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Introduction to Environmental and Natural Resource Economics

1. What is Environmental Economics? Economics - is the study of choice under conditions of scarcity o Economics can be applied to a variety of fields, not just traditional commodities o Economics is not about profits or money Money is used to help allocate the resources o Economists study how incentives impact people's behavior Due to scarce resources, individual behavior is constrained Humans cannot satisfy all their wants and needs Environmental and natural resource economics- the application of economics to the study of how environmental and natural resources are developed and managed. 2. Resource A resource is something which is valuable and useful in that condition in which we find it. Resources used as inputs to production of goods and services. Like uranium is an input to produce electricity. Two forms Row or unprocessed form Final product consumed directly The resource which are unknown or the utility of the things are not found are not resources as they have no value. Thus the resource must be scarce and should have value attached. Resource is dynamic concept because the possibility is always exists the changes in Relative scarcity Information Technological change:- that may force to be resource materials that were not earlier consider as resources. 3. Dimension of the resources Resources has multiple dimension quality, quantity, time and space dimension Examples Air is available in most places in such vast quantities relatives to demand that it may seems more like a free goods then a resource but in many places the like hospital the oxygen cylinder are available in scarce amount and hence have high value. In space capsule the flow of the oxygen is limited. Similarly the quality of the air also have

positive value that is individuals and society are willing to spend money to obtain the air of high quality. 4. Type of the resources Major resources used in agriculture are land, labor, capital and management. Generally there is imperfection in categorization of the natural resources. One resource can be categorized into more than one group. Certain resources may not be fit well into any group. Examples forest as a whole is environmental resources but timber individual is renewable resources. According to purpose there are 3 groups of the resources A) Natural resources The goods and services provided by the living and nonliving environment to meet the human needs and desire are natural resources. i. Two types 1. Renewable - the resource can be replenished a. Fish, cattle, fruits, etc. 2. Nonrenewable - one the resource used, it is gone forever a. Petroleum - diesel fuel, gasoline, plastics B) Environmental resources - resources provided by nature that are not utilized or consumed by humankind directly but services can be valued. Parks and wild life Usually impacted by pollution C) Flow resources These are provided in some predetermined quantity and quality beyond the human control and must be used when provided or otherwise wasted. There is no chance of stock and storage examples labor, building, radiation from the sun. D) Fund resources Storage changes the flow resources into the fund resources. It is more and more manipulated by people. Examples are solar energy, electricity, water and soil nutrients.

On the basis of the divisibility 1. Divisible resource For e.g. seeds, fertilizer, pesticides etc. these are variable resources which can be easily divisible. 2. Lumpy resources There is no chances of the dividing and only one part of if used cannot produce outputs ex tractor, pumping sets etc these are fixed. Why Study Environmental Economics?

Market economies - prices reflect the relative scarcity of goods. o High price - good is relatively scarce relative to demand Market and prices do not usually exist in environmental economics o Environmental and natural resource economics is unique? 1. Market failures is common in the natural resource economy- government intervention may be necessary Monopolies, public goods, externalities, absence of well-defined property right etc. 2. Long time horizons - choices today can impact mankind centuries down the road Nuclear waste Polluting water in a lake Mining for metals 3. Study environmental economics to bring harmony to the economic system and the environment 4. NR requires multi-disciplinary approach it is master of all Biological process growth all need to be known for optimum harvest economics model only does not fit it.

5. Questions for Environmental Economics 1. What is the market failure? a) Monopolies - one firm controls a market Usually the reduce production to cause the market price to increase Can earn substantial profits Examples Natural monopolies - telephone, water, natural gas, and electricity Microsoft DeBeers Corporation - control the raw diamonds market b) Externalities- buyers and sellers in a market impact third parties Person plays (consumes) loud music impacts the neighbors A firm emitting air pollution impacts people living nearby Positive - public immunizations Gov. inoculates its people, preventing the spread of diseases c) Asymmetric information - one party in the market has more information Used car salesman has more info. than the buyer A person with a heart problem gets medical insurance d) Public goods - private markets have trouble supplying public goods Usually police, military, inoculations, clean air, etc. Expanded to include education, highways, libraries, mail delivery, etc. Markets may not supply enough of them, so gov. supplies them because they benefit society e) Open resource - property that is owned by everyone or absence of ownership People tend to over exploit the resource Tragedy of the Commons Over fish in public lakes Dump trash and litter on a public land 2. How to correct market failure? o Markets do not exist for environmental resources. Government can regulate the resource Traditional method Government creates a market for the resource More governments are using this option 3. How to evaluate environmental programs? o Cost-Benefits Analysis - compare the costs and benefits of protecting a resource Economists find the level of protection where marginal costs equals marginal benefits. This is calculus - max. benefits and min. costs

Careful - if a firm is polluting the air, the choice is not to shutdown the firm for zero pollution Firm could relocate to another country and export its products back Further, there is job losses Economists find the firm's production where benefits of pollution abatement are maximized and its costs are minimized Note - difficult to place a value on environmental protection. No market prices

4. Efficiency versus Equity

If an efficient solution occurs, it might not be desirable. o Marginal benefits = marginal costs, thus the benefits are maximized relative to the costs o Welfare economics says nothing about how the distribution of resources in a society are allocated Equitable - people own equally all of society's resources Highly inequitable - one person owns all society's resources o Policymakers need to consider how various groups will be impacted. This can be complicated in environmental economics Global warming - how should the welfare of future generations be weighed when making global warming policy?

5. Why is Pollution an Economic Problem?

Two types of economic analysis: o Positive economics - the scientific study of economic relationships Either true or false How do people respond to higher gasoline prices? 0 The temperature today is 30 C How does a firm maximize profits? o Normative economics - judgments about "what ought to be" in economic matters Value judgments Neither true or false Many policies are normative Economists should use positive economics as well as everyone else o Economists are people with biases o Many people take a moral approach to the environment Polluting is the result of unethical behavior Thus, all pollution is evil and should stop

Environment resources should be viewed in terms of positive economics o Could environmental resources provide us with benefits? o Could government change the incentives for environmental protection? o Policy makers and society's view points can impact the type of environmental policies

6. Models of Scarcity:
o o o o

o o

o o o

Malthus - population is growing geometrically but food production is growing arithmetically Malthus was a priest and economist Wrote - Essay on the Principle of Population as It Affects the Future Improvement of Society (1798) Land is a fixed, scarce resource and food production is limited If the population exceeded its food production, then some people would "die off." Why economics is called the abysmal science Problem - Malthus ignored the impact of technology Technology increases the production from scarce resources Paul Ehrlich, a biologist in 1971 stated Environmental Impact = (Population)*(Affluence)*(Technology) Growing population puts increased pressure on the environment\ Technology helps reduce the impact on the environment Affluence - a wealthier society has more alternatives Citizens can afford to pay higher prices for pollution abatement, etc. Malthusian ideas keep coming back Population Time Bomb Global warming will destroy mankind Doomsday Models - computer models that predicted severe shortages of resources Usually future prices are missing from these models As resources become scarcer, the prices rise. Higher price has four impacts Consumers reduce their demand for products Sellers want to increase production of product Development of new technologies Exploration for new resources Example - Petroleum - scientists predicted in the 1970s that the world would run out of petroleum by 2000

o o o

As oil became more expensive, companies explored and drilled for more oil High cost oil extraction - Northern Slope of Alaska Deep drilling in the Gulf of Mexico??? New technologies Satellite imaging Drilling Oil from shale??? Malthusian ideas have not happened! The price of most resources has actually fallen over time! Food prices have fallen by 50% since 1960, and 90% since 1800. Be careful! We have not accounted for environmental damage. Why do pessimistic predictions get more attention than reality? 1. Funding for scientific research goes to areas with many problems Researchers have to substantiate the problem to receive more funding i.e. Global warming 2. Environmental groups need to be noticed by both the mass media and by potential donors. 3. Attitude of the media Bad news is more interesting than good news. Humans focus on bad experiences more than good experiences

Lecture #2 - Growing Population and Economic Growth


The Economic System

Starting with Physics

First Law of Thermodynamics - "The change in the internal energy of a closed thermodynamic system is equal to the sum of the amount of heat energy supplied to or removed from the system and the work done on or by the system." o Energy is neither created or destroyed Second Law of Thermodynamics - "The total entropy of any isolated thermodynamic system always increases over time, approaching a maximum value." o To do work, there has to be an energy difference. o Entropy means energy differences equalize over time.

Example - you place a hot cup of coffee on your desk. The room's temperature and coffee's temperature equalizes. The room is slightly, slightly warmer while the coffee is colder The energy is still there from the first law Economic activity like production, consumption, transportation, etc. all use energy and resources from the environment. o Everything comes from the environment o Examine the graph:
o

Humans extract resources and energy from the environment o Humans use resources and energy to produce goods and services o Then humans consume these products o Each human activity generates wastes and energy that is returned to the environment Human activities could do the following: Resource depletion - humans extract more resources than can be replenished o Example Humans extract water and supply it to cities Many cities are extracting more water than the amount being replenished by rainfall Pollution - human activities that degrade the environment or resource base o Example Humans emit sulfur dioxide from burning of coal.

The Sulfur dioxide turns into acid rain, which damages forests and lakes. Acid rain depletes minerals from the soil and raises the ph of water, killing the fish Environment does have a sink capacity o Sink capacity - the environment can handle a level of pollution or waste with minimal impact. Once the pollution or waste exceeds the sink capacity, then it damages the environment.

What factors drives this model? 1. Population growth - more people consume goods and services Demands for resources and energy increases More wastes and waste energy is produced 2. Economic growth - society produces more goods and services Each person consumes more goods and services More wastes and waste energy is produced Be careful o Technology and institutional arrangement impact the amount of resources, energy, and waste that humans produce o Last 10 years, people in the United States recycle more Glass bottles, aluminum, paper, plastics, etc are recycled o New institutions and arrangements had to be developed Bins and collection centers where people can dispose of their wastes Recycling centers that separates the types of waste Industries adjusting their production processes to include recycled materials New transportation vehicles for recycled wastes o Traditionally, metals have always been recycled like copper Nobody throws away silver and gold o Market prices exist for recycled materials o Be careful! Recycled materials do not mean it is cheaper Costs money for recycling centers, sorting, machines, equipment, and transportation Some claim recycling makes products and services more expensive

You have to compare the cost of recycling the material to extracting the material from the environment. High-income countries like United States and Europe are big recyclers More is said later in the Environmental Kuznet's Curve

Population Growth

More people put more pressure on the environment o Primary energy consumption increased globally by 4.3% in 2004 o As much as 60% of the global population depends on the waters of international fresh water systems Rivers and lakes of which basins are shared by more than two countries Predicting fresh water shortages Could have more wars and conflicts over fresh water Graph below shows how fast the world's population is growing

The developed world is 75% urban o The rate is accelerating in the developing world o By 2030 urban population is expected to rise to five billion or 60% of the worlds population Sources - U.N. Population Division report World Urbanization Prospects: 2003 Revision; BP Statistical Review of World Energy June 2005; GEO Year Book 2006; WRI 2005 The prediction has a problem

Population growth rate has been slowing and is shown below

Why is population slowing? o Children are expensive in both money and time Developed countries have close to a zero population growth rate People delay having children Complete an education Accumulate assets like a house, car, etc. Much of the population growth is in developing countries HIV is impacting population growth rates in some African countries

Now we see why Mathusian ideas keep coming back rt o Population growth is taken as, Pt = Poe P is population, r is growth rate, and t is time Net growth is birth rate death rate o Paul R. Ehrlich wrote The Population Bomb in 1968 A best seller o Disastrous predictions for resources and environmental degradation Running out of petroleum Killing off all the fish (over harvesting) Many species are going extinct o Biologist use a logistic growth function for species It is an upside down "U-Shape" Example - yeasts Add yeasts to a juice, wort (i.e. before beer is beer), or sugar solution The yeasts rapidly multiply, consuming the sugar Ethanol and carbon dioxide are waste products Eventually the yeast population reaches a peak and then population declines As ethanol reaches about 12%, the yeast dies in their wastes Many examples of this in biology o Environment has a carrying capacity

The level of population a natural resource base can sustain without depletion, whether is be humans or animals Once the population passes the threshold of the carrying capacity, then population declines. Population is depleting the resources

More people consume more goods and services Economics o Demand function - relationship between a market price and quantity demanded by the consumers Law of Demand - a higher market price means consumers reduce their quantity demanded o Supply function - relationship between a market price and quantity supplied by the producers Law of Supply - a higher market price means producers want to increase their quantity supplied o A market brings these two behaviors together Market price and quantity are shown below:

