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It is concerned with the efficient allocation of environmental resources. The environment provides both a direct value as well as raw material intended for economic activity, thus making the environment and the economy interdependent. For that reason, the way in which the economy is managed has an impact on the environment which, in turn, affects both welfare and the performance of the economy. It would therefore be in order if we first define its parent discipline. Economics is a social science that deals with the explanation and prediction of economic behaviour of rational individual or other economic decision making entities. Economic behaviour is revealed in terms of choices that people or group of people made. So, economics is called a science of making choices. It is the science which studies human behaviour as a relationship between ends and means which have alternative uses. In brief, it is the multiplicity of ends and limited availability of resources that give rise to the problem of choice. Environmental economics deals with the application of the principles of economics to study why and how human beings interact with their environment the way they do, how they use and manage the environmental resources, and what are the impacts of human activities on environment. It draws from all sub-disciplines of economics such as microeconomics, macroeconomics, and welfare economics, as well as, from natural science, including environmental science. It attempts to explain the economic aspects of attitudes and behaviour of people with regard to natural environment. It is also concerned with how economic institutions and polices can be changed to bring the environmental impacts of human activities into balance with human desires and the needs of ecosystems. Several economic concepts and tools such as marginalism, consumer surplus, producer’s surplus, and opportunity cost, externalities, subsidies, taxes, social welfare, Pareto optimality and cost-benefit analysis have relevance and applications in analyzing environmental problems. Environmental economics deals with economic aspects of interdependence and interaction between human being and the environment. Since many environmental assets, goods and services have no markets and hence either have no prices or have prices that are distorted; most environmental problems could be considered as problems of nonoptimal pricing. In other words, environmental problems arise either due to non-existence or failure of market. Environmental economics deals with non-market goods, amenities and services provided by Mother Nature. The definition of environmental economics as a discipline dealing with the relationship between economic activities and environment focuses attention on economic development and its effects on environment. Man has been tampering with the ecosphere
society can have more of them only by giving up significant quantity of other goods and services. conservation.since a long time. But now is being realized that environmental goods and services are also scarce and exhaustible. the operations of other functions. pollution control. damming a river to provide hydropower. Why is the air polluted? Why are rivers and lakes polluted? What is the right amount of carbon dioxide in the atmosphere? Answers to these and similar questions can serve as the basis of sound policies that can eliminate or at least lessen the severity of the problems. or monetary – are not infinite. Economics is an important tool for making decisions about the use. economic activity reduces its ability to supply 2 . Environmental economics (EE) takes into consideration issues such as the conservation and valuation of natural resources. waste management and recycling. that is. that is. The Rationale of Environmental Economics Because humans interact with the environment and because humans allocate scarce resources applying economic principles and tools. The positive EE draws heavily upon microeconomic and macroeconomic theories to describe and explain the way in which economic factor influence the consumption and production of environmental goods and services. these public policies are most effective when they achieve the maximum possible benefit in the most efficient way. EE has two braches—positive EE and normative EE. and the efficient creation of emission standards. natural. destroys habitations and agriculture and possibly a whole range of associated cultural and recreational activities. It is largely descriptive and predictive. and the likely outcome of environmental and other policies. it attempts to prescribe what ought to be done to protect and conserve the environment. the costs and benefits of various proposed measures. and protection of natural resources because it provides information about choices people make. Normative EE is largely prescriptive. using the atmosphere as a dumping ground for chlorofluorocarbons (CFCs) or carbon dioxide (CO2) damages the ozone shield and reduces climate stability. Environmental problems arise when the use of environment for one set of functions interferes with. Since resources – whether human. one job of policymakers is to understand how resources can be utilized most efficiently in order to accomplish the desired goals by weighing the costs of various alternatives to their potential benefits. Therefore. It can be seen from these example that environmental problem occurs mainly when the use of the environment to supply resources to or disposal of waste from. or prevents. study of EE can lead to greater insights about why environmental problem exists and what the best solution to the problem is. there is a trade-off between environmental goods and other goods. It applies the principles of welfare economics to determine the socially optimum allocation of environmental goods and services currently and overtime that maximize the net social welfare of present as were as future generations. Therefore. For example. All environmental problems can be traced to the fundamental economic problem of ‘scarcity’.
