20 Externalities the Environment and Natural Resources Environmental

20 Externalities, the Environment, and Natural Resources Environmental taxes are perhaps the most powerful tool societies have forging economies that protect human and environmental health. DAVID MALIN ROODMAN, WORLDWATCH INSTITUTE

Contents ● Part 1: The Economics of Environmental Protection ♦ Externalities: A Critical Shortcoming of the Market Mechanism ♦ Supply-Demand Analysis of Environmental Externalities ♦ Basic Approaches to Environmental Policy ♦ Two Cheers for the Market Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Contents (continued) ● Part 2: The Economics of Natural Resources ♦ Economic Analysis: The Free Market and Pricing of Depletable Resources ♦ Actual Resource Prices in the 20 th Century Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Part I: The Economics of Environmental Protection

Externalities: Shortcoming of the Market Mechanism ● Remember that the market tends to create an undesired abundance of damaging externalities. ● In this chapter we focus on one of the most publicized externalities--pollution. Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

Externalities: Shortcoming of the Market Mechanism ● The Facts: Is the World Really Getting Steadily More Polluted? ♦ Our society faces serious environmental problems. ♦ However, we should realize that many of our environmental problems have improved significantly in recent years. Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

20 -1 National Long-Term Air Quality Trends, 1975 -1999 FIGURE Sulfur Dioxide NAAQS standard = 50 micrograms per cubic meter 80 60 40 20 0 1975 ’ 80 ’ 85 ’ 90 ’ 95 0. 030 Parts per Million Micrograms per Cubic Meter Particulate Matter ’ 99 NAAQS annual standard = 0. 03 parts per million 0. 025 0. 020 NAAQS 24 -hour standard = 0. 14 parts per million 0. 015 0. 010 0. 005 0 1975 0. 08 0. 06 NAAQS annual standard = 0. 053 parts per million 0. 04 0. 02 0 1975 ’ 80 ’ 85 ’ 90 ’ 95 0. 16 0. 12 4 ’ 90 ’ 95 ’ 99 Micrograms per Cubic Meter Parts per Million 8 ’ 85 ’ 99 New NAAQS 8 -hour standard = 0. 08 ppm 0. 04 ’ 80 ’ 85 ’ 90 ’ 95 ’ 99 Lead NAAQS 8 -hour standard = 9 parts per million ’ 80 ’ 95 0. 08 Carbon Monoxide 0 1975 ’ 90 Old NAAQS 1 -hour standard = 0. 12 ppm 0 1975 ’ 99 16 12 ’ 85 Ozone (Smog) Parts per Million Nitrogen Dioxide ’ 80 1. 6 NAAQS standard = 1. 5 micrograms per cubic meter 1. 2 0. 8 0. 4 0 1975 ’ 80 ’ 85 ’ 90 ’ 95 ’ 99 Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Externalities: Shortcoming of the Market Mechanism ● The Facts: Is the World Really Getting Steadily More Polluted? ♦ Not all pollution can be attributed to modern industrialization ■Medieval cities were littered w/garbage and stank of rotting wastes ■The automobile was hailed as an improvement in cleanlines over problems regarding horse dung Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

Externalities: Shortcoming of the Market Mechanism ● The Facts: Is the World Really Getting Steadily More Polluted? ♦ Air quality in most U. S. cities has improved over last 30 years ♦ 100% decrease in ambient concentrations of lead Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

Externalities: Shortcoming of the Market Mechanism ● The Facts: Is the World Really Getting Steadily More Polluted? ♦ Although environmental problems are neither new nor confined to capitalist, industrialized economies, we continue to inflict damage on ourselves and our surroundings. Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

Externalities: Shortcoming of the Market Mechanism ● The Law of Conservation of Matter and Energy ♦ Nothing can disappear completely. ♦ Once a material is used, it must be recycled or become a waste product. Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

20 -2 Annual Mean Global Surface Air Temperature FIGURE 14. 8 14. 6 Temperature (°C) 14. 4 14. 2 14. 0 13. 8 13. 6 13. 4 0 1880 1900 1920 1940 1960 1980 2001 Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Externalities: Shortcoming of the Market Mechanism ● The Role of Individuals and Governments in Environmental Damage ♦ Firms create pollution, but so do private individuals and governments. Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

Externalities: Shortcoming of the Market Mechanism ● Environmental Damage as an Externality ♦ Environmental damage is usually an externality because people do not pay directly for the damage they impose. ♦ Therefore, the unconstrained market system generates too much pollution. Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

Supply-Demand Analysis of Environmental Externalities ● Supply and demand curves for pollutants can be constructed. ● The supply curve represents the real costs to society. ● The problem is that since the cost is external, people behave as if it were zero. Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

20 -3 Free Dumping of Pollutants FIGURE Price per Ton per Year of Garbage Removed D S A P S E T 0 5 10 15 20 Quantity of Garbage T 25 Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Basic Approaches to Environmental Policy ● Voluntarism--this has proved to be unreliable ● Direct controls --these have been the chief instruments of environmental policy in the U. S. ● Taxes on pollution emissions--imposing penalties on polluters Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