Market is stable o If price is higher than market price of $2 Market has a surplus Producers are supplying more than what consumers want Producers lower the price until the price is $2 again o If price is lower than market price of $2, Market has a shortage Consumers want more than what producers are supplying Producers raise the price until it is $2

Market has many assumptions o Lectures 3 and 4 we will discuss market failures Why do some markets have a perpetually shortage or surplus? o Government is intervening with the market price Why is demand and supply important? o Higher population means more people, and thus, more consumers o Demand shifts to the right o Market price and quantity both increase o Producers increase their quantity supplied

Humans have market prices for their goods and services High market prices cause 1. Industries expand to the higher demand and price More suppliers enter the market Supply shifts right Market price falls The price drop depends on industry and its long-run cost 2. More products are supplied to market More resources are located and extracted More waste are generated 3. Spurs technological progress If many industries are expanding within a country, then we have economic growth Economic Growth

Macroeconomics

Gross Domestic Product (GDP) - the traditional measure of macroeconomic performance GDP is the sum of the money values of all final goods and services produced in a country during a year. Does not include sales of intermediate goods and services Only includes products and services produced within a country Does not include voluntary work Does not include degradation to the environment Does not include depletion of resources Depleting a stock of natural resources (e.g. oil, minerals, forests) increases GDP Used in production of goods and services Future generations could be hurt Less petroleum or no forests if they are cut down Economic growth -increases in GDP o Usually GDP per-capita output Per capita is per person A higher GDP per capita means each citizen has more goods and services Thus, population is important. o Picture below shows GDP percent-growth rate in 2007 Before the 2008 Financial Crisis
o

Derivation of a Growth Model o Total production of goods and services in a country are treated as one large production function for whole economy o Common in growth theory GDPt = f(A, Kt , Lt , Rt , Et)

Variables are o GDP at time t o A is autonomous growth Reflects technology, usually the intercept in a regression equation o K is capital o L is labor o E is for energy o R is for natural resources o Usually equation has E or R, but not both Petroleum or coal are resources that society derives energy from Is economic growth good or bad for the environment? o More growth means GDP is increasing o Requires more resources and energy o Technology can change A too, creating an offset! If government imposes restrictions on natural resources or energy use, then regulations put restrictions on natural resources, R, or energy, E.

Companies could adjust capital, K, or labor, L, but restrictions would most likely lower GDP growth o Technological progress could increase A also It is difficult to measure impacts of regulations on resources, environment, and GDP o Example o Government imposes a regulations to reduce air pollution in a city Causes higher costs People may be healthier Live longer, work harder, pay less money for medical problems, etc o Thus, regulations slow GDP down initially, but healthier people make GDP grow faster.
o

The Environmental Kuznet's Curve

Kuznet's curve is a hypothesized relationship between environmental degradation and income per capita. o The shape of the relationship is an upside down U-shape. 2 The shape is estimated as a quadratic, Et=f(GDP, GDP ), where E is pollution emissions at time t per capita and GDP per capita. When income per capita is low, a country does not invest in pollution abatement. As income per capita increases, a country invests in more pollution abatement.

Examples:

Society goes through transitions from agricultural to heavy industrial, which increase pollution. o Over time, heavy industrial is replaced with services and light industrial, which generates less pollution. o Environmental regulations can strengthen over time as country develops. o Higher income allows more investment in pollution equipment. o Country goes through deforestation and then afforestation. Criticism o Some pollution levels increase at a decreasing rate. Carbon dioxide emissions Technology reduces a car engine's CO2 emissions Higher incomes means more people buy cars o One possible reason for the problems of finding the Kuznet curve is the process of learning. As developed countries develop pollution abatement technologies, developing countries can implement these technologies at a faster rate, which give different estimates of the Kuznet curve. Latecomers had the advantage of learning from other nations' environmental policies. They learn what works and does not work This is a technological leader-follower model.
o

Japan's History of Environmental Policy


Early concerns about damage from copper mining arose in 1868 Government did not pay serious attention to the environment until after World War II. o United States helped re-develop their country National economic development was the central governments top priority. o Pollution was viewed as a local government problem. Rapid growth in the 1950s led to increases in pollution. 1958 o Japan had disease outbreaks from water pollution o The National Diet passed two water quality laws in 1958 The first laws at the national level. Before hosting the Tokyo Olympics in 1964 o International pressure to improve water quality in the Sumida River in Tokyo. o Japanese government created the Pollution Control Division of the Ministry of Health and Welfare (1964) and the Basic Law for Environmental Pollution Control (1967).

Recently, Japan has focus policy focus shifted to global issues. o Kyoto Protocol - reduce greenhouse gas emission to slow down global warming o Japan is now focusing on quality of life issues. Not mentioned o Since the early 1990s, the Japanese economy entered into two decades of sluggish growth Real estate prices are still dropping and economy has weak growth China's History of Environmental Policy

Mao Zedong declared in 1949 that pollution was a capitalist problem that did not exist in socialist countries. In 1972, water pollution began to attract the governments attention Environmental Protection Law passed in 1979. o The Constitution stated that protecting the environment was the responsibility of the state. o Polluters should be held responsible for pollution treatment, including a polluter pays fee system. Government has lack of resources Local governments focus on growth More factories, more jobs, more income, and more taxes Local governments opened illegal coal mines and built electric power plants without the national government's approval The Olympics were held in China in 2008 o China was embarrassed about the green water off of Shanghai o Some Olympiads wore gas mask in Beijing because of the high air pollution levels o Maybe the Chinese government will add more environmental laws The Developing World

The developing world o Have higher population growth rates o Moving from agrarian societies to industrialized societies, which results in more pollution. o Increasing urbanization People are moving to the cites, because that is where the jobs are Same thing in the United States and Kazakhstan Potential Problems

1. Urbanization - environmental problems become problems when people are close together, so that their actions affect others nearby. The infrastructure to support increased populations is lacking in many cities. Fresh water, collecting and treating waste water, solid waste disposal, etc. 2. Weak governance Not only are regulations often weaker, but the government may not enforcement compliance. 3. Corruption and lack of democracy are also problems. 4. Lack of information/education Educated people (in the United States) are pro-environment Encourage environmental regulations 5. Developing countries have wide spread poverty Leaders emphasize economic growth Place less weight on future considerations like environmental damage or resource depletion Developing countries may use less efficient technologies They could buy the old equipment and machines used in developed countries Less efficient machines use more energy and resources Benefits o If they become high-income societies, then they may invest in green technologies or replenish renewable resources o Population growth rate slows down o However, high-income societies use more resources and produce more pollution such as carbon dioxide. Leakages - not in many introductory courses o United States - environmental laws became too harsh Compliance costs were too high Some industries relocated to countries like Mexico and China Weak environmental laws Cheaper labor These industries pollute even more shipping their products to the United States High U.S. incomes are indirectly creating large amounts of pollution o I think this happened to Japan too Japan started to outsource the production of goods and services to other Asian countries.

Japan was big investors in other countries like China, South Korea, etc. Some countries activity seek out companies, trying to get them to invest in their economies Creates jobs, incomes, economic growth, and more tax revenue Lecture #2 - Growing Population and Economic Growth The Economic System Starting with Physics First Law of Thermodynamics - "The change in the internal energy of a closed thermodynamic system is equal to the sum of the amount of heat energy supplied to or removed from the system and the work done on or by the system." Energy is neither created or destroyed Second Law of Thermodynamics - "The total entropy of any isolated thermodynamic system always increases over time, approaching a maximum value." To do work, there has to be an energy difference. Entropy means energy differences equalize over time. Example - you place a hot cup of coffee on your desk. The room's temperature and coffee's temperature equalizes. The room is slightly, slightly warmer while the coffee is colder The energy is still there from the first law Economic activity like production, consumption, transportation, etc. all use energy and resources from the environment. Everything comes from the environment Examine the graph:

Humans extract resources and energy from the environment Humans use resources and energy to produce goods and services Then humans consume these products Each human activity generates wastes and energy that is returned to the environment Human activities could do the following: Resource depletion - humans extract more resources than can be replenished Example Humans extract water and supply it to cities Many cities are extracting more water than the amount being replenished by rainfall Pollution - human activities that degrade the environment or resource base Example Humans emit sulfur dioxide from burning of coal. The Sulfur dioxide turns into acid rain, which damages forests and lakes. Acid rain depletes minerals from the soil and raises the ph of water, killing the fish Environment does have a sink capacity Sink capacity - the environment can handle a level of pollution or waste with minimal impact.

Once the pollution or waste exceeds the sink capacity, then it damages the environment. What factors drives this model? Population growth - more people consume goods and services Demands for resources and energy increases More wastes and waste energy is produced Economic growth - society produces more goods and services Each person consumes more goods and services More wastes and waste energy is produced Be careful Technology and institutional arrangement impact the amount of resources, energy, and waste that humans produce Last 10 years, people in the United States recycle more Glass bottles, aluminum, paper, plastics, etc are recycled New institutions and arrangements had to be developed Bins and collection centers where people can dispose of their wastes Recycling centers that separates the types of waste Industries adjusting their production processes to include recycled materials New transportation vehicles for recycled wastes Traditionally, metals have always been recycled like copper Nobody throws away silver and gold Market prices exist for recycled materials Be careful! Recycled materials do not mean it is cheaper Costs money for recycling centers, sorting, machines, equipment, and transportation Some claim recycling makes products and services more expensive You have to compare the cost of recycling the material to extracting the material from the environment. High-income countries like United States and Europe are big recyclers More is said later in the Environmental Kuznet's Curve Population Growth More people put more pressure on the environment Primary energy consumption increased globally by 4.3% in 2004 As much as 60% of the global population depends on the waters of international fresh water systems

Rivers and lakes of which basins are shared by more than two countries Predicting fresh water shortages Could have more wars and conflicts over fresh water Graph below shows how fast the world's population is growing

The developed world is 75% urban The rate is accelerating in the developing world By 2030 urban population is expected to rise to five billion or 60% of the worlds population Sources - U.N. Population Division report World Urbanization Prospects: 2003 Revision; BP Statistical Review of World Energy June 2005; GEO Year Book 2006; WRI 2005 The prediction has a problem Population growth rate has been slowing and is shown below

Why is population slowing? Children are expensive in both money and time Developed countries have close to a zero population growth rate People delay having children Complete an education Accumulate assets like a house, car, etc. Much of the population growth is in developing countries HIV is impacting population growth rates in some African countries

Now we see why Mathusian ideas keep coming back

Population growth is taken as, Pt = Poert P is population, r is growth rate, and t is time Net growth is birth rate death rate Paul R. Ehrlich wrote The Population Bomb in 1968 A best seller Disastrous predictions for resources and environmental degradation Running out of petroleum Killing off all the fish (over harvesting) Many species are going extinct Biologist use a logistic growth function for species It is an upside down "U-Shape" Example - yeasts Add yeasts to a juice, wort (i.e. before beer is beer), or sugar solution The yeasts rapidly multiply, consuming the sugar Ethanol and carbon dioxide are waste products Eventually the yeast population reaches a peak and then population declines As ethanol reaches about 12%, the yeast dies in their wastes Many examples of this in biology Environment has a carrying capacity The level of population a natural resource base can sustain without depletion, whether is be humans or animals Once the population passes the threshold of the carrying capacity, then population declines. Population is depleting the resources More people consume more goods and services Economics Demand function - relationship between a market price and quantity demanded by the consumers Law of Demand - a higher market price means consumers reduce their quantity demanded Supply function - relationship between a market price and quantity supplied by the producers Law of Supply - a higher market price means producers want to increase their quantity supplied A market brings these two behaviors together Market price and quantity are shown below:

Market is stable If price is higher than market price of $2 Market has a surplus Producers are supplying more than what consumers want Producers lower the price until the price is $2 again If price is lower than market price of $2, Market has a shortage Consumers want more than what producers are supplying Producers raise the price until it is $2 Market has many assumptions Lectures 3 and 4 we will discuss market failures Why do some markets have a perpetually shortage or surplus? Government is intervening with the market price Why is demand and supply important? Higher population means more people, and thus, more consumers Demand shifts to the right Market price and quantity both increase Producers increase their quantity supplied

