Download Chapter 9

The Economic Approach to
Environmental and Natural
Resources, 3e
By James R. Kahn
© 2005 South-Western, part of the Thomson Corporation
Part II
Exhaustible Resources,
Pollution and the
Environment
Chapter 9
The Use of Energy and the
Environment
© 2004 Thomson Learning/South-Western
Introduction
 The focus of this chapter is on the impact of
energy use on the environment, with a
particular focus on air pollution and acid
rain.
 Although all types of energy have some type
of environmental impact, fossil fuels are
responsible for the majority of the negative
impacts of energy use. This is due to:
the large environmental impact per BTU of
fossil fuel use, and
the magnitude of fossil fuel production and use.
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Introduction
 Perhaps the greatest negative interaction
between energy and the environment occurs
with air pollution, where the combustion of
fossil fuels is the major source of the air
pollutants that were initially regulated by the
1972 Clean Air Act, with amendments in 1977
and 1990.
 These pollutants include particulates, sulfur
oxides (SOx), nitrogen oxides (NOx), carbon
monoxide (CO), volatile organic compounds
(VOCs), and lead (Pb).
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Introduction
 As Figure 9.1 indicates, the level of most of these
pollutants have declined since the passage of the
Clean Air Act, except for nitrogen oxides.
 Nitrogen oxides have increased because of the
increasing emissions from on-road and off-road
vehicles and off-road engines.
 In addition to fuel consumption, the use of energy is
responsible for virtually all the pollutants in the
transportation sector and a good portion of the
emissions in industrial processes.
 Despite reductions in overall emission levels in the
US, approximately 98 million people live in
“nonattainment areas” (locations which persistently
fail to meet national ambient air quality standards).
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Regulations on Stationary Sources of
Pollution
 Stationary sources of criteria air pollutants
(smokestacks from factories and buildings) are
regulated under the Clean Air Act of 1972 and its
amendments (1977 and 1990).
 Using federal government established national
ambient standards on concentration of each
pollutant, states implemented command and control
policies to reduce emissions.
 These command and control policies did not allow
firms to seek cost-minimizing alternatives in
production.
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Regulations on Stationary Sources of
Pollution
 The “Pollution Bubble” concept was a modification
of the command and control regulations which
treated each firm as if a glass bubble encased the
entire firm's operations.
 Firms could make adjustments within the bubble as
long as the pollution that left the bubble conformed
to emissions limitations.
 While allowing some flexibility to respond to
pollution standards, even the modified the policy
was not effective in reducing pollution.
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Regulations on Stationary Sources of
Pollution
 An interesting case in point is Southern
California which, primarily because of
automobile traffic, could not meet the federal
standards.
 Southern California was declared a nonattainment zone, and no new sources of
pollution were permitted.
 This meant no growth in industry and the
possibility of a stagnant economy.
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Regulations on Stationary Sources of
Pollution
 Modification to the Clean Air Act allowed new
emission sources if they induced existing
polluters to reduce pollution by 150 percent
of the amount generated by the new source.
 This "offset" system allowed development
but limited trade to new firms and was not as
efficient a policy as marketable permits.
 As part of its effort to meet ambient quality
standards, California currently has the most
stringent standards on emissions from
automobiles in the nation.
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Stationary Source of Pollution and Acid
Rain
 Acid deposition refers to a process by which certain
types of pollutants chemically transform into acidic
substances in the atmosphere and then fall to the
earth.
 Forms of precipitation include acid rain, acid snow,
and acid fog.
 It also possible to have dry deposition.
 While acid rain has received a lot of press, there is
considerable uncertainty about the actual damages
generated by the emissions of acid deposition
precursors.
 Precursor pollutants are those pollutants that are
chemically transformed to generate the substances
that actually cause the environmental damage.
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Stationary Source of Pollution and Acid
Rain
 The Acid Precipitation Act of 1980 was the
culmination of concerns about acid
deposition which began in the 1970s.
 This act established the National Acid
Precipitation Assessment Program (NAPAP)
to provide regional information about effects
of acidity on resources, the extent to which
acid deposition and related pollutions are
responsible for causing these impacts, and
strategies to control acid deposition and
related pollutants.
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Stationary Source of Pollution and Acid
Rain
 Acid rain belongs to a category of pollutants referred
to as regional pollutants, which have effects over
more than just the vicinity of their emission.
 Unlike global pollutants, location of emissions is
important with regional pollutants.
 Acid deposition problems often manifest as
transboundary (transfrontier) pollutants.
