner than that of western countries because firms had no profit motives to produce pollution. IV. Fill-in the Blanks 1. According to the _________ theorem, it does not make any economic difference who pays for the pollution, the polluters or the victims. 2. __________ advocates disagree with the Coase hypothesis and argue that polluters, not victims, should pay for the cleanup. 3. The __________ see the value of the environment only as long as it brings them happiness. 4. Polling people to find their willingness to pay for a product is called _______________. 5. The environment is a ________ good and is therefore subject to the same law of _______ ____________ as other goods. 6. The enjoyment one gets from a cleaner beach, enjoying water sports, and a greener park is examples of the ____________ benefits of environmental cleanup. 7. In the United States environmental regulations are usually mandated by _____________. 8. The agency responsible for implementing US laws on environmental protection is ____________. 9. Under command-and-control strategy, to control emissions, firms are required to deploy the __________________ . 10. An area near a source where there is an elevated concentration of pollution is called a _________. 438