According to the neoclaasical system of thought the economic value of marketable commodities. clean air. environmental economics provides solid foundation for most of the policy measures designed to address environmental problems. fertilizers. Malthus. Ricardo argued that economic growth would peter out in the long run because of scarcity of natural resources and diminishing returns to land. which like apples. Determining the most reasonable trade-offs among various uses of the environment is where the study of environmental economics is important. post-war Keynesian economics got the discipline into economic and political agendas. environmental pollutions caused mainly rapid economic 3 . Subsequently. but remained pessimistic about long term economic growth prospects. But the principles that determine the price of economic goods can also apply to non-market goods like clean air. Much of environmental economics has focused on the relative merits and demerits of different policy responses to various flaws of market mechanism in the areas of environmental degradation and pollutions. at least for some environmental problems. requires resources to produce. the environmental problems have a negative impact on economic activity. No one has distinct ownership of clean air supplies (all of us—and none of us—on the atmosphere). unpriced environmental goods and services or sympathy for future generations is determined based on the amount of personal utility yielded. among others ‘clean air’ production requires that the atmosphere not be used as waste dump or at least used less so. is to introduce some market interactions where none had existed previously. With the help of these. For instance. Classical theory of political economy highlighted the importance of market as an instrument of stimulating both growth and innovation. Traditional economics begins with the interaction of supply and demand. there is ‘not a direct market’ that can mediate between buyers and sellers. Evolution and Growth of Environmental Economics Classical economist such as Adam Smith. for example.other environmental services. Neo-classical economists introduced a new methodology of marginal analysis that dealt with the study of the relationships between small or incremental changes in inputs and outputs.S. With the emphasis on government intervention and deficit spending. and have been re-introduced into. should emissions be stopped by regulation or should be taxed? In fact. As apple production needs land. and labour. But for many environmental goods and services. In addition. Solving environmental problems requires an understanding of fundamental economic concepts such as scarcity. Mill did not explicitly address the environmental aspects of economic growth but they left a legacy of ideas many of which are relevant to. such as. it can be explained how well-established markets functions. That is one key goal of environmental economics. Ricardo and J. water. One solution. during 1960s. That means waste must be diverted elsewhere which also requires scarce resources. contemporary environmental debates. It seeks to compare the expected social costs and benefits of policy measures and advocates the promulgation of only those measures which promise to enhance the net social welfare.
Then. combining every thing from legislation. To sum up. in which he concludes there is no reason why welfare should not continue to improve and that increasing population contributes to that improvement in the long run. Therefore. there began a widespread shift in values and expectations that represented a sort of return to the pre-revolutionary colonial tradition of social control. mandating improvements in air and water quality. a key factor in economic growth is the human capacity for creating new ideas and contributing to the knowledge base. a number of ‘work views’ have crystallized within environmentalism. this increases prices. Our society then started looking for its response towards environmental protection. the faster obstacles are removed. We began to notice the effects of our economic actions on the environment. eventually the innovations are so successful that prices end up below what they were before the resource shortages occurred. providing a rationale for the emergence of environmental economics as a sub-discipline of economics. In Simon's view. Four basic wolrld views can be distinguished. Under the ‘laissez-faire’ economic system. One reason for the recent emergence of environmental economics is the change in our society’s attitude towards the environment overtime. We noticed that our air and water had become filthy. only economic development was emphasized upon and no questions were asked. His keystone work was The Ultimate Resource. through a position favouring managed resource conservation and growth. This led to the emergence of new environmental ideologies and mass awareness about the need and importance of keeping the quality of the environment intact. In this context. The need of the 21st century and beyond is self-sustaining development.growth in developed countries intensified and became wide-spread. the late economist Julian Simon began countering arguments against economic growth. to ‘eco-preservationist’ positions which explicitly reject the economic growth paradigm. rivers demanded as long as it was in the interest of economic growth. the major landmarks in the growth and development of the discipline are as follows: 4 . Since 1970s. ranging from support for a market and technology-driven growth process which is environmental damaging. and the greater the economic condition for current and future generations. published in 1981 and updated in 1996 as The Ultimate Resource 2. to agitations protesting against wasteful and profligate use of our natural resources and the environment. whether trees were felled or mines quarried. the more people who can be trained to help solve arising problems. By the late 1970s. economists concentrated on reallocation of scarce land and labour and did not consider environment as a scarce resource. Economists responded by studying the causes of degradation of the environment and seeking alternatives for preserving the quality and integrity of the environment. which provides both opportunity and incentive for innovation. His theory was that population growth and increased income puts pressure on resource supplies. Until 1960s. it is of vital importance to allocate the plant’s scarce resources such that the goal of sustainable development is attained.