 Two examples include:
 Sulfur dioxide emissions in the United States which
affect environmental quality in Canada and vice versa.
 Pollution generated in Great Britain and German which
causes acid deposition in Scandinavia.
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What Causes Acid Deposition?
 The most important precursor pollutants in the acid
deposition problem are sulfur dioxide and nitrous
oxides.
 Sulfur dioxide is associated with the burning of coal
and oil as boiler fuel.
 Nitrous oxides are primarily associated with
automobile emissions.
 Acid rain and other forms of acid deposition are
caused when sulfur dioxide and nitrous oxides form
sulfate and nitrate in the atmosphere, which then
combines with hydrogen ions to form acids.
 Sulfate and nitrate molecules are formed when sulfur
dioxide and nitrous oxides combine with oxidants in
the atmosphere.
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What Causes Acid Deposition?
 Tropospheric ozone (03) is an important oxidant
which is formed when two pollutants, nitrous oxide
and volatile organic compounds (VOCs) chemically
interact in the presence of sunlight.
 The presence of VOCs in the atmosphere, while not
directly responsible for acid deposition, leads to
greater proportions of sulfur dioxide being
converted to sulfate and nitrous oxides being
converted to nitrate.
 The following tables provide various anthropogenic
sources of sulfur dioxide, nitrogen oxides, and VOCs
emissions and trends in emission levels (a complete
list is in the Appendix).
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What Causes Acid Deposition?
 The nature of the chemical relationships requires a
coordinated effort at reduction of the differing
pollutants.
 A reduction in nitrous oxides not only directly
reduces acid rain, but indirectly reduces the
conversion of sulfur dioxide by reducing ozone.
 The interactions among these pollutants make the
identification of the optimal level of pollution an
extremely difficult problem.
 The marginal damage function for sulfur dioxide
depends not only on itself but also on the level of
nitrous oxide and VOCs.
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What Causes Acid Deposition?
 Even if the marginal abatement cost function was known, one
could not determine the optimal level of sulfur dioxide
emissions without also knowing the costs of reducing nitrous
oxide and VOCs, which in turn could shift the marginal damage
function.
 The process of identifying the optimal level of sulfur dioxide (or
nitrous oxide or VOCs) can be even more complex if the
marginal abatement cost of one pollutant is a function of the
abatement level of other pollutants.
 Changes in a production process that increase energy
efficiency could reduce the level of all pollutants, while some
abatement devices, scrubbers for example, result in a decrease
in one type of pollutant and an increase in another.
 As Figure 9.3 indicates the optimal level of a pollutant becomes
a moving target.
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What Causes Acid Deposition?
 Since the optimal level of each of the three pollutants cannot be
determined independently of each other, the level of emissions
of each must be chosen to minimize the sum of the total
abatement costs and total damages associated with all three
pollutants.
 Equation 9.1 represents the situation where total abatement
costs (TAC) are a function of the level of emissions of all three
pollutants (El,E2,E3).
 Equation 9.2 represents total damages (TD) as a function of all
three pollutants.
 The minimization of the sum of total abatement costs and total
damages requires that the marginal damages of each pollutant
are equal to the marginal abatement costs of each pollutant.
 Equations 9.3 – 9.5 must be solved simultaneously to
determine the optimal output level of each pollutant.
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The Impacts of Acid Deposition
 Acid deposition and related pollutants have many significant
impacts on natural systems and human systems.
 These include acidification of surface water and detrimental
effects on high elevation coniferous forests.
 Sulfur dioxide, sulfate particles, and acid aerosols are all
suspected of having detrimental effects on human health.
 Ozone, caused by the emission of nitrous oxides, has harmful
effects on both vegetation and humans.
 The particles that generate acid deposition also serve to scatter
light, creating a "pollution haze" and reducing visibility.
 Acid deposition also leads to the premature weathering and
degradation of materials used in buildings, monuments, fences,
and other structures.
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The Impacts of Acid Deposition
 Table 9.1 illustrates the effects associated
with acid precipitation, as presented in the
1990 Integrated Assessment Report of
NAPAP.
 Market effects indicated impacts that are felt
by producers and consumers of goods that
are bought and sold.
 Nonmarket values can be either use or nonuse values.
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Acid Deposition Policy
 Although research conducted to determine acid deposition
relationships yielded important insights into cause and effect
relationships, the knowledge was site specific and not easily
generalized to larger regions.
 The NAPAP research program, which spanned the decade of
the 1980s, resolved many scientific questions concerning the
dispersion of pollutants, the chemistry of its transformation
into acid deposition, and many of the ecological effects of the
acid deposition.