Humans have market prices for their goods and services High market prices cause Industries expand to the higher demand and price More suppliers enter the market Supply shifts right Market price falls The price drop depends on industry and its long-run cost More products are supplied to market More resources are located and extracted More waste are generated Spurs technological progress If many industries are expanding within a country, then we have economic growth Economic Growth Macroeconomics Gross Domestic Product (GDP) - the traditional measure of macroeconomic performance GDP is the sum of the money values of all final goods and services produced in a country during a year. Does not include sales of intermediate goods and services Only includes products and services produced within a country Does not include voluntary work Does not include degradation to the environment Does not include depletion of resources Depleting a stock of natural resources (e.g. oil, minerals, forests) increases GDP Used in production of goods and services Future generations could be hurt

Less petroleum or no forests if they are cut down Economic growth -increases in GDP Usually GDP per-capita output Per capita is per person A higher GDP per capita means each citizen has more goods and services Thus, population is important. Picture below shows GDP percent-growth rate in 2007 Before the 2008 Financial Crisis

Derivation of a Growth Model Total production of goods and services in a country are treated as one large production function for whole economy Common in growth theory GDPt = f(A, Kt , Lt , Rt , Et) Variables are GDP at time t A is autonomous growth Reflects technology, usually the intercept in a regression equation K is capital L is labor E is for energy R is for natural resources Usually equation has E or R, but not both Petroleum or coal are resources that society derives energy from

Is economic growth good or bad for the environment? More growth means GDP is increasing Requires more resources and energy Technology can change A too, creating an offset! If government imposes restrictions on natural resources or energy use, then regulations put restrictions on natural resources, R, or energy, E. Companies could adjust capital, K, or labor, L, but restrictions would most likely lower GDP growth Technological progress could increase A also It is difficult to measure impacts of regulations on resources, environment, and GDP Example Government imposes a regulations to reduce air pollution in a city Causes higher costs People may be healthier Live longer, work harder, pay less money for medical problems, etc Thus, regulations slow GDP down initially, but healthier people make GDP grow faster. The Environmental Kuznet's Curve Kuznet's curve is a hypothesized relationship between environmental degradation and income per capita. The shape of the relationship is an upside down U-shape. The shape is estimated as a quadratic, Et=f(GDP, GDP2), where E is pollution emissions at time t per capita and GDP per capita. When income per capita is low, a country does not invest in pollution abatement. As income per capita increases, a country invests in more pollution abatement.

Examples: Society goes through transitions from agricultural to heavy industrial, which increase pollution. Over time, heavy industrial is replaced with services and light industrial, which generates less pollution. Environmental regulations can strengthen over time as country develops. Higher income allows more investment in pollution equipment. Country goes through deforestation and then afforestation. Criticism Some pollution levels increase at a decreasing rate. Carbon dioxide emissions Technology reduces a car engine's CO2 emissions Higher incomes means more people buy cars One possible reason for the problems of finding the Kuznet curve is the process of learning. As developed countries develop pollution abatement technologies, developing countries can implement these technologies at a faster rate, which give different estimates of the Kuznet curve. Latecomers had the advantage of learning from other nations' environmental policies. They learn what works and does not work This is a technological leader-follower model. Japan's History of Environmental Policy Early concerns about damage from copper mining arose in 1868 Government did not pay serious attention to the environment until after World War II. United States helped re-develop their country

National economic development was the central governments top priority. Pollution was viewed as a local government problem. Rapid growth in the 1950s led to increases in pollution. 1958 Japan had disease outbreaks from water pollution The National Diet passed two water quality laws in 1958 The first laws at the national level. Before hosting the Tokyo Olympics in 1964 International pressure to improve water quality in the Sumida River in Tokyo. Japanese government created the Pollution Control Division of the Ministry of Health and Welfare (1964) and the Basic Law for Environmental Pollution Control (1967). Recently, Japan has focus policy focus shifted to global issues. Kyoto Protocol - reduce greenhouse gas emission to slow down global warming Japan is now focusing on quality of life issues. Not mentioned Since the early 1990s, the Japanese economy entered into two decades of sluggish growth Real estate prices are still dropping and economy has weak growth China's History of Environmental Policy Mao Zedong declared in 1949 that pollution was a capitalist problem that did not exist in socialist countries. In 1972, water pollution began to attract the governments attention Environmental Protection Law passed in 1979. The Constitution stated that protecting the environment was the responsibility of the state. Polluters should be held responsible for pollution treatment, including a polluter pays fee system. Government has lack of resources Local governments focus on growth More factories, more jobs, more income, and more taxes Local governments opened illegal coal mines and built electric power plants without the national government's approval The Olympics were held in China in 2008 China was embarrassed about the green water off of Shanghai

Some Olympiads wore gas mask in Beijing because of the high air pollution levels Maybe the Chinese government will add more environmental laws The Developing World The developing world Have higher population growth rates Moving from agrarian societies to industrialized societies, which results in more pollution. Increasing urbanization People are moving to the cites, because that is where the jobs are Same thing in the United States and Kazakhstan Potential Problems Urbanization - environmental problems become problems when people are close together, so that their actions affect others nearby. The infrastructure to support increased populations is lacking in many cities. Fresh water, collecting and treating waste water, solid waste disposal, etc. Weak governance Not only are regulations often weaker, but the government may not enforcement compliance. Corruption and lack of democracy are also problems. Lack of information/education Educated people (in the United States) are pro-environment Encourage environmental regulations Developing countries have wide spread poverty Leaders emphasize economic growth Place less weight on future considerations like environmental damage or resource depletion Developing countries may use less efficient technologies They could buy the old equipment and machines used in developed countries Less efficient machines use more energy and resources Benefits If they become high-income societies, then they may invest in green technologies or replenish renewable resources Population growth rate slows down However, high-income societies use more resources and produce more pollution such as carbon dioxide. Leakages - not in many introductory courses

United States - environmental laws became too harsh Compliance costs were too high Some industries relocated to countries like Mexico and China Weak environmental laws Cheaper labor These industries pollute even more shipping their products to the United States High U.S. incomes are indirectly creating large amounts of pollution I think this happened to Japan too Japan started to outsource the production of goods and services to other Asian countries. Japan was big investors in other countries like China, South Korea, etc. Some countries activity seek out companies, trying to get them to invest in their economies Creates jobs, incomes, economic growth, and more tax revenue This Page is an outdated, user-generated website brought to you by an archive.It was mirrored from Geocities at the end of October, 2009. For any questions about this page contact the respective author. To report any malicious content send the URL to oocities[at]gmail[dot]com. For any questions concerning the archive visit our main page:OoCities.org. The drought in Africa puts millions of people in danger to die of hunger. If we donate, then we can help saving lives.

Lectures #3 and #4 - Property Rights and Market Failure


Private Property Rights

Property rightsa bundle of entitlements o Describe an owners rights, privileges and limitations for use of a resource. o Government restricts use of private property o Example - land You own land in a neighborhood of one-story houses Zoning laws You cannot build a factory there You cannot build a 40-story skyscraper o Conflict between Government and the Public Endangered Species Act: - A U.S. federal law that protect threatened and endangered species by preserving their environment 5th Amendment to the Constitution - Government cannot take land without compensating the land owners If government finds an endangered species living on your property, then Owner has severe restrictions on their property The government took the property, because it severely limited the owners choices Government does not compensate to protect endangered species Private property regimes - individuals hold entitlement State-property regimes - governments own and control property. Common-property regimes - property is jointly owned and managed by a specific group. o They can exclude outsiders Open access regimes - no one owns or exercises control over the resources. Markets

Markets - bring buyers and sellers together o Creates harmony o Adam Smith - coined the phrase "The Invisible Hand" Free market of individuals acting in their own self interest leads to a socially-desirable result. o Market price communicates information to market participants If price is high, then suppliers could be earning profits

if suppliers are earning profits, then they should expand production If price is low, then suppliers could be earning losses if suppliers are earning loses, then they should contract production Profits and market prices direct resources to the most profitable industries Market requires many assumptions o Large number of buyers and sellers o Thus, market has the maximum social welfare Both consumers' and producer's surpluses are maximized Market price is $1.50

Market failure - something prevents the market to allocate resources efficiently o Example If a market has one buyer (i.e. monopsonist), then the buyer dictates the market price Walmart - the largest corporation in the United States strong arms its suppliers If a market has one seller (i.e. monopolist), then the seller dictates the market price A market failure implies wastefulness or economic inefficiency o Graph below shows reduced welfare Consumer surplus shrinks The demand function determines the market price Producer surplus - could expand Firms still in the market are selling for a higher price

Black triangle - Deadweight loss to market Trade has been reduced

Transaction costs - costs involved in making a transaction. o High transaction costs could prevent trade Include o Search and information o Bargaining and decision o Monitoring and enforcement o Transportation and setup Example - land transfers in the United States have high transaction costs o From 3% to 9% of value o A $100,000 house could have transaction costs up to $9,000 New York Stock Exchange has high setup costs, but once market is operating tends to be low cost. o Financial instruments are uniform and many participants Private goods - goods supplied by producers in private sector

Characteristics o Rivalry - if one person buys and consumes a product, then another cannot buy and consume that product If a person buys and drinks a Coca-cola, then another customer cannot consume that Coca-cola. o Excludable - producers can restrict consumption of their product to consumers who paid for it. A store can restrict its sell of Coca-cola to a paying customers. Two people are in the market.

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Each person has their demand function. The quantity denoted by q is for a person, while Q is the total market quantity. Likewise, demand by a consumer is denoted by d, while market demand is D. Market demand - at each market price, horizontally sum the quantity that each consumer buys.

Market Failures 1. Public Goods - the market under supplies public goods and over supplies public bads, like pollution (Knut Wicksell 1896).

Two conditions o Non-rival one person consuming and enjoying a good does not prevent another person from consuming that good. Marginal Cost = 0 o Non-excludable no person can be excluded from consuming that good. Free riders will consume public good, but not help pay for it Examples: o National defense (military) o Radio and television broadcast signals (FCC) o Clean air (EPA) o Stable monetary and financial environment Central bank - influences inflation, interest, and foreign exchange rates Examples o Air Pollution

Non-rival - one person or firm polluting the air does not prevent another from polluting the air Non-excludable - difficult to prevent people from polluting the air o Global Warming Substitute greenhouse gases for pollution Quasi-public goods - market could supply these goods, but the supply would not be enough o Highways o Libraries o Education o Sewage disposal o Postal service Could be perverse market conditions for public goods if supplied by private market o Rome had no fire department around 115 B.C. o Marcus Licinus Crassus - started a private fire department in Rome As a person house was burning down, Crassus would be negotiating a price for his services Crassus had market power One of the wealthiest Roman citizens Lindahl Price - a way to theoretically correct the market failure for public good o If we could ask people the price they would be willing to pay for public good o Then government charges each person his price (i.e. tax) o However, free riders may not truthfully reveal their preferences or willingness to pay o Not practical o Example If government supplies 100 units of a public good If people truthfully reveal willingness to pay Person A pays $50 for these units Person B pays $75 for these units Total price is $125 for public good o "Vertical summation"

2. Asymmetric information - either the buyer or seller has more information than the other side

Market may undersupply goods with severe asymmetric information problems Examples: o Credit card companies - calculating interest rates o Difficult to inspect good or seldom purchases the good from the same producer o Some firms will provide: low-quality defective even harmful goods Moral hazard - one of the parties to a contract change their behavior that imposes a cost on the other party

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A person gets car insurance and drives more crazy A person gets theft insurance for his apartment and he leave the door unlock o Government insures bank deposits through FDIC Banks may lend to more risky borrowers, because their depositors are protected from deposit insurance. o Financial institutions may invest in more risky assets, if they are certain government will bail them out. Adverse selection - one of the parties to a transaction withholds critical information o Usually people who buy insurance plan to use it o Person gets health insurance, knowing he has a medical condition o Person hires an arsonist to burn his business down after getting fire insurance o A person buys fire insurance, knowing he faulty wiring in his home o A person gets a credit card, knowing he will not make payments on it. Correcting asymmetric information Government Some forms may be illegal and prosecuted by government Weights and measures - government has inspectors that make sure gas pumps and supermarket scales are accurate Are you sure you if you pumped one gallon and it is truly one gallon Government sues producers that make false claims Regulations - government approves new products and has inspectors that inspect products Example - USDA has inspectors that frequently inspects meats Licenses - ensures professionals have a high level of competency Professionals like doctors, lawyers, mechanics, etc. need licenses to practice Private market Purchasing good regularly Brand names Franchises Product warranties Public information - Consumer Reports - magazine that examines consumer products Databases - companies compile information about customers and payment history
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3. Open access property - property owned by society or the absence of ownership.