Industrial Discharge of Heavy Metals, Netherlands, 1976 -1994 150 Lead Index (1976 = 100) 120 Zinc 100 Copper 75 Cadmium 50 25 Mercury 0 1976 1980 1984 1988 1992 1994 Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Basic Approaches to Environmental Policy ● Emissions Taxes versus Direct Controls ♦ Problems of direct controls: ■Enforcement issues ■Inefficiencies in the clean up Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

Emissions Taxes versus Direct Controls ● Enforcement Issues ♦ Enforcement of direct controls requires vigilance and enthusiasm by the regulatory agency. ♦ It also requires speed and rigor on the part of the court system. Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Emissions Taxes versus Direct Controls ● Enforcement Issues ♦ Direct controls work only if the legal system imposes significant penalties on violators. ♦ In contrast, pollution taxes are automatic and certain. ♦ The only sure way for the polluter to avoid paying pollution charges is to pollute less. Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Emissions Taxes versus Direct Controls ● Efficiency in Cleanup ♦ A second important advantage of emissions taxes is that they tend to cost less than direct controls. ♦ Only polluters who can reduce emissions cheaply and efficiently can afford to take advantage of the built-in loophole--the opportunity to save on taxes by reducing emissions. Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Emissions Taxes versus Direct Controls ● Advantages and Disadvantages ♦ An emission is so dangerous that it must be prohibited altogether ♦ A sudden change in circumstances calls for prompt and substantial changes in conduct ♦ Where effective and dependable pollution metering devices have not been invented or are too costly to install and operate. Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Financial Device to Protect the Environment: Emissions Permits ● Another way for the government to control pollution is to sell or auction emissions permits. ● Emissions permits in many ways work like a tax--they make it too expensive for firms to continue polluting as much as before. Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Financial Device to Protect the Environment: Emissions Permits ● One advantage of the permit approach over taxes is that it reduces uncertainty about the quantity of pollution that will be emitted. Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Two Cheers for the Market ● Through appropriate legislation, the forces of the market can be harnessed to correct the market’s own failings. Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

Part 2: The Economics of Natural Resources

Economic Analysis ● A reliable indicator of the availability of depletable resources is the price of the resource. Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

Past Petroleum Prophecies (and Realities) Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Economic Analysis ● Scarcity and Rising Prices ♦ Resource scarcity prices ♦ Hotelling theorem ■Shows that the price of a depletable resource must rise at the rate of interest ■Assumes perfect competition ■Assumes the costs of transportation and extraction are negligible Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

The Price of Economite Over Four Years Initial Date 1 Year Later 2 Years Later 3 Years Later 4 Years Later $100 $110 $121 $133. 10 $146. 41 Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Economic Analysis ● Supply-Demand Analysis and Consumption ♦ The ever-rising prices accompanying increasing scarcity of a depletable resource discourage consumption (encourage conservation). ♦ Even if quantity demanded grows, it will grow less rapidly than if prices were not rising. Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

20 -4 Consumption over Time of a Depletable Resource FIGURE D Price per Ton D 2 C $121 B 110 A 100 D 1 $121 G 110 100 A F D 2 D 1 D 0 88 95 100 Quantity Demanded (a) 0 100 110 120 Quantity Demanded (b) Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Actual Resource Prices in the Twentieth Century ♦ In fact, the real prices of natural resources have grown much slower than the rate of interest, if at all. Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

20 -5 Real Prices of Lead, Zinc, and Copper, 1900 -2000 FIGURE Price per Pound (in Constant 1982 Cents) 180 160 140 Copper 120 100 80 Zinc 60 40 Lead 20 0 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Actual Resource Prices in the Twentieth Century ● Interferences with Price Patterns ♦ Unexpected discoveries of reserves whose existence was previously not suspected ♦ Invention of new methods of mining and refining that may significantly reduce extraction costs ♦ Price controls that hold prices down or decrease them Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

20 -6 Price Effects of a Discovery of Additional Reserves FIGURE S 1 Price per Ton D Before discovery S 2 After discovery P 1 P 2 S 1 D S 2 0 Quantity in Millions of Tons Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Actual Resource Prices in the Twentieth Century ● Is Price Interference Justified? ♦ Market sets quantity demanded = quantity supplied even if a finite resource is undergoing rapid depletion. ♦ Reason: price adjustments ♦ Any shortage must be artificial due to a decision to prevent the price mechanism from doing its job. Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

20 -7 Controls on the Price of a Resource FIGURE Price per Ton D S P A P* B S D 0 2 4 5 Quantity in Millions of Tons Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Actual Resource Prices in the Twentieth Century ● On the Virtues of Rising Prices ♦ Rising prices help to control resource depletion ■Promote conservation ■Stimulate more efficient use ■Encourage the discovery of alternate resources and techniques Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

? Growing Reserves of Exhaustible Resources ● Over time, the known reserves of many resources have actually increased, probably because rising prices induced exploration and discovery. Copyright© 2003 Southwestern/Thomson Learning All rights reserved.