 Very little research money was spent looking at the willingness
to pay to prevent identified impacts based on the belief that the
uncertainty involving the scientific relationships would result in
meaningless estimates of economic relationships.
 How do policymakers develop a set of efficient policies when
the benefits of reducing acid deposition are unquantifiable?
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Pre-1990 Acid Deposition Policy
 The pre-1990 Acid Deposition Policy focused primarily on the
establishment of cause and effect relationships.
 The Reagan administration's policy required that more
information be developed before implementing any reductions
in emissions of SO2 and NOx.
 SO2 and NOx are "criteria pollutants” that are regulated under
the 1972 Clean Air Act and the 1977 Clean Air Act Amendments.
 The fact that these regulations focus on local effects of
emissions may have exacerbated the problem.
 One way in which a local polluter can minimize the local effect
of pollution emissions is to build a tall smoke-stack which
injects pollutants into higher wind currents which carry these
pollutants into other areas.
 These tall smokestacks were, to a large extent, responsible for
the sulfur component of the acid deposition problem.
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Acid Deposition Policy and the 1990
Clean Air Act
 The political problem associated with supporting legislation
which reduces the standard of living of constituents was dealt
with through the creation of the 1990 Clean Air Act
Amendments (CAAA), which packaged several environmental
problems within the same pieces of legislation.
 These amendments address the problems of acid rain, local air
quality associated with ozone and carbon monoxide, pollution
from cars and trucks, air toxins, and stratospheric and global
climate protection.
 Acid deposition is dealt with in Title IV of the 1990 CAAA, which
specifies a ten million ton reduction in annual sulfur dioxide
emissions to be achieved by the year 2000.
 An interesting aspect of Title IV of the 1990 CAAA is that it
represents the first attempt by the federal government to
implement a system of marketable pollution permits.
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Acid Deposition Policy and the 1990
Clean Air Act
 Economists applauded the incorporation of marketable permits
as an important step in improving the efficiency of
environmental regulations.
 The primary criticism against the permits was that there is no
attempt to make geographic distinctions associated with the
location of emission of SO2.
 The first trade to occur was between a Wisconsin utility and the
Tennessee Valley Authority (TVA).
 The sale of allowances from Wisconsin to Tennessee resulted
in less pollution by the Wisconsin utility and more by TVA.
 The cost of reducing pollution by the amount of the traded
allowances must be less than the price of the allowances, or
the Wisconsin utility would not have agreed to the sale.
 Similarly, the savings in the abatement costs for TVA must be
greater than the cost of the permits.
 Both companies lowered their costs.
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Acid Deposition Policy and the 1990
Clean Air Act
 If the only impact of sulfur dioxide pollution is acid
rain, the cost of which is independent of location,
then there will be no change in environmental
quality.
 If local pollution effects exist, then the trade will
reduce local environmental quality in Tennessee and
increase the quality in Wisconsin.
 A comparison will have to be made between the loss
to citizens in Tennessee and the gain to citizens in
Wisconsin.
 A potential Pareto improvement is still possible if the
citizens of Wisconsin gain by more than the loss by
citizens in Tennessee.
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Acid Deposition Policy and the 1990
Clean Air Act
 Another potential problem with the acid rain
provisions of the 1990 CAAA is that not all emitters
of SO2 are incorporated into the system, and NOx is
not part of any trading system.
 It may be that obtaining greater reductions from
small emitters and mobile sources (which were not
included) is cheaper at the margin.
 The 1990 CAAA amendments did take positive steps
to reduce the acid rain problem.
 With a goal of reducing sulfur dioxide emissions by
roughly 50%, Phase I of the program, which began in
1995, developed a cap on emissions of most
polluting power plants.
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Acid Deposition Policy and the 1990
Clean Air Act
 One of the fears expressed by opponents of the Sulfur Trading
Program was that local air quality would decline in areas where
most of the electric power generation was from older plants
facing higher abatement costs.
 Although the system has lead to some patterns of trading that
increase emissions in certain areas, it does not appear that this
has caused any areas to violate the federal standards.
 The sulfur trading program has been relatively successful with
long run cost savings associated with the program estimated at
$0.78 billion, however the volume of trade has been less than
anticipated.
 Factors which have contributed to this include uncertainty
about the future, obstacles to trading created by state-level
regulatory agencies, and a desire, on the part of firms, to bank
emission reductions for the future, rather than selling them
today.