Also called Tragedy of the Commons (Hardin 1968) Property rights are not well defined o Open access is nonexcludable but rivalrous o Outsiders cannot be excluded from using the property o Outsiders can consume the resource, leaving nothing behind People have less incentive to develop, improve, or maintain land, if others cannot be excluded from consuming it. Examples o Fishermen over fish in public waters. o Fishermen catch too many fish, causing fish populations to decrease to such a level that hurts future fish catching. o Companies dump wastes onto public lands or waters. o Air can be an open access resource. Some firms pollute and send pollution into the air Correcting this market failure o Allow one firm to control the resource The firm acts like a monopoly and develops the best plan to utilize that resource Monopoly may abuse that resource too Example - monopolist - owns rights to common land with a forest Monopolist cuts down all the trees if lumber prices are high o Government create a permit system Anyone harvesting or extracting the resource needs a permit Common property becomes private property Permit holders will monitor the resource against invaders and poachers Government has to monitor the permit holders to ensure they comply with the terms of the license 4. Externalities - The consumption or production of one individual or firm affects another persons utility or production without their consent.

The externality influences profits and utility, but does not impact market prices. Key - choice is not incorporated into the market price Therefore, an externality is not efficient (Arrow 1969).

(i) Positive externality - an individual's or firm's actions generate benefits for nonparticipating parties

The private market may not supply enough Supply function understates the true value of output o S is regular supply function and D is for demand o Society would desire a higher supply Social Marginal Costs (SMC) - the marginal cost function that is beneficial for the whole society

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Example 1 - Inoculation for diseases o Each person who gets an inoculation can prevent spread of a disease Example 2 - scientific knowledge or technological know-how Fixing positive externality Subsidies - government provides subsidies so producers will supply more Example - government grants subsidies to producers of vaccines Note - government could subsidize the consumer to take advantage of the externality Government provides the good Health departments give vaccines to the poor and elderly Government provides legal protection Patent - grants inventors exclusive right to producer their invention for 17 years in the United States Some countries may not honor patents (ii) Negative externality - an individual's or firm's choice or action negatively harms others without their consent

Property rights are not defined well Not all costs are registered, therefore supply function understates the true cost of production Example: A firm emitting pollution will typically not take into account the costs that its pollution imposes on others. o Market price is too low o Market quantity is too high o The goal is to have firms pay for pollution o The goal is not to set the pollution to zero! o The pollution is in excess of the 'socially efficient' level.

Correcting this market failure o Have a large list in next section o If negative externality is between two firms, gov. could be possible to merge both firms together Not likely Government seizure of property or aiding the growth of a monopoly Fixing Negative Externalities, like Pollution Also works for some open-access sources and some types of public goods 1. Prohibit or outlaw the pollution

Government makes the pollution illegal or shuts down industry Problems

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Creates job losses as industry shuts down. If industry that generates pollution has a strong demand, then black markets could develop. Government spends money to monitor, arrest, and incarcerate violators Industry relocates to another country and exports it back to the original country 2. Lawsuits - U.S. has a variety of laws that allow people to sue to address externalities

If firms know that they are creating negative externalities, they reduce negative externalities to reduce likelihood of being sued Firms compare marginal abatement cost to the marginal damage o By avoiding damage, the firm lowers its liability o Damage to the environment is very hard to estimate. Note that the government does not need to know the marginal costs of the firm in order to achieve the desired level of pollution. Problems o The burden of proof may be difficult in court. o Litigation is costly Large legal fees and damage awards o Need to know both who causes the harm and what the damages are. o Courts are slow o Renting seeking behavior encourage attorneys to sue for large legal fees and damage awards o Leakages manufacturing firms may flee to developing countries with weak environmental laws o Courts usually do not come up with comprehensive plans Rules are developed from a case-to-case basis 3. Command-and-control regulations (CAC) - government uses laws and regulations that dictate the standards and/or technology used to reduce pollution.

Government fines and penalizes companies that violate the rules. Government could permanently shut down a company for excessive violations U.S. has historically used command and control (CAC) policies o Why, when market-based environmental policies are more efficient? o Reasons 1. Environmental groups - firms shouldn't be able to buy the right to pollute Immoral to hurt the environment

2. Politicians prefer CAC because: Many are trained as lawyers. Created laws and regulations are their jobs The costs of CAC are less obvious The private firms bear most the costs 3. All firms are treated fairly (i) Types of command and control regulations 1. Ambient Standards - Regulates the amount of pollutant present in the surrounding (ambient) environment. o Government has sensors the measure pollution levels in an area o Examples: Parts per million (ppm) of dissolved oxygen in a river Sulfur dioxide (SO2) in an airshed o Measures are often an average over a 24 hour period or per year Concentrations vary by time of day and by season (e.g. due to changes in weather) o Note that the level itself cannot be directly enforced o Government tracks down the suspects, i.e. the polluting firms The firms have to develop a plan to reduce pollution 2. Emission standards - regulates the level of emissions allowed o Environmental Protection Agency (EPA) has links to sensors in electric power plants in the United States o The polluter may have freedom to choose the technology used o Examples Emissions rates (pounds of SO2 per hour) 3. Technology standards - require polluters to use certain technologies, practices, or techniques. o Examples Before 1990, electric utilities were required to install scrubbers with 90% efficiency ratings. Coal has trace amounts of sulfur The scrubbers removed SO2 from the exhaust o U.S. gov. requires catalytic converters in automobiles with gasoline Converts have platinum, which is expensive Reduces NOX emissions Oxides of Nitrogen, such as nitrous oxide (N2O) and nitrogen oxide (NO) (ii) Grandfathering of regulations- standards and regulations depend on the date the company starting using specific machines and equipment

The date a electric power plant started operating Newer units face more restrictive regulations. Older units are often exempt, i.e. grandfathered. o Grandfathering reduces resistance to the new regulations o Easier to pass regulations if they do not harm existing firms Could lead to more emissions in the short run o Companies use the older, less efficient equipment longer o New technology may be expensive Firms may reduce investment in new technologies or renovated an old plant or factory o If a firm upgrade or renovates its facilities, then the new regulations apply Potential for economic rent for existing firms o rent - unfair, long-run profits o firms with old equipment may have a cost advantage New firms may not enter the market o Creates a barrier to entry This protects monopolies o Higher investment costs to implement that regulations (iii) Problems with command and control regulations

Not efficient Freezes technology and limits firms flexibility U.S. government uses self-monitoring o Firms keep their own records on emissions, and are subject to surprise audits. Although regulations are set by the federal level, the local governments enforce the regulations. o Local government may be more concerned about creating jobs and expanding the tax base 4. Coase Theorem - disputing parties will work out a private agreement that is efficient

Named after Noble laureate Ronald Coase (1960) Externalities are reciprocal in nature o Not only does the pollution cause an externality, but also the presence of the victims harms the polluter o Pollution is not a problem if no one were harmed Polluting firms and the people that are harmed by the pollution can negotiate to reduce pollution.

Does not depend which party holds the property right. Example - a firm dumps pollution into a lake that kills the fish. 1. If the right to use the lake is given to the fishermen, then the polluting firm has to negotiate and compensate fisherman in order to pollute the lake 2. If the right is given to the polluting firm, then the fishermen will pay the firm not to pollute the lake. Benefits o Could work for small group of people o Private parties solve a pollution problem without the governments help Assumptions and Problems o Property rights are well defined Someone owns the resource o Need to be able to clearly establish who causes the harm. Some victims aren't well defined (e.g. endangered species) o Zero transaction costs Search and information Bargaining and decision Monitoring and enforcing o Perfect information o A court system enforces contracts without any costs. o Two parties (it is more difficult for large groups of people to agree about something). o No wealth effects. If ownership of the resource makes one party wealthier, then that party may be more resistant to bargaining. o More people will come to the problem if they are likely to be compensated.
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5. Market incentives - government uses price or quantity mechanisms to internalize the externalities.

Price incentives o Pollution taxes - government puts a price on pollution o Subsidies - government helps firms pay for pollution equipment Quantity rationing o Market permits - government requires firms to have a permit in order to pollute Government creates permits Firms may purchase or sell permits in a market

(i) Pigouvian Taxes - government places a tax directly on pollution.

Government imposes a tax for each unit of pollution that is emitted o Firms are supply too many units to the market Creating pollution o Government places a tax on pollution Taxes increase a firm's costs and reduces profits The Pigouvian tax works by internalizing the cost of the externality. Polluter incorporates the social cost of pollution. o Firms also have an incentive to develop new pollution control technology in order to avoid paying taxes o Government implements a tax on pollution, which puts a price on pollution Equilibrium price increases while quantity supplied decreases This is efficient because firm pays all costs including pollution Firms still pollute, but less Firms can pay the tax on pollution or avoid the tax by reducing pollution

Welfare effects o Usually taxes cause a deadweight loss on society o However, firms are polluting, which is harming the environment o It is like the environment is subsidizing the production o Shown in graph below Red triangle - shows up as consumer and producer surpluses, but represents damage to the environment Price is too low and quantity is too high

Yellow triangle - damage to environment; nobody benefits from this Quantity should be less than Q* It is not the price that damages the environment, but the quantity

Alternative method to show tax o Be careful of the scale o MB - as firms invest in more abatement equipment, the marginal benefits to the environment decreases o MC - as firms invest in more abatement equipment, its marginal costs increase o Gov. places a tax on pollution If there were no tax, firms would not invest in abatement equipment

1. 2. taxes.

Have to be careful how tax is placed o If tax is place on any else other than pollution, then perverse incentives could exist. o Example 1 - Gov. places tax on coal to reduce sulfur emissions. Utilities may use dirtier, cheaper coal to avoid tax and increase emissions. o Example 2 - Difficult to measure the actual emissions from cars Gov. taxes gasoline, then drivers reduce their mileage Gasoline consumption and emission are directly related Advantages o Gives firms more flexibility. o Firms may meet pollution objective with lower costs Problems o Piguovian taxes require massive amount of information to implement the tax correctly o Regressive taxes - placing a tax on an industry makes products more expensive The higher price may impact low-income families, because they spend more of their income on it. o Government may be more interested in the tax revenue than setting the correct tax rate Double-dividend debate o The Pigovian tax causes two things. The externality is corrected. The tax gives the government revenue, so it could reduce other distortionary

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Taxes distort markets, because market prices are higher and market quantities are lower. Empirical research indicates Pigovian taxes may also be distortionary (ii) Government can implement a subsidy

The opportunity cost of polluting is losing the subsidy. Government grants a subsidy to help a firm pay for a specific abatement technology. o The technology helps reduce pollution. Problems with subsidies o The polluter receives money from the government, rather than paying o New firms may enter market, so that total pollution increases o Need to raise taxes to pay for subsidies Taxes create distortions in the market Market price is higher and market quantity is lower. o Ethics - should we have to pay to avoid pollution? o Subsidies are often politically motivated, and can be difficult to remove when no longer needed. (iii) Market Permits - A transferable discharge permit places the maximum limit of pollution or concentration level that any firm is allowed to discharge into the environment.

Examples o Some electric generation plants use coal to generate electricity Some coal has sulfur that turns into sulfur dioxide when burned Sulfur dioxide leads to acid rain They have to buy sulfur dioxide permits o Proposing a permit system for mercury emission and greenhouse gases Government places the maximum amount of pollution that can be emitted o Also called cap and trade system o Each polluter has to buy a permit One permit allows firm to emit 10 metric tonnes of sulfur dioxide into atmosphere o Government creates enough permits, where Sum pollution levels in permits = maximum pollution level Quantity rationing Pigouvian tax - is price rationing The permit creates a market price of pollution. o Firms with high marginal abatement costs buy permits, so that they could pollute more

Firms with low marginal abatement costs sell permits, and pollute less. Firms with low abatement costs may be investing in new technology Government sets the max. pollution level o Firm 1 buys permits and pollutes more o Firm 2 abates pollution and can sell its permits o Marginal Social Costs (MSC) of pollution o Q bar is max. pollution level
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Thus, the permit market is efficient, because o Producers have to keep their pollution level at or below the amount specified in the permits. Used in sulfur dioxide emissions, quotas on fish harvesting, etc. Theoretically, you get the same result as a Pigouvian tax How are permits allocated o Government auctions permits - government sells permits to the highest bidder Auctioning permits gives government gets revenue from the permits. Plan appears as a "tax" o Grandfathering - government give permits to the firms Firms are less likely to resist the implementation of a permit system. How are permits distributed? Some firms are bigger than others, etc. Distribute permits relatively to their pollution levels

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Hybrid - government could give some of the permits freely and hold some back to auction off at the market Permits require the following to have low transaction costs o Homogeneous - all permits are identical o Perfectly divisible o Exchangeable -producers can buy and sell their permits without interference Market participants - can anyone buy the permits? o Environmental groups or private individuals could buy permits and retire them o Pollution is not released into atmosphere Benefits The permit is a right that can be sold or bought in a market. The permit creates a market price for pollution Gives firms more flexibility Firm may meet objective with lower costs Problems Regulators must have sufficient knowledge to design the market. Government has to monitor pollution levels Prevent illegal emissions or illegal dumping. Government may have higher enforcement costs Market-based policies may lead to localized "hot spots." Hot spots - a group of neighboring polluters buy permits to pollute more Concentrated area of pollution Does government set a maximum pollution level that applies forever Example - no more than 10 trillion tons of sulfur dioxide can be emitted into atmosphere Does government create new permits each year The price of market permits can "shoot" up quickly if government establishes a maximum pollution level forever. Hotelling's Rule - Covered in non-renewable resources Permit market may have few participants, because it is a specialized market A firm may have market power
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Lecture #5 - Pollution
Precautionary Principle 1. Precautionary Principle-there is much uncertainty about how much pollution is needed to damage the environmental resources and to what degree.