One population issue is that of carrying capacity – the number of individuals an ecosystem can support without having any negative effects.• • • • • • 1972: the Stockholm conference on Human Environment created formal international awareness of the need for maintaining the quality and integrity of the environment. consumption of resources. and the level of pollution and environmental degradation that results. living organisms must adapt to new levels of consumption or find alternative resources. Carrying capacity can be affected by the size of the human population. several professional journals have also been launched and national and international conferences and training courses in environmental economics organized. and social implications. Swedish Royal Academy’s Beijer Institute. ecological. 1992: Agenda 21 of the United Nations conference on Environment and development (earth submit) in Rio de Janeiro. It also includes a limit of resources and pollution levels that can be maintained without experiencing high levels of change. 1992: Convention on Biological Diversity highlighted the need for biodiversity conservation. If carrying capacity is exceeded. however. Basic Concept 1. Our Common Future. Malthus further argued that population was likely to grow at 5 . 1992: The world Bank’s the world development report highlighted the links between development and environment. 1987: Brundtland Commission’s report . Besides. departments and professional bodies including the IIED. One of the original arguments appeared in 1798 by English economist Thomas Malthus who stated that continued population growth would cause overconsumption of resources. popularized the concept of sustainable development. • These and other related developments led to the setting up of several specialized institutes. held in Johannesburg . This trend is continuing and is likely to gain momentum as awareness about the need to protect and conserve the environment grows in developing countries. need not be fixed and can be expanded through good management and the development of new resource-saving technologies. 2002: The second Earth Summit. International Society for Ecological Economics and Indian Society for Ecological Economics. was an attempt by the UN to review the progress of the expectations raised in Rio and to reaffirm the commitment of world leaders in continuing to pursue actions towards sustainable development 1990s and beyond: Growth and development of theoretical and applied economic analyses of environmental issues. Carrying capacity. The relationship between carrying capacity and population growth has long been controversial. Carrying Capacity Changes in population can have a variety of economic.
" which has become the accepted standard definition. It was here that the international community first agreed on a comprehensive strategy to address development and environmental challenges through a global partnership. as a result. is an unpaid benefit that extends beyond those directly initiating the activity. The framework for this partnership was Agenda 21. Malthus believed that an ever increasing population would continually strain society's ability to provide for itself and. was the best tool in order to preserve both the health and sustainability of the environment. The United Nations attempted to reconcile these views in 1992 by convening the first Earth Summit in Rio de Janeiro. mankind would be doomed to forever live in poverty. Over a century later. however. environmental protection. Externalities Externalities are unintentional side effects of an activity affecting people other than those directly involved in the activity. or otherwise Simon was also one of the founders of freemarket environmentalism. the owner of the factory does not directly pay the additional cost to address any health issues or to help maintain the cleanliness of the air or water. 2. and democratic and effective governance. social justice. This pollution may pose health risks for nearby residents or degrade the quality of the air or water. the United Nation's World Commission on Environment and Development commissioned a study on the subject by what is now known as the Brundtland Commission. many definitions of sustainable development have been suggested and debated. Sustainable Development Over the past few decades. A negative externality is one that creates side effects that could be harmful to either the general public directly or through the environment. which covered the key aspects of sustainability – economic development. 3. He believed human intellect to be the most valuable renewable natural resource that would continue to find innovative solutions to any problems that might arise –environmental. together with appropriate property rights. The report also identified three components to sustainable development: economic growth. One example would be a 6 . A positive externality. American economist Julian Simon countered Malthus' arguments. defined sustainable development as "development that meets the needs of the present without compromising the ability of future generations to meet their own needs. and suggested that all three can be achieved by gradually changing the ways in which we develop and use technologies. not keeping up with the exponential population growth. environmental protection. The resulting report. An example would be a factory that pollutes as a result of its production process. finding that a free market. asserting that an increase in population would improve the environment rather than degrade it. the harmed parties can use legal measures to receive compensation for damages.an exponential rate while food supplies would increase at an arithmetic rate. In some cases. Our Common Future (1987). In recognition of the need for a clearer understanding of sustainable development. resulting in a concept that has become broad and somewhat vague. economical. on the other hand. and social equity. Either way.