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Acid Deposition Policy and the 1990
Clean Air Act
 One interesting outcome of the program is that
prices of allowances have been lower than
anticipated suggesting that marginal abatement
costs are lower than predicted.
 The US Environmental Protection Agency originally
predicted an allowance price of $1500 per ton, but
revised this downward to about $500 in 1990.
 Actual prices started out around $250-$300 per ton
and fell to $70 per ton by 1996.
 The price has risen in more recent auctions.
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Acid Deposition Policy and the 1990
Clean Air Act
 Table 9.2 contains a summary of the acid rain
provisions (Title IV) of the 1990 Clean Air Act,
and Figures 9.4 and 9.5 show the anticipated
levels of emissions as a result of this
legislation.
 An important point to remember is that the
target of ten million ton reduction was not an
optimal reduction but rather a value
supported by the scientific research and
acceptable to most members of Congress.
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Acid Deposition Policy and the 1990
Clean Air Act
 The 1990 CAAA required NAPAP to conduct an assessment of
the costs and benefits associated with this reduction by 1996
with periodic assessments every 4 years and to identify the
levels of reduction that will prevent adverse ecological impacts
(not defined in legislation).
 Another important point is that Title IV relies primarily on
command and control provisions. The only exceptions are the
trading allowances.
 The Clean Air Act also reflects a negotiated agreement between
the United States and Canada.
 The two countries entered into a "Bilateral Agreement on Air
Quality" in 1991 to deal with acid deposition precursor
pollutants and other types of air pollution.
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Regulations on Mobile Sources of
Pollution
 The primary regulation on mobile sources of
pollution is specifying abatement control
devices for vehicles.
 All automobiles are required to employ a
catalytic converter.
 Platinum in the converter serves as a
catalyst that lowers the ignition temperature
of many of the unburned hydrocarbons and
other pollutants in gasoline.
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Regulations on Mobile Sources of
Pollution
 One problem with this command and control regulation is that
it controls all areas of the country in the same fashion,
regardless of impact of an additional units of emission.
 Additionally, it does not provide incentives to reduce pollution
by driving less, maintaining their cars, or choosing an
alternative vehicle or mode of transportation.
 Air pollution from automobiles is also indirectly controlled by
Corporate Automobile Fuel Efficiency (CAFE) standards, which
specify the average miles per gallon that must be achieved by
each automobile manufactured, where a higher MPG means
less gasoline burned per mile which means less emission.
 This standard does not reduce the number of miles driven and
may actually induce greater mileage.
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Regulations on Mobile Sources of
Pollution
 Mills and White suggest an alternative policy which
would tax cars based on the total amount of
pollution that they generate each year.
 An annual diagnostic test would determine the
emissions per mile and this multiplied by the
odometer reading would give annual emissions.
 A combination of federal and state taxes could be
used to account for regional difference in ambient air
quality.
 This would create incentives to drive less, live closer
to work, and develop lower polluting automobiles.
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Energy Policy and the Environment
 US Presidential Administrations have
integrated environmental policy and energy
policies usually with two major goals:
Increase domestic supplies of energy and reduce
dependence on foreign oil.
Promote a cleaner environment by requiring energy
users to utilize cleaner technologies.
 These policies have had a mixed record of
success.
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Energy Policy and the Environment
 One dominant factor in the failure of US
energy/environmental policy is that it fails to
allow the cost of energy, particularly
imported petroleum, to reflect its true social
cost.
 This cost has two components:
The social cost of dependence on insecure imports
of petroleum.
The environmental cost of energy use.
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Energy Policy and the Environment
 Energy policy has traditionally been
designed to keep energy costs low.
 A higher cost associated with energy use
would result in the development of
alternatives to fossil fuels, a reduction in the
amount of pollution per unit of energy used,
a reduction in energy use, the development
of more energy efficient technologies and a
reduction in oil imports.
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Energy Policy and the Environment
 There is a fundamental disparity between the private
cost of energy use and the social costs associated
with its use.
 There are a variety of ways to eliminate this
disparity.
 The least costly would be a comprehensive series of
market pollution permits or a system of per unit
pollution taxes.
 A combination of both permits for large stationary
polluters and taxes for mobile sources may be best.
 Externalities in the production of energy could be
addressed with liability and bonding systems.
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Energy Use and Environmental Taxes
 Fuel taxes may be a second best solution to
pollution taxes or permits.
 A tax added to the price of fuel based on the average
amount of pollution of the fuel would provide an
incentive to burn less fuel and encourage energy
efficiency.
 However, taxes do not provide incentives to reduce
emissions per unit of fuel burned.