Thus, we do not know what our current choices impact the future - we should take a stance now to reduce the pollution. If we wait and see, then the environmental damage may not be correctable in the future.
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Examples

Global Warming - buildup of greenhouse gases in atmosphere Ozone depletion - certain chemicals destroy the ozone layer

Have a hole in the ozone layer above the South Pole Ozone prevents cosmic radiation from entering earth

Precautionary Principle relates to Safe Minimum Standard


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Safe Minimum Standard - society is unsure of future costs of current environmental degradation. If natural stocks like fish, mammals, etc dip below a critical level, then the resource may be irreversibly lost. Examples

Whales were close to extinction Certain fish and animals are becoming extinct

Problems - both Precautionary Principle and Safe Minimum Standard


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Has no cost-benefit analysis. Has three premises.


Loss of biodiversity may lead to large future losses. Future loss is uncertain. Intergenerational fairness is a social goal

How to weigh fairness with future generations?

How much say does the future get.

2. Cost-Benefit Analysis - Government should use cost-benefit analysis to evaluate public projects, environmental laws, or resource depletion.

Marginal benefit (MB) - the additional amount society benefits, if government supplies one more unit of a resource.
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Public goods - This is the total demand Negative slope Usually I drop MB and use D for demand for public goods

Marginal cost (MC) - the increase in cost to society, if government supplies one more unit of a resource
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Positive slope This is the supply for a public good Usually government assesses taxes on society to finance projects

Government maximizes society's return to a public good when MB = MC


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If MB > MC, government should increase one more unit of a public good If MB < MC, government should decrease a public good by one unit

Examples Government builds a new highway


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Benefits

Businesses and people benefit from the highway if people use it. Relieves congestion from surrounding roads and highways Creates construction jobs

Costs

Government pays construction companies to build highway Government has to assess taxes Opportunity costs

Land could be used for another activity

Construction companies could build something else

Government passes a tougher environmental law


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Benefits

Less pollution People and the environment may be healthier from less pollution

Cost

Firms are required to comply with law Firms' costs are higher

Cost-benefit analysis for public projects can be complicated. Easy to manipulate numbers. Government does not have to maximize society's well being.
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Another strategy is to maximize its finances. Maximize tax revenues and minimize government expenditures.

3. Uncertainty - impossible to describe the current state or predict future outcomes


Uncertainty presents a huge problem for the Precautionary Principle. Uncertainty - means is it immeasurable Risk is different from uncertainty
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Risk - values can be assigned to risk, usually probabilities Example - government requires firms in an industry to invest in a specific technology

Firm has two choices

Firm complies and invests in equipment

Marginal cost of compliance

Firm does not comply

Firm has a problem of getting caught


Has probability of getting caught Pays penalty

Has probability of not getting caught, then pays no penalty

Firm's marginal abatement costs become

marginal abatement costs = penalty for cheating * probability caught + MC of compliance

Government can force compliance by


Increasing probability of getting caught Increasing the penalty if caught

Uncertainty for environmental problems is highly non-linear


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Damages may be barely noticeable for low levels, but become severe above some uncertain threshold, or tipping point. Man should not go beyond the tipping point. Our world is too complex, we do not know where the tipping points are.

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4. Irreversibility - a process or choice that is not reversible


Goes with the Precautionary Principal Two types 1. Mankind's impact on the environment

A species goes extinct. Pollution kills all living organism in a lake Note - some environmental damage is reversible

A country cuts down its forests This country could replant its forests

Note - Global warming

Theoretically - it is possible to remove greenhouse gases out of atmosphere Plant more trees, use biofuels, etc.

2. Sunk Costs - historical costs that are not recoverable

Usually firm invests in capital like machines and equipment Government forces firms to install equipment to abatement pollution Economists - usually do not include sunk costs in cost-benefits analysis

Choice is already made and not recoverable, so why include it.

5. Long time horizons


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Economists use the discount rate.

Incorporate time value of money

Example

If you receive $1,000,000 in 100 years The interest rate is 10% Then you place a present value of $45.40 on it today You can put $45.40 into bank today and it will grow in $1 million at 10% interest rate

Use the exponential function for discounting


e-rt where r is discount rate and t is time continuous compounding is ert

Arbitrary to choose discount rate for environmental damage

Environmental damage can persist for centuries

Example

Country buries nuclear waste Causes $50 million in damage exactly in 200 years If a discount rate of 10% is chosen,

Value of damage today is $0.10

If a discount rate of 1% is chosen,

Value of damage today is $6.8 million

Environmentalists and alarmist choose low discount rates

Future generations probably would choose a low discount rate too, but their decisions are not known

Note - Environmental damage is viewed like a cash flow

I have environmental damage appearing out of no where and causing problems in exactly 200 years

Complications of Pollution 1. Pollution sources are defined as two types

Point source pollution - the pollution has an identifiable source


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Examples - Smoke stacks to factories and electric power plants Policies for reducing pollution from Lectures 3 and 4 work well with type

Command and control regulations Pigouvian taxes Subsidies Market permits Lawsuits

Nonpoint source pollution - pollution is emitted from many sources and it is extremely difficult to identify and monitor.
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Example

Soil erosion - farmers till the soil. The soil is loose, so rain may erode it. Fertilizer and other chemical runoffs - farmers use fertilizers and chemicals like pesticides

Rain dissolves the chemicals and they build up in lakes and rivers

Pollution emissions like CO2 from automobiles


United States has millions and millions of cars Usually large

Causes asymmetric information

Polluters have more information than government about their pollution Therefore, polluters can take advantage of asymmetry of knowledge and pollute more.

Correcting nonpoint source pollution

Prohibiting the use of certain production methods or require specific technology standards Easier to enforce than direct monitoring of emissions.

2. Pollution is defined as two types

Flow pollutant - pollutant that the environment can absorb.


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Only the amount that occurs at a specific point in time matters, like waste flowing into the river. The environmental damage may not change over time.

Stock pollutant - A pollutant that the environment cannot absorb. The level of the pollutant in the environment grows over time as the pollutant is accumulated.
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Example: CO2 emissions (take 200 years to decay). The damage to the environment grows over time.

3. Transboundary externality - pollution emissions in one country or several countries affect other countries without pollution problems.

Transboundary pollution
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Examples

Acid rain Global warming Polluted oceans and seas

Can be point source or nonpoint source


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Acid rain - point source emissions


Electric power plants burn coal to generate electricity Coal contains trace amounts of sulfur

Burning sulfur creates SOx emissions The SOx emissions drift north from the United States to Canada Sunlight converts the SOx into sulfuric acid Rain pours down taking the acid with it The acid dissolves and leeches minerals from the soil, killing the trees The Ph decreases in lakes and ponds, killing the fish and other life forms.

Global warming - nonpoint source emissions

Burning fossil fuels release carbon dioxide into the atmosphere, allowing the earth to trap more heat. It makes no difference where the carbon dioxide was emitted.

Countries enter into agreements with each other to fix pollution problems
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Montreal Protocol in CFC production Kyoto Protocol to fix greenhouse gase emissions at the 1991 level.

Problems
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Free rider problem - Game theory is extensively used in transboundary pollution problems. Prisoners dilemma Two countries: United States and Canada

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Enter agrees to reduce a mutual transboundary pollution

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If both countries choose tough environmental laws, their GDPs grow at 1% If one country has soft environmental laws and the other has tough, then industries with the weak laws have a cost advantage.

They can produce more output, increasing GDP They grow at 6%

If both countries have soft environmental laws, then their GDPs growth at 5%

They are producing too much pollution

United States choice is to choose between tough or soft environmental laws.


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The choices are the green ellipses The dominant strategy is to choose the soft environmental laws, given Canada has a choice.

The reason is GDP is larger

Canadas choice is to choose between tough or soft environmental laws.


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The choices are the red ellipses

The dominant strategy is to choose the soft environmental laws, given the United States has a choice.

The reason is GDP is larger

We should be at Cell A, but we always end up at Cell D

4. Interjurisdictional competition - local governments compete for resources, like citizens, companies, jobs, etc.

United States has three levels of government


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Federal State Local governments - county and city government

Each level can pass laws

If the federal government did not have national standards, would local government choose lower levels of environmental protection?
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Local governments compete to attract industry Local governments offer tax abatements, etc. Local government may lower environmental standards if it could

There is no empirical evidence on whether governments choose less than optimal levels of protection.

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Firms choose to locate in areas with lower control costs. These are likely to be areas with low initial levels of pollution. Firms in the United States

Moved from the North to the South

From the snow belt to the sun belt

Then moved to Mexico and then China Now, they are moving to Bangladesh

Industry may ask the federal government to take the lead


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Example - Automobile industry


U.S. automobile industry opposed federal emission standards for cars in 1960s States started to push for emission standards Then car industry pushed for federal standards, because it is easier to have one set of regulations from the federal government than 50 separate, but different regulations from the 50 states. California has passed tougher emission regulations for cars

California standard and the 49 state standard

State only has to meet the minimum standard of the federal government

States can choose to set tougher limits

5. The Porter Hypothesis - environmental regulations can increase a firm's competitiveness through innovation and new technology

Environmental regulations - causes technological progress that lowers costs and increases quality.
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Benefits of innovation can exceed the cost burden of regulation. Example

Robbins Company - EPA was going to shut down this company because it was discharging contaminated water

Used water to electroplate jewelry

Company engineers found a way to recycle the water The recycled water was cleaner than buying the water from the city government Company produced higher quality jewelry

Less jewelry were rejected

Company's water bill was greatly reduced

Does not mention how cost increased for purifying the water

Environmental Regulations:

1. Provide signals to companies about resource inefficiencies and areas for potential technological improvements. 2. 3. Companies gather information on pollution, increasing corporate awareness. Reduces uncertainty about investments to reduce pollution

Gov. is tells them to reduce the pollution

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Imposes costs and burdens on businesses that encourages innovation and progress. Levels the playing field
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All companies are subjected to the same regulations.

Criticism

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Regulations are costly, because of compliance costs. Theoretically, innovation offsets are possible, but there are many counter examples.

2. Competitive businesses actively search for profitable innovations and will not overlook profitable opportunities. 3. Have to examine the costs and benefits of environmental regulations

Specific Pollution Types 1. Sulfur Dioxide (SO2)

Acid rain - caused by sulfur dioxide (SO2) and nitrogen oxides (NOx).
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Comes from burning of fossil fuels

Coal contains sulfur

Car and truck exhaust contains NOx

Before the 1990, SO2 and NOx were only regulated as local pollutants.
o

Electric utility companies would build tall smokestacks that carried pollution high up into the atmosphere. It would not be a local problem

After 1990 government established a permit market for sulfur dioxide.


o

Point Source

1,493 electric power plants in the United States 1.991 trillion kilowatt-hours per year in 2006

Reduce SO2 emissions by 10 million tons.

Requires Continuous Emissions Monitoring Systems (CEMS) - power plants have to keep track of all their emissions 24 hours a day. Current price around $600 per ton Program is a success In 2007, total SO2 emissions were 8.9 million tons Far ahead of the 2020 goal

o o

Estimated cost savings over command and control regulation: $1 billion per year! Why?

1. 2. 3.

Flexible standards made using clean coal, rather than a scrubber, a viable option. Deregulation of railroads made it cheaper to transport low-sulfur coal across United States Technological innovation.

