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

●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 ●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 Contents Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

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

Part I: The Economics of Environmental Protection

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. 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. ●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. ●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.

FIGURE 20-1 National Long-Term Air Quality Trends, Copyright © 2003 South-Western/Thomson Learning. All rights reserved. NAAQS 24-hour standard = 0.14 parts per million NAAQS standard = 50 micrograms per cubic meter ’99 NAAQS standard= 1.5 micrograms per cubic meter ’95’90’85’ Micrograms per Cubic Meter Lead Old NAAQS 1-hour standard = 0.12 ppm New NAAQS 8-hour standard= 0.08 ppm ’95’90’85’ Parts per Million Ozone (Smog) Sulfur Dioxide NAAQS annual standard = 0.03 parts per million ’99’95’90’85’ Parts per Million NAAQS 8-hour standard = 9 parts per million ’95’90’85’ Parts per Million Carbon Monoxide NAAQS annual standard = parts per million 0.08 ’90’95’85’ Parts per Million Nitrogen Dioxide Particulate Matter 80 ’95’90’85’ Micrograms per Cubic Meter

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. ●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 ●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 Externalities: Shortcoming of the Market Mechanism

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. ●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 ●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 Externalities: Shortcoming of the Market Mechanism

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. ●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. ●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. Externalities: Shortcoming of the Market Mechanism

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. ●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. ●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. Externalities: Shortcoming of the Market Mechanism

FIGURE 20-2 Annual Mean Global Surface Air Temperature Copyright © 2003 South-Western/Thomson Learning. All rights reserved Temperature (°C)

Copyright© 2003 Southwestern/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. ●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. ●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. ●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.

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

Copyright© 2003 Southwestern/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 ●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

Industrial Discharge of Heavy Metals, Netherlands, Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Mercury Cadmium Copper Lead Index (1976 = 100) Zinc

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

●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. ●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. Emissions Taxes versus Direct Controls Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

●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. ●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. Emissions Taxes versus Direct Controls Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

●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. ●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. Emissions Taxes versus Direct Controls Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

●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. ●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. Emissions Taxes versus Direct Controls Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

●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. ●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. Financial Device to Protect the Environment: Emissions Permits Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

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

Copyright© 2003 Southwestern/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.

Part 2: The Economics of Natural Resources

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

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

Copyright© 2003 Southwestern/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 ●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

The Price of Economite Over Four Years Copyright © 2003 South-Western/Thomson Learning. All rights reserved. $121$133.10$ Years Later3 Years Later4 Years Later $110 1 Year Later $100 Initial Date

Copyright© 2003 Southwestern/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. ●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.

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

Copyright© 2003 Southwestern/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.

FIGURE 20-5 Real Prices of Lead, Zinc, and Copper, Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Price per Pound (in Constant 1982 Cents) Zinc Copper Lead

Copyright© 2003 Southwestern/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 ●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

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

Copyright© 2003 Southwestern/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. ●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.

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

Copyright© 2003 Southwestern/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 ●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. ?