The key point is that most 7 . Any individuals or groups that gain additional benefits without contributing are nown as "free riders". Marginal cost measures the change in cost over the change in quantity. “what does it cost to produce one more unit?” or “what will be the benefit of acquiring one more unit?” When necessary. Marginal cost will normally initially decrease through a short range. as a whole. such as a community park. businesses. These are now known as Pigovian taxes and subsidies. In other words. if a company is producing 10 units at $100 total cost. Therefore the marginal cost curve is typically thought of as upward sloping. it is the derivative of the total cost. or are equal. and steps up production to 11 units at $120 total cost. Pigou supported taxes to discourage activities that created harmful effects and subsidies for those creating benefits to further encourage those activities. which allows a company to evaluate how much they actually pay to ‘produce’ one more unit. a British economist best known for his work in welfare economics.neighborhood resident who creates a private garden. but increase as more is produced. and consumers. we must take cost into consideration. like pollution. the social cost is generally higher than the individual cost due to externalities. Arthur Pigou. we can utilize the same information in order to analyze pollution abatement – in terms of the production or reduction of pollution – within the market. argued that the existence of externalities justified government intervention through legislation or regulation. the marginal cost is $20 since only the last unit of production is measured in order to calculate marginal cost. Mathematically speaking. However. Similar to the production of goods and services. Marginal Costs and Benefits Marginal costs and benefits are essential information for economists. others may benefit without contributing to the project. Marginal cost is an important measurement because it accounts for increasing or decreasing costs of production. The cost of these improvements is often thought of as the direct cost of any action taken in order to improve the environment. For example. the aesthetic beauty of which benefits other people in the community. individual and social marginal cost and benefit curves can be drawn separately in order to understand different effects that a given action or policy might have. Also. Traditionally. 4. we all make decisions based on our marginal evaluations of the alternatives. In order to assess environmental improvement. an economic system is considered efficient at the point where marginal benefit and marginal cost intersect. In the case of pollution. when a group voluntarily chooses to create a benefit. The marginal cost curve can represent a wide range of activities that can reduce the effects of environmental externalities. Even if we do not realize it.when a free market does not allocate resources efficiently. both negative and positive externalities are considered to be forms of market failure .
Marginal benefit is similar to marginal cost in that it is a measurement of the change in benefits over the change in quantity. Taking a look at the graph above. In cases such as these the measurement may involve utilizing revealed preferences. An average benefit 8 . the total consumer benefit that is represented as the dark grey area. The marginal benefit curve represents the tradeoff between environmental improvements and other things we could do with the resources needed to gain the improvement. through a survey or another mechanism. Each additional unit that is cleaned up is valued at a somewhat lower level than each previous one because the overall pollution level continues to decrease. benefits are more difficult to measure because they are not always monetary. it becomes more and more expensive as additional cleanup is done. the first unit of this pollution that is cleaned up has a very high benefit value to consumers of the environment. We could increase total benefit by adding pollution controls beyond Q. Oftentimes. While marginal cost is measured on the producer’s end. Once the pollution is reduced below a certain point. For example. resources must be expended in order for improvement to occur. in order to discover the maximum price consumers are willing to pay for a particular quantity of a good. take an environment that has been polluted – while the initial unit of cleanup may be cheap. the net benefit is greatest when the quantity – “Q” – reaches the marginal benefit curve. Again take an environment that has been polluted.environmental improvements are not free. so it is no longer efficient to further increase the benefits. but only with marginal costs (MC) greater than marginal benefits (MB). marginal benefit is looked at from the consumer’s perspective – in this sense it can be thought of as the demand curve for environmental improvement. the marginal benefit of additional pollution control measures will be negligible because the environment itself is able to absorb a low level of pollution.