2. Ground-Level Ozone (O3)

When Ozone is near the ground, it is bad.


o

When it is high up on the atmosphere, then it is good.

Ground-level ozone has significant impact on respiratory health, crops, vegetation, soil, water, materials, animals, and visibility.
o

Health concerns for people with impaired respiratory systems

Ozone is highly reactive


o

Ozone will oxidize metals, except gold, platinum, and iridium

Ozone is not formed directly from car and truck exhaust


o

Ozone forms as sunlight hits air containing hydrocarbons and nitrogen oxides

Government policies
o o

A combination of nonpoint and point source Point source - reducing NOx emissions from power plants and industrial combustion sources 1. Introducing low-emission cars and trucks

Reduce NOx emissions from exhaust

2. Use "cleaner" fuels


Cities with ozone problems have to use reformulated gasoline Some components easily evaporate, especially during the summer Source of hydrocarbons Reformulated gasoline evaporates less easily, but it is more expensive.

3. Improving vehicle inspection programs.


Many states passed vehicle inspection programs for large cities Vehicle owners have their car emissions checked each year If it passes, then they get an inspection sticker on window If cars do not have inspection stickers, then police can pull them over and issue citations

Inspection stickers change color and appearance each year

3. The Montreal Protocol

Example of a successful international agreement.


o o

Signed in 1987 Phase-out the use, production, and exports of chlorofluorocarbons (CFCs)

Used as a coolant in refrigerators and air conditioners

CFCs destroy the ozone layer in upper atmosphere


o o o

Contains chlorine that destroys the ozone by turning it back into O2 Publicity surrounding the ozone hole over Antarctica provided public pressure. India and China did not sign until1990

A $260 million fund was established to help finance the transition to HCFC Wanted to reduce leakages - countries that did not sign would start producing CFCs

Why the Montreal Protocol was successful?


o

Most international agreements are not successful


Leakages Cheating

o o

Only six main companies produce CFCs, so monitoring simple. Clean technological substitutes have developed quickly.

This helped keep the costs of compliance low. One substitute, hydrochlorofluorocarbons (HCFC) also depletes the ozone layer, but at a slower rate.

It will be phased out by 2030

Note - both CFCs and HCFCs are greenhouse gases

The United States passed a tax on CFCs


o

Producers paid $1.37 per pound for CFCs in 1990

$5.35 per pound in 1995

The power to tax is the power to destroy


HCFC became relatively cheaper $10 per can

Additional Pollution Economics

1. Civic duty - people and firms may voluntarily reduce their pollution

Why do firms voluntarily reduce their pollution? Examples


o

General Electric's commitment to reduce CO2 emissions


GE's CEO thinks this will be profitable. GE hopes to be a technology leader if regulations are put in place.

British Petroleum (BP) is investing in green technologies

Solar panels at gas stations

Why? United States and Europe have a strong movement for "Being Green"
o

Allows firms to differentiate products


Some consumers are willing to pay a premium for 'green' products. Examples:

Dolphin-friendly tuna

Dolphin is smart and cute, and the tuna fish is not

Organic foods - uses no chemicals like pesticides and fertilizers

Preempting tougher regulation

Industry tries to act first before government passes tougher environmental laws

Investor pressure

"Green" investors may prefer socially responsible firms All investors may be concerned about liability from environmental pollution Example:

Chemical Manufacturers Association started 'Responsible Care Program' Started because of the 1984 Union Carbide storage tank leak in Bhopal, India.

42 tonnes of toxic methyl isocyanate (MIC) gas were released

Approximately 8,000-10,000 died within 72 hours 25,000 have since died from gas-related diseases.

All chemical companies became part of program

2. Tax codes could perpetuate environmental problems


Taxes can correct externalities, but can also exacerbate problems. United States
o

Percent depletion allowance - Oil and gas producers can deduct a fixed percentage of gross income each year.

This was established in 1909 to stimulate domestic production. Is it still needed? Repealing would save $900 million over five years.

Oil and gas companies can treat exploration and development as an expense, rather than depreciating over a number of years.

Repealing would save $17 billion over five years. Encourages greater extraction of virgin materials, discourages recycling.

Sport utility vehicle deduction

Businesses can deduct $25,000 of purchase of large vehicles (> 6,000 lbs or 2,727 kg) in the first year No expensing allowed for light vehicles. Originally intended for large equipment (e.g. construction) Repealing would save $700 million over five years.

The former Soviet Union and Eastern European countries implemented environmental taxes in the late 1970s and early 1980s.
o o o o

Create incentives for state owned enterprises to reduce emissions. Used complicated engineering formulas, not market based policies Could lead to odd results. Before 1999, Lithuania charged several million dollars per ton of SO2.

Not surprisingly, non-payment was an issue.

3. Two Firm Carbon Cap Model


One firm is an old plant with out-dated equipment and technology Therefore, firm has high marginal abatement costs. Trick - reverse the marginal cost function so it looks like a demand function Gov. is going to setup a permit system
o

This firm will buy permits

The other firm invests in new technology, and therefore has lower has lower abatement costs. The new plants low marginal abatement cost curve that goes left to right with abatement.
o

The firm supplies pollution permits

Firms engage in trade


o o

The vertical axis become the market price The quantity axis becomes the permits

Firms have an incentive to adopt new technology to reduce their marginal abatement costs.

4. Environmental Damage and Free Trade

Countries engage in free trade


o

Free trade may lead to more environmental damage

Modify supply and demand for a product that is imported


o

No free trade - market price and quantity are PD and QD

Importing a product
o

The world price is PW, QT is total amount consumed, and QD is amount produced domestically Small country case, where country does not influence the world price Yellow triangle is the gain from free trade

o o

Unfortunately the product causes environmental damage.


o

If producing the product causes environmental damage

Marginal Social Cost (MSC)

o o o

Free trade causes less environmental damage to importing country Environmental damage is shifted to exporting country The green trapezoid is the reduced environmental damage from importing

Benefit to importing country

Unfortunately, consuming the product causes environmental damage within the importing country
o

Country has a true marginal benefits function, D'

Equivalent to the MSC

The red trapezoid is the increased environmental damage from importing good

Cost-Benefit Analysis - Engage in free trade if the marginal benefits of free trade equal or exceed its marginal costs

Do not worry about the case for exports Do not memorize all the trade agreements!

This Page is an outdated, user-generated website brought to you by an archive.It was mirrored from Geocities at the end of October, 2009. For any questions about this page contact the respective author. To report any malicious content send the URL to oocities[at]gmail[dot]com. For any questions concerning the archive visit our main page:OoCities.org. The drought in Africa puts millions of people in danger to die of hunger. If we donate, then we can help saving lives.

The drought in Africa puts millions of people in danger to die of hunger. If we donate, then we can help saving lives. The drought in Africa puts millions of people in danger to die of hunger. If we donate, then we can help saving lives.

Lecture #6 - Global Warming Global Warming and Climate Change

Greenhouse effect - As these gases accumulate in the atmosphere, they trap infrared radiation (heat) that would otherwise escape into the earths atmosphere.
o o

The effect is natural. Without the greenhouse effect, the earths temperature would be -180C (-0.40F), rather than +150C (590F).

Global warming - greenhouse gases (made by man) are accumulating in the atmosphere, trapping more solar energy, and causing the world to become warmer through the greenhouse effect
o

Climate change comes from the impact of higher temperatures

Swedish scientist Svante Arrhenius


o

Proposed 100 years ago that man made greenhouse gases may enhance the greenhouse effect.

Evidence
o o

18 of 20 warmest years in last 100 were in last 20. Global mean sea level has risen between 10 and 25 cm (18 cm average) during the last 100 years. Since 1850, European Alps glaciers have lost 30-40% of surface area and half of their volume. Aerial surveys show that more than 11 cubic miles of ice is disappearing from the Greenland ice sheet annually Readings of infrared light from the earth's surface in 1970 and 1997 found less was escaping into space in 1997. Disappearances of species of frogs and toads Upward shifts in the ranges of mountain birds, and declines in lizard population. Ocean levels become higher as the polar ice caps melt Shrinkage of glaciers and sea ice

o o o o

Thawing of permafrost

Permafrost - in cold climates, the ground is always frozen through out the whole year

Earth is experiencing a warming trend Are greenhouse gases causing the world to be warmer or is this one of the earth's natural cycles?
o o

Global warming is a theory Sun is having a lot of activity


Spike in sun spot activity 17th century very few sun spot activity, which is called the mini-ice age

1960s the public was worried about an impending ice age

Slight cooling trend between 1930s and 1960s

Carbon dioxide is main greenhouse gas


o

Concentration level was 270-290 ppm for thousands of years before the Industrial Revolution By 1998, concentrations were at 365 PPM.

Parts per million (PPM)

The human activities may be increasing the growth

CO2 concentration from Mauna Loa Observatory, Hawaii

What percentage of (dry) air is composed of carbon dioxide?


o o o o

Dry air is: 78.08% nitrogen 20.95% oxygen 0.93% argon 0.038% carbon dioxide

Global Warming is probably a combination of sun and human activities Below is connection between temperature and CO2 concentration
o o

Predicting a 2.50 C increase in global temperature A difference of 30 C determines whether we go into an ice age or not.

Below is forecasted trend for temperature change in the troposphere


o o o

Boundary layer - from 0 to 1 km Troposphere - second layer from 1 km to 15 km Stratosphere - top layer from 15 km

Greenhouse Gases 1. Global Warming Potential (GWP) - 1 metric ton of carbon dioxide in the atmosphere traps a specific amount of the suns radiation

Carbon dioxide is always defined as a GWP of 1


o

Other greenhouse gases are compared to carbon dioxide

Note
o o

Many compounds break down over time Example methane has an initially high warming potential but drops over time as methane breaks down in atmosphere

Carbon dioxide is stable and persists for centuries

GWP is defined over a period of time, usually 100 years Greenhouse Gases Carbon dioxide (CO2) Methane (CH4) Global Warming Potential (GWP) 1 23

Nitrous Oxide (N2O) Sulfur Hexafluoride (SF6) Hydrofluorocarbons (HFCs) Chlorofluorocarbons (CFCs)

296 22,200 varies varies

Hydrochlorofluorocarbons (HCFCs) varies 2. Carbon dioxide (CO2)


CO2 contributes to 49% of greenhouse gases Sources


o o

Deforestation (because forests are carbon sinks) Fossil fuels


Electricity coal Transportation diesel and gasoline Heat natural gas and heating oil (i.e. diesel)

Animals, bacteria, and humans

Sinks - algae, plants and trees

3. Methane (CH4)

Methane contributes 18% of greenhouse gases Sources


o o

Industries Swamps, wetlands where anaerobic decay of organisms occurs

Anaerobic - without oxygen

Cattle enteric fermentation


Cows have two stomachs. The first stomach ferments grass into nutrients that the cow and use

Leakage from natural gas pipelines.

4. Nitrous Oxide (N2O)


Laughing gas / NOZ in racing cars Contributes to 6% of the greenhouse effect Sources
o o o o

Agricultural soil application of fertilizers Decaying of animal manure Sewage treatment Combustion of fossil fuels

5. Sulfur Hexafluoride (SF6)


Sources completely created by man High-voltage transformers and switchgears, magnesium smelting, and semiconductor manufacturing

6. Hydrofluorocarbons (HFCs) / Chlorofluorocarbons (CFCs) / Hydrochlorofluorocarbons (HCFCs)


Man made chemicals CFCs used as refrigerants for air conditioning and refrigerators HFCs various chemicals including refrigerants HCFCs - used as refrigerants, solvents, blowing agents for plastic foam manufacture, and fire extinguishers. Montreal Protocol developed countries stopped producing chlorofluorocarbons (CFCs)
o o

CFCs deplete the ozone layer, allowing more radiation to enter atmosphere Example car manufacturers switched from Freon (R) 12 to HFC 134a in air conditioners

134a is a greenhouse gas GWP is 1,430

7. Water vapor a greenhouse gas

Water is very efficient at absorbing and transferring heat energy


o

Water is used to cool car and diesel engines

Water (steam) is used in electric power plants to drive steam turbines

GWP is not calculated because water vapor is sensitive to temperature changes


o

Cold temperatures causes vapor to condense

Cost Benefit Analysis of Global Warming and Climate Change 1. World is too complicated

Feedback loops - global warming causes earth to be warmer but something changes that strengthens or weakens warming effect
o

Water vapor

Positive feedback - water vapor is a greenhouse gas that increases greenhouse effect Negative feedback - water absorbs energy to become vapor

Some of the sun's energy is used to change water's state

Clouds

Positive feedback - clouds absorb and re-radiates infrared light, increasing the greenhouse effect. Negative feedback - clouds prevent less sunlight from hitting the earth, reflecting sunrays back into outer space

Oceans

Positive feedback - warmer water releases its stored carbon dioxide, increasing greenhouse gases. Negative feedback - oceans can absorb heat, thus slow down global warming

Which effects dominate?

