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Welcome to
Environmental Economics
What is environmental economics?
• Economics – study of how society allocates
scarce resources.
• Environmental economics – offers
explanations and solutions for both the
causes and consequences of environmental
degradation (env. econ). The study of how
society allocates scarce natural resources
such as fish, trees, water, oil, etc. (resource
econ.)
What is environmental economics?
• 2 parts of a whole – every economic action
can impact the environment, and every
environmental change can impact the
economy.
• Recognizes that we need not give up
environmental quality to have a better
economy or give up economic benefits to
have better environmental quality.
Class Objective
• Develop a framework for thinking about the
significance of an environmental problem
and about what constitutes a feasible set of
solutions to the problem.
• Economics alone incapable of generating
either understandings of or solutions to
environmental problems
• Integrate ecology, physics, chemistry,
philosophy, sociology, other disciplines to
develop solutions
Part I. Principles
A.
B.
C.
D.
E.
Markets
Market failure
Discounting & PV
Dynamic efficiency
Pollution solutions
A. Markets
Chapter 2, handout
Demand
• The relationship between the quantity
demanded and the price of a good when all
other influences (tastes and preferences,
prices of substitutes and complements,
income, numbers of consumers and
consumer expectations) on buying plans
remain the same
Demand
• Law of demand – ceteris parabis (With all
other factors remaining the same) –
if p ↑, QD ↓
if p ↓, QD ↑
• Demand curve downward sloping
$
Demand
Quantity
Demand = MB
• Demand curve for pizza tells us dollar’s
worth of other goods give up to get 1 more
pizza
• Consumer surplus: MB – price paid
Consumer surplus
Supply
• The relationship between the quantity
supplied and the price of a good when all
other influences on selling plans
(production costs such as labor, energy,
capital, and materials) remain the same
Supply
• Law of supply – ceteris parabis –
if p ↑, QS ↑
if p ↓, QS ↓
• Supply curve upward sloping
$
Supply
Quantity
Supply = MC
• Supply curve for pizza tells us dollar’s
worth of other goods give up to produce 1
more pizza.
• Producer surplus: Price – MC
Producer surplus
Market equilibrium
• Buyers and sellers’ plans consistent
• QD = QS
Equilibrium
• Equilibrium is the price at which quantity
demanded equals to quantity supplied.
• What happens when price is not at equilibrium?
• If price < P*, then QD > QS and there will be
pressure on price to rise (up to equilibrium).
• If price > P*, then QS > QD and there will be
pressure on price to fall (down to equilibrium).
Shortage
• If p < p*, QD > QS, price ↑, suppliers
supply more.
or,
• If MB > MC – good valued more highly
than it costs – ↑ production
Surplus
• If p > p*, QS > QD, price ↓, suppliers
supply less.
or,
• If MC > MB – good costs more than it is
valued – ↓ production
Market equilibrium
Market equilibrium
• At q*, MB = MC, net benefits maximized.
Cannot increase benefits by changing q
• MB = MC → Efficiency – cannot make one
person better off without hurting another
• Why?
$
MB = MC
S = MC
D = MB
Quantity
MB > MC
q*
MC > MB
MB = MC
• If MB > MC, can increase quantity →
increases benefits more than increases costs
→ total net benefits increase
• If MC > MB, can decrease quantity →
decreases cost by more than decreases benefits
→ total net benefits increase
• Only at q* impossible to increase net benefits
by changing quantity
Measuring Net Benefits
• The market demand curve is the sum of all
individual demand curves.
• Every individual demand curve reflects a
WTP based on a perceived value (or
benefit) of the good.
• As a result, the market demand curve
reflects private benefits.
Measuring Net Benefits
• The supply curve reflects the costs of
producing the good or service.
• These costs are incurred in production and
can be viewed as private, since all these
costs are borne by the suppliers.
• As such, the supply curve embodies private
costs.
Social costs and benefits:
MSC, MSB
• MSC – marginal cost incurred by entire
society, by the producer and by everyone
else on whom the cost falls = MC + MEC
• MSB – marginal benefit enjoyed by society,
by the consumers and by everyone else who
benefits from it = MB + MEB
Maximizing Private & Social Benefits
• We know private net benefits are
maximized at equilibrium.
• In order for social net benefits to be
maximized, it is necessary that private MB
be identical to MSB and private MC be
identical to MSC.
• If this condition holds, then market forces
will equate both marginal private costs and
benefits and marginal social costs and
benefits: social welfare maximized.
Will MB = MSB, MC = MSC?
• For many goods (sushi, surfboards), YES
• For many environmental-related goods
(paper produced by water polluting paper
mill, snorkeling at Hanauma Bay), NO
• MB ≠ MSB and/or MC ≠ MSC → market
failure, the topic of the next lecture