 In addition, many people object to being taxed on
both philosophical and practical grounds.
 Philosophical grounds center on the belief that
government is too big and intrusive.
 Practical grounds center around the idea that
government spending tends to be wasteful.
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Energy Use and Environmental Taxes
 The importance of increasing the price of fuel can be seen both
in pollution problems arising from energy use and the lack of
progress in developing alternative energy sources.
 Alternative sources of energy include solar power, geothermal
power, wind power, and liquid fuel from renewable sources
such as ethanol and methanol from a variety of plant sources.
 While alternative sources of energy are generally less polluting
than fossil fuels, alternative energy technologies are more
expensive for energy users than coal or oil, so they have not
become established as important sources of energy.
 Alternative fuels and energy technologies would be
significantly advanced if the price of fossil fuels rose to
incorporate the full social cost of these fuels as illustrated in
Figure 9.6.
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Energy Use and Environmental Taxes
 The marginal private cost curve for all fuels is
constructed by horizontally summing the MPC curve
for alternative fuels and the MPC curve for oil.
 The market equilibrium is tl where total fuel MPC is
equal to the market demand curve.
 The social optimum, t2 occurs at a lower output
where total marginal social cost is equal to market
demand.
 MPC plus an externalities tax or other options would
bring private and social optimum together.
 At this lower output level, oil usage declines and
alternative fuel use increases.
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The Macroeconomic Impact of Fuel Taxes
 Are low energy prices a requirement for U.S. economic
success?
 Table 9.3 lists gasoline prices in US dollars (current, not
inflation adjusted) per liter for selected developed countries.
 It is clear that other economies with higher energy prices
(based on higher taxes) have strong and growing economies.
 One of the reasons for the undesirable macroeconomic impact
of high prices in the 1970s was the fact that the price change
was so sudden.
 This suggests that implementing increased gas taxes over time
will not hurt the economy and will allow consumers and
producers to incorporate the higher prices into their future
plans.
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The Macroeconomic Impact of Fuel Taxes
 If taxes are efficiently utilized, the tax revenue
generated could be used to reduce taxes in other
areas of the economy, for example, income taxes.
 This reduction in income taxes could lead to greater
productivity which would offset, at least partially, the
negative impact of fuel taxes.
 A pollution tax, system of marketable pollution
permits, or fuel taxes will cause less of a negative
impact on the macroeconomy than a corresponding
increase in the prices from OPEC monopoly power.
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Transition Fuels and the Future of Fuels
 Many people believe that sometime in the future
there will be radically different sources of energy.
 The question is “How do we get from the present
time to the time when these innovations in energy
are available, or what should be our transition fuel?”
 The mechanism which will move the economy from
one fuel to another is rising prices in the market.
 As the marginal extraction cost of oil increases
relative to the marginal extraction cost of coal, the
opportunity cost of using oil decreases.
 The transition point to a new fuel is when total
marginal cost of oil (MEC+MUC) is equal to total
marginal cost of coal.
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Figure. 9.7. - Fuel Transition
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Transition Fuels and the Future of Fuels
 Policy makers have been concerned with managing
the transition from one source to another.
 One concern is that the market will not adequately
spur research and development into new
technologies.
 Another is the continued policy of abundant, cheap
energy at a low price.
 A more recent concern is that if environmental
externalities are not reflected in the market price,
then transition to cleaner fuels will occur later than
socially optimal.
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Transition Fuels
 The Carter administration adopted a policy that
defined coal as a transition fuel but concerns about
high levels of pollution from burning coal changed
this choice.
 Viewed as the cleanest of fossil fuels, another
possibility is deep natural gas, which is 1000s of feet
deeper and more expensive than conventional gas.
 However, if all fuels included all social costs in their
prices, then the market would pick the fuel with the
lowest social cost as the transition fuel.
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Energy and the Third World
 The real energy crisis is in the Third World nations,
where the economies are much less capable of
adjusting to price shocks associated with oil price
increases.
 Often Third World countries have to use much
needed foreign reserves to purchase oil which leads
to borrowing for development projects.
 The increase in the price of fossil fuels has forced a
greater reliance on fuel wood which has contributed
to a growing rate of deforestation.
 Environmental externalities from energy use have
also contributed to dreadful environmental quality.
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Summary
 Although the Clean Air Act and other
legislation in the US has had some impact in
reducing the negative consequences of
energy use, much progress needs to be
made.
 Internalizing the external cost of emissions
and national security externalities through
permits and taxes will generate a series of
reactions which lead to higher social welfare.
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