2. Estimating the Damages from Climate Change


How do you put a value on these events? How do separate the damage from global warming and earth's nature weather cycles Costs
o

Rising sea level increases loss of land area, including beaches and wetlands

o o

Loss of species and forest area, including coral reefs Disruption of water supplies to cities and agriculture

Ground water becomes contaminated with salt water

o o o

Health damage and deaths from heat waves and spread of tropical diseases Increased costs of air conditioning Loss of agricultural output due to drought

Benefits
o o o

Increased agricultural production in cold climates Lower heating costs Less deaths from exposure to cold

Less predictable but possibly more damaging effects, including:


o

Increase frequency of hurricanes and other extreme weather events

Hurricanes come in cycles

A possible rapid collapse of the Greenland and West Antarctic Ice Sheets, which would raise sea levels by 12 meters or more, drowning major coastal cities Sudden major climate changes, such as a shift in the Atlantic Gulf Stream, which could change the climate of Europe to that of Alaska

"The Day after Tomorrow"

Preventive measures:
o

Mitigation - reducing emissions of greenhouse gases


Use less fossil fuels. Install pollution control devices. More energy efficient technology

Sequester - something absorbs carbon dioxide and stores it


Forests, crops, and plants convert CO2 into oxygen Carbon is stored in the wood, roots, and plant structures

Even if wood is made into lumber, the carbon is still there

Re-Cycle - absorb carbon dioxide from atmosphere and re-lease it for energy

Biofuels

Liquid fuels - ethanol, butanol substitute for gasoline and biodiesel for diesel Biomass - burn wood and plants to generate bio-electricity Manure - burn manure to generate electricity

Manure releases methane as it decays

Adaptive measures include:

Construction of dikes and seawalls to protection against rising sea level and extreme weather events such as floods and hurricanes. Shifting cultivation patterns in agriculture to adapt to changed weather conditions in different areas, and relocating people away from low-lying coastal areas

Note - much more complicated in practice

Have to look at life-cycle emissions

Solar cells do not release greenhouse gas emissions when in operation

Releases a lot of greenhouse gases during manufacturing

Constructing a power plant, etc. with concrete

Concrete uses limestone, which releases a lot of carbon dioxide into the atmosphere

Policy Options 1. Greenhouse gases are a stock pollutant

If humans stop generating greenhouse gases, then the amount we put up there is still there.
o o o

Economics - many policies just have firms and people pay for generating externality Internalizing the cost of the externality Thus, they would still producing greenhouse gases.

All policies that reduce greenhouse gases would increase market prices and lower market quantities Thus, policies may not slow down global warming

Developing countries argue that they should not have to limit their emissions
o o

Limited emissions may limit growth Should developed countries compensate the undeveloped ones to reduce greenhouse gas emissions Developed countries already used fossil fuels to develop a rich society

Environmental Kuznet's Curve

United States
o o o

Has 5% of world's population Emits 25% of world's CO2 emissions USA is world's biggest emitter

China is currently the second largest emitter


o o

Expected to over take the United State Dutch Scientists already said it happened.

Decreasing greenhouse gas emissions depend on future technologies


o

Especially in technologies where carbon dioxide is abated, sequestered, or recycled

2. Appeal to peoples civic duty


Green energy costs more than standard fossil fuels People invest in green technologies even though they are more expensive Example
o o o o

Homeowner invests in solar panels for home Supplements 500 watts of power during the day time Electricity from the grid costs $0.08 per KWH Electricity from solar panels costs $0.20 per KWH

Thus, homeowner places a $0.12 per KWH implicit price on protecting the environment

Benefits
o o

Environment would benefit as the public invests in green technologies Private parties solve an externality without the governments help

Problem
o o o

People lose sight of the big picture People may desire to help the environment However, people tend to always buy at the lowest price, ignoring long term impacts

3. Lawsuits - U.S. has a variety of laws that allow people to sue that address externalities

If firms know that they are creating greenhouse gases (or pollution), they reduce emissions in order to reduce likelihood of being sued Problems
o o

Courts are slow Renting seeking behavior encourage attorneys to sue for large legal fees and damage awards Leakages manufacturing firms may flee to developing countries with weak environmental laws Courts usually do not come up with comprehensive plans Rules are developed from a case-to-case basis

o o

Lawsuit Example
o o o o

Clean Air Act of 1990 Gives EPA the authority to regulate 189 toxic chemicals EPA specifies (or mandates) how businesses and companies lower pollution Massachusetts vs. EPA several states sued the EPA because they believe they will lose coastlines in a 100 years from now The EPA lost and has to add greenhouse gases on to the list of pollutants

Thus, the EPA was given vast authority to regulate every facet of American society

4. Command-and-control regulations - government uses laws and regulations that dictate the standards and technology used to reduce greenhouse gases

Government imposes the technology and machines that an industry uses Government fines and penalizes companies that violate the rules Benefits
o o

Government easily enforces the rules Lower greenhouse gas emissions

Problems
o o o o o o

Regulations limit a firms flexibility and freezes technology Firms may not produce at minimum costs Bureaucrats have a tendency to perpetually change the rules May encourage violators Gov. could have a large cost to monitor, prosecute, and punish violators Encourages leakages

5. Market incentives - government uses price and quantity mechanisms to internalize the externalities

Price incentives Greenhouse gas tax - puts a price on greenhouse gas emissions
o

A firm emitting greenhouse gases pays the tax or abates by using technology to reduce emissions

Subsidies
o o

Firms planting trees (sequestering carbon) Public uses biofuels to recycle carbon from atmosphere

Global warming potential (GWP) is used as an exchange rate If the tax is $100 per metric ton of carbon dioxide emissions, then firms pay $2.220 million to emit 1 metric ton of sulfur hexafluoride
o

Sulfur hexafluoride has a GWP of 22,200

Quantity incentives Cap and trade system gov. places the maximum limit on amount of greenhouse gases that can be emitted Gov. creates tradable permits
o o

Quantities specified within the permits add up to the limit of greenhouse gases Gov. auctions or gives permits to greenhouse gas emitters

Use global warming potential (GWP) as an exchange rate for different gases
o

Allow producers to create permits if they abate / sequester / recycle greenhouse gases

Create a market for tradable permits Market incentives give firms more flexibility
o o o o

Some firms will invest in technology to reduce greenhouse gases These firms could sell their permits to other emitters Some firms will choose to emit and buy the permits Firms may meet pollution objectives with the lowest costs

Benefits
o

Gov. dictates level of greenhouse emission, firms are given the flexibility in how to meet objectives Emitting greenhouse gases becomes a property right Permits and taxes put a price on emissions Possibly a subsidy on abatement, sequestration, and carbon recycling Gov. collects revenue

o o o o

Problems
o o o o

Imposes higher enforcement costs on government Greenhouse gases have many sources Will gov. allow some sources to be exempt? Gov. may be more interested in tax revenue or revenue from auctioned permits

Kyoto Protocol 1. Kyoto Protocol - an international agreement that attempts to stabilize greenhouse gas buildup in the atmosphere

Kyoto was adopted on December 11, 1997 in Kyoto, Japan WhY? Transboundary pollution - all countries are producing greenhouse gases
o

For people to reduce greenhouse gas emissions, then all countries have to organize and develop a uniform policy This prevents leakages

Kyoto Protocol is the first attempt


o o

183 Countries signed the agreement Gives countries flexibility in how to meet emissions

Permits, command and control regulations, etc.

o o

United States signed but did not ratify agreement 13 countries did not sign, including China

China surpassed the United States as a major greenhouse gas emitter

India did sign the Kyoto Protocol


India introduced the $2,000 car The developing countries want the Western living standard

The agreement only forces countries to reduce emissions 5.2% below a countrys 1990 emission level
o

Even if all countries signed the Kyoto Protocol, our net greenhouse gas emissions are still increasing Kyoto Protocol does not prevent global warming

Kyoto Protocol entered into full force on February 16, 2005


o o

European Union reduces emissions by 8% United States reduces by 7%

o o o o

Japan reduces 6% Russia reduces by 0% Australia can increase emissions by 8% Iceland can increase emissions by 10%

United States signed, but did not ratify it.


o o o o

Why? Economic growth! President Bush set a goal of reducing greenhouse gas intensity by 18% Illusion

Greenhouse gases are still increasing Greenhouse gas intensity is the ratio between greenhouse gas emissions and GDP Using more efficient technology decreases greenhouse gas emissions relative to GDP Although economy is bigger (i.e. GDP), greenhouse gas emissions are still increasing, but the ratio (i.e. intensity) is decreasing.

This was already happening without President Bush

Countries are supposed to reduce emissions to below 1990 level

Some complained about former Soviet Union countries


o o o

Many former Soviet Union countries are under their 1990 levels and have room to grow Russia President Putin signed Kyoto in 2004

The following opposed Kyoto: Russian Academy of Sciences, Ministry for Industry and Energy, and economic adviser, Andrey Illarionov Politics - Europe supported Russia admission to the World Trade Organization (WTO)

Penalties

If a country does not comply, then they have to make up the difference plus an additional 30% Kyoto has weak enforcement

What if country does not comply?

2. The European Union Emissions Trading Scheme (EU-ETS)

Each country gets allowances based on its national cap in Kyoto.


o

Specific industries will participate in trading


electric utilities oil refineries coke ovens iron & steel cement kilns glass manufacturing ceramics manufacturing the pulp and paper industry

If a company is going to exceed its greenhouse gas emissions


o o o

It buy carbon credits from the market Or has to abate its emissions Possible for international permits

One country that cannot meet emission levels can buy credits for countries who are below their emission levels. Theoretically possible - one country plants a forest. Trees sequester carbon dioxide from atmosphere and earn carbon credits. Credits can be sold to a factory in China that is emitting greenhouse gases.

European Countries - to generous in passing out permits


o

Countries have incentives to give more allowances to industries that trade goods, so that they do not have a competitive disadvantage with firms from other countries

Has not been effective in reducing carbon dioxide


2005, permit's price was 30 per ton 2006, permit's price was under 10 per ton 2007 permit's price was under 1 per ton

3. Comparison of the U.S. SO2 program and the EU CO2 trading program (EU-ETS)

European Union program is larger


o

Around 11,500 sources, compared to about 3,000 for U.S. SO2 market

E.U. program decentralized


o o o o

Individual countries have jurisdiction Value of allowances higher Worth around $41 billion, compared to about $5 billion worth of SO2 permits. However, required reductions much greater for U.S.

SO2 permits call for 50% reduction from baseline, compared to just a few percent reduction for E.U. SO2 was a pollutant that had been controlled before, so there was experience with abatement costs.

This Page is an outdated, user-generated website brought to you by an archive.It was mirrored from Geocities at the end of October, 2009. For any questions about this page contact the respective author. To report any malicious content send the URL to oocities[at]gmail[dot]com. For any questions concerning the archive visit our main page:OoCities.org. ...possible rude language detected. Read at your sole discretion.

Lecture #8 - Nonrenewable Resources Hotelling's Rule 1. Non Renewable Resource - once the resource is used, it cannot be replenished; its gone forever.

Three classifications of exhaustible resources:

1.

Current reserves - known reserves that can be profitably extracted at current prices. Potential reserves - reserves that could be recovered at higher prices. Resource endowment - the entire geological supply of resources (including those not yet discovered).

2. 3.

The problem is scientists and companies are not 100% certain how much reserves are in the ground Engineers define the following: 1. Proven reserves - have at least 90% or 95% certainty of containing the amount specified. 2. Probable reserves have an intended probability of 50% 3. Possible reserves have an intended probability of 5% or 10%

Current technology is capable of extracting about 40% of the oil from most wells.
o

Some say future technology will make higher extraction possible, but this is already included Proven and Probable reserve numbers.

Companies have incentives to overstate their proven reserves


o o

Oil companies want to improve their financial statements and their potential net worth Producing countries gain a stronger international stature.

Other countries will be nicer to them.

o o

Governments of consumer countries give false security and stability to their citizens. In 2004 Shell Corporation had a scandal, where 20% of its reserves evaporated

BP's estimate of a country's Proved Petroleum Reserves as of 2009

2009 Country 1. Saudi Arabia 2. Iran

Non-OPEC OPEC (Billions of barrels) (Billions of barrels) 264.209 138.400

3. Iraq 4. Kuwait 5. United Arab Emirates 6. Venezuela 7. Russia 8. Libya 9. Kazakhstan 10. Nigeria 11. United States 12. Canada 13. Qatar 14. China 15. Brazil 16. Algeria 17. Mexico

115.000 101.500 97.800 87.035 79.432 41.464 39.828 36.220 30.460 27.664 27.436 15.493 12.624 12.270 12.187

Resource depletion
o o o

Mathematical analysis is much more complicated Extraction involves dynamic decisions As resource is extract, then less can be extracted in the future

The present and future are tied together

Costs of Extraction
o

Extraction cost - the cost to remove resource out of ground, process it, and transport it to the market

Producers extract when P >= Marginal Extraction Cost (MEC)

If MEC = $60 to extract oil out of Alaska

Producers shut down production when petroleum price drops below $60 Producers extract oil when price equals or exceeds $60

User cost - the opportunity cost of not having the resource to sell in the future

The owner of a resource has two sources of money for next year:

Sell all the oil now, and invest the profits at interest rate, i. Wait and sell the oil next year.

The price of the resource has to be greater than the MEC, because of user cost

Proof

Called intertemporal arbitrage Case A: Expected price next year rises less than the rate of interest:

The owner of the resource is better off selling the oil now and investing it. Leads to lower prices now (greater supply) and higher prices next year (lower supply).

Case B: Expected price next year rises faster than the rate of interest:

The owner of the oil is better off waiting to sell the oil next year. Leads to higher prices now (lower supply) and lower prices next year (higher supply)

By using this arbitrage, the petroleum companies cause petroleum prices to increase at the rate of interest

Profit maximization
o o

Farmer: Choose output where p = MR = MC Miner: Choose output where p = MEC + user costs (i.e. rent)

Miner: rent = P - MEC Still assuming it is a competitive industry

Similar to a monopoly

Market price is higher, and thus, market quantity is lower Miners could earn long run profits, called rent

Hotelling rent - profit created by a resource scarcity in a competitive market, because the resource is fixed in nature Also called Ricardian rent, resource rent, and user costs

2. Hotelling's Rule

In Year 0, the firm starts extracting a depletable resource


o

The market price and quantity are P* and Q*

In Year 1, the firm extracts less resources, because some of it has been used up
o o

The supply function decreases The market price is higher and market quantity is lower

In Year 2, the firm again extracts less resources


o o

Supply function decreases The market price becomes higher and market quantity is lower

Thus, market prices should continuously increase for a depletable resource


o o

The higher prices are not evidence of abuse of market power. The higher prices represent economic rent due to scarcity.

3. Marginal Extraction Costs (MEC) should increase over time as petroleum and ores are depleted

Producers will extract the highest-quality ores first. As the high quality ores are depleted, then producers start to mine the less pure ores The MEC should increase over time
o o o o

Energy cost to extract may increase Higher cost to process the metal May create more toxic waste Example 1 - Petroleum

Heavy crude oil, oil sands, and oil shale are not included in oil reserves Producers can uses these petroleum sources

They contain more sulfur and heavy metals Higher costs to extract this crap out Produces more greenhouse gas emissions

May be as three times as much as regular petroleum

Example 2- Gold mining in Nevada


Produces 6 million ounces per year (82% of the supply within the United States) Uses open pit mining and cyanide heap leaching recovery

Producers dig out large pits Then they form large mounds They spray it with cyanide that dissolves the gold Collect the leeched residue and recover the gold

Our present mining operations have left a legacy of scarred earth and polluted water how will we deal with future higher-impact requirements? Thus, market price for minerals have to increase for companies to extract lower quality ores.

4. Problems with Hotelling's Rule


The empirical evidence is mixed for Hotelling's Rule Hotelling's Rule ignores three factors 1. Technological improvements cause marginal extraction costs to fall over time

A competitive industry passes the lower costs to the consumers as a lower price

2. Hotellings prices depend on the petroleum reserves being known and fixed

Then petroleum extraction is based on intertemporal arbitrage. Petroleum companies do not know the location of all reserves.

Petroleum companies have a strong incentive to explore and drill for new petroleum reserves, when petroleum prices are high High petroleum prices

Companies are exploring where extraction is much more expensive Extremely deep wells Extreme downhole temperatures Environmentally sensitive areas Allow extraction from the deep waters of the Gulf of Mexico or the cold Alaskan climate.

3. Demand for petroleum can change

As petroleum price increases, consumers reduce quantity demanded for petroleum products

High fuel prices cause consumers to reduce their demand


Conserve Law of Demand

Consumers buy more fuel efficient cars Consumers move closer to work

Consumers can greatly decrease their consumption of fossil fuels when market prices are high in the long run

Hubbert's Life Cycle Hypothesis or Peak Oil M. King Hubbert - a petroleum engineer

Petroleum prices, petroleum extraction, and well productivity should be parabola shaped
o

Violates Hotellings rule.

When the petroleum industry was young and expanding its infrastructure, petroleum companies discovered and developed new large petroleum reserves
o

Market price is initially high but falls once companies get the infrastructure in.

As discoveries become rarer and smaller, and petroleum depletion caused marginal extraction costs to increase, then petroleum prices exhibit scarcity and begin to increase over time. Below is U.S. Petroleum Production.

Oil depletion - when production of petroleum begins to decline


o

The declining portion of the u-shaped production curve

U.S. peaked in 1969


o o

Hubbert (1959) underestimated the U.S. oil production peak by 10 years. Why?

Technology - companies became better at extracting oil


Companies also become better at locating new reserves Companies can drill deeper, etc.

Many believe the world's petroleum production peaked in 2005 / 2006


o o o o

Out of the largest 21 petroleum fields, at least 9 are in decline Saudi Arabia admitted its mature fields are now declining at a rate of 8% per year Kuwait - the Burgan field, second largest in the world, is in decline since November 2005 Be careful

Many countries nationalize their petroleum production industries All OPEC members - government owns the petroleum resource Incentive to keep production low and market prices high Firms maximize profits Political organizations do crazy things which may not maximize profits

I think this is the refinery's acquisition of oil


o

The dollars have been converted to real


Nominal - measured in U.S. dollars Real - remove the effect of inflation

A price increase may be from stronger demand or smaller supply

In 2005, petroleum prices dramatically shot up


o

China and India are developing

o o o

China has some petroleum resources India has to import most of its petroleum needs As these two economies develop, they can put upward pressure on demand for petroleum

U.S. dollar was depreciating against the Euro and other strong currencies
o o o o

Petroleum producing nations want to be paid in non-U.S. dollars Euro plunged in value during the 2008 Financial Crisis Some countries are worried about the U.S. to pay its $10 trillion debt Some countries are trying to move away from the U.S. dollar to another currency or commodity

Many of the large and easy fields have been exploited


o o

Petroleum companies have to drill deeper and develop drills from smaller reserves Some claim that the U.S. outer continental shelf holds an estimated 100 billion barrels of oil and natural gas

Located in the deep waters of the Gulf of Mexico

As the petroleum reserves are depleted, wellhead pressure decreases and crude oil viscosity increases, increasing marginal extraction costs Gold is another depletable resource
o

More is said about gold in Lecture 9

Gold can be recycled

o o o

The monthly gold price is below This is nominal and has not been adjusted for inflation Again, not obeying Hotelling's Rule

Silver is another depletable resource


o

More is said about silver in Lecture # 9

Silver can be recycled too

o o

The nominal monthly sliver price is below Again, price of silver is not obeying Hotelling's Rule

Monopolies 1. Pure monopoly - a firm is sole producer / supplier of a product in the market

Usually mineral and petroleum extraction and energy generation are dominated by very large corporations Characteristics 1. Single seller of a product

The demand for the monopolist's product is the market demand curve A one firm industry

2. No close substitutes for the product

You either buy the product from him or you don't

3. A monopolist can exert control over the price

He decreases production level and market price increases

4. Other firms are prevented from entering the market, because of high barriers

No competition

Market Entry Barriers - Prevent entry of competitors into the market


o

Economies of scale - also called a natural monopoly - monopoly has to be large to obtain low per-unit cost.

Firm has very large fixed costs A new firm entering this market would need substantial amounts of capital to reach this low-cost production level Monopoly usually supplies the whole market. Examples: Local phone service, electricity, natural gas, petroleum, and mining companies

Requires large amount of equipment & infrastructure

Legal Barriers - government's rules or regulations create an entry barrier

Government usually nationalize the important minerals and petroleum industries Government owns the companies directly or indirectly

A firm controls an essential resource

Example: Before World War II


Aluminum Company of America (Alcoa) controlled the supply of bauxite Other firms could not produce aluminum cheaply without bauxite.

Example: DeBeers Corporation of South Africa.


Controlled 80 to 85% of the world's supply of diamonds Currently controls approximately 55% of market "Diamond is forever."

Unfair competition:

Example: Standard Oil - John Rockefeller.


Came into a small town and charge a price below cost. Drove competitors out of business.

Standard Oil would buy these businesses for cents on the dollar and consolidate them into Standard Oil. With no competition, Standard Oil charged monopoly prices. Controlled 90% of U.S. oil market.

2. Price and output under monopoly

Profits are maximized at MR = MC


o o

Monopolists expand output when MR > MC Monopolists contract output when MC > MR

Unregulated monopolist: Market price, P* and production level, Q*


o o o o

P* > C*, therefore monopolist earns economic profits High entry barriers prevent competition Monopolist earns long-run profits Market barriers prevents competition

Monopolist does not have a supply function


o

Monopolist produces at MC =MR, which is one point

P* > MR

Monopolist has lower social welfare than a competitive market


Monopolistic market has higher price and lower quantity Consumer surplus is transferred from consumers to monopolist as profits

A Monopolist Price, Per-unit costs

Quantity

If the market was competitive, then the market price would be lower and the market quantity would be higher
o o

Shown by the bars Remember - purely competitive firms set the P = MR = MC

A monopolist conserves depletable natural resources


o o

He extracts less over time than the pure competitive market Higher market prices force consumers to conserve more of the resource too.

Shown below: A Monopolist Price, Per-unit costs

Quantity 3. Why are monopolies bad? Not only does this list apply to monopolies in the private market, but also includes government that has monopolies over certain services.

Little competition limits the options to consumers


o

You either buy the product from the monopolist or you go without

Reduced competition results in allocative inefficiency


o

Allocative efficiency is when P = MC

Only purely competitive markets are allocative efficient

Consumers value the products more highly than what it costs to produce them

P* > MC Firms are earning economic profits

Consumers are not able to direct monopolies to serve their interests


o o

Bad service No incentive to improve products, etc.

X-Inefficiency - firms or agencies may not produce at low cost


o o

lack of competition no incentive to minimize costs o mismanagement

o o

poorly motivated workers X-Inefficiency - may be worse with government organizations because they can be much larger

Monopoly power may encourage rent seeking behavior


o

Rent seeking behavior - government officials take cash & assets from private companies & people Russia:

Companies bribe public officials, then officials grant licenses to those businesses, restricting competition.

U.S.

Corporations funnel campaign money to Congressmen Congress passes laws favorable to corporations

Backstop Technology Backstop technology means - resource is a perfect substitute for another natural resource, but has a higher cost.

Price may have to increase to a high enough level Makes the alternative resource feasible.
o

The alternative resource may have higher extraction costs or requires expensive technology. Example 1: Oil from shale rock

If petroleum price becomes too high, then someone invents new technology that allows petroleum to be extracted from shale rock

Example 2: Solar panels

If the price of electricity becomes high enough, then people supplement their electricity demand with solar panels.

Example 3: Pyrolysis and liquefraction

Use heat and pressure to convert organic substances like vegetable oils and crop residues into crude oil.

Supply and demand are shown for a depletable resource

If the market price equals or exceed PB, then everyone switches to the backstop technology

Market demand would go to zero for this resource

This analysis has one flaw At the backstop technology price, PB, enough of the backstop technology has to be supplied in sufficient quantities to the market
o

The supply function for the backstop technology has to be perfectly elastic supply, i.e. flat

Hotelling model
o

Resource price grows at the constant interest rate as supply function decreases each year. If there is no backstop technology, then the resource extraction is driven to zero. With backstop technology, at the switching point, the shadow price has to equal zero for the resource and extraction stops.

o o

The resource may not be exhausted.

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