It represents opportunities forgone.. 6.is used when considering society as a whole because each individual’s willingness to pay is different. on the other hand. Often. aiming to explain why markets and institutions have evolved as they have and how they work. If a person has a job offer that pays Rs. The opportunity cost of a resource can be defined as the value of the resource in its next best use. It is called opportunity cost or displacement cost. Positive and Normative Economics Positive economics is more value free. Fundamental to environmental economics is the notion of market failure. e. Normative economics. this becomes an essential component in cost-benefit analysis 5. Opportunity Cost The Australian School of economics and its followers gave an alternative concept of real cost. attempts to use economic tools to design government policies to intervene in the market place. Examples are to understand why the price of petrol increases when OPEC meets to restrict the output and how the spatial distribution of pollution emissions changes when a marketable permit system is established to regulate sulfur emissions. value judgment may enter the process of policy formulation. If measured marginal costs and benefits are provided.75 for an hour's work. this requires a way of defining what is best—a much more valueladen process than why the economy works as it does. and instead chooses to take a nap. it is much easier to calculate the ideal price and quantity. When considering environmental issues. the real cost of production of a given commodity is the next best alternative sacrificed in order to obtain that commodity. According to them. When working in the environmental problems it is not possible to restrict attention solely to positive economics. What kinds of government interventions? That is a normative question. Repairing the market failure typically requires government interventions. the efficient point at which marginal costs and marginal benefits are equal is an important economic concept because it captures the essence of tradeoffs. Marginal costs and benefits are a vital part of economics because they help to provide the relevant measurement of costs and benefits at a certain level of production and consumption. Inevitably the question arises as to the ‘best’ way of intervening in the marketplace. environmental improvement concerns often revolve around whether we are above or below this point –whether any additional environmental improvement can provide more benefit than it will cost. Clearly. It is where the two intersect that will always be the most economically efficient point of production and consumption. In developing the normative theory of regulation to correct market failure or the public provision on non-market goods. what could have been accomplished with the resources expended in the undertaking. if it were not being used for the present purpose. then the accounting cost 9 . it is the value of the best alternative that was not chosen in order to pursue the current endeavour--i. i. Thus.e.
Imagine an economy that can produce only wine and cotton. You may. The production possibility frontier shows there are limits to production.75 that could have been earned by him by working. But you can always change your mind in the future since there may be some instances when the mashed potatoes are just not as attractive as the ice cream. wants. the opportunity cost is the Rs. B and C—all appearing on the curve—represent the most efficient use of resources by the economy. The opportunity cost of an individual's decisions. 7. time. 10 . is determined by his or her needs. must decide what combination of goods and services can be produced. the production possibility frontier (PPF) represents the point at which an economy is most efficiently producing its goods and services. 8. points A. forego ice cream in order to have an extra helping of mashed potatoes. Production Possibility Frontier (PPF) Under the field of macroeconomics. For you. It is a direct or indirect payment by a government to households or firms and may also includes grants or other aids from a central government to local governments. Opportunity cost is the value of what is foregone in order to have something else. resources are being managed inefficiently. If the economy is not producing quantities indicated by the PPF. the mashed potatoes have a greater value than dessert. However. Subsidy Subsidies are used by the government to promote social objectives. while point Y represents goals that the economy cannot attain with its present levels of resources. According to the PPF. and resources (income). and the production of society will dwindle. for instance. therefore. Point X represents an inefficient use of resources. the person did not hand over any money in order to nap. This value is personal to each individual. to achieve efficiency. so an economy. and therefore allocating its resources in the best way possible. Let's turn to the chart below.of the nap is zero.
Point Y. and capital remained the same. or. Point X means that the country's resources are not being used efficiently. more specifically. If the economy started producing more cotton (represented by points B and C). labor. represents an output level that is currently unreachable by this economy.As we can see. given the potential of its resources. it would have to divert resources from making wine and consequently produce less wine than it is at point A. in order for this economy to produce more wine. it must give up some of its resources used to produce cotton (point A). on which Y would appear. As you can see. by moving production from point A to B. if there were a change in technology whiles the level of land. and the PPF would be pushed outwards. the time required to pick cotton and grapes would be reduced. the country is not producing enough cotton or wine. would represent the new efficient allocation of resources: 11 . as we mentioned above. Output would increase. A new curve. the economy will have to decrease wine production a small amount in comparison to the increase in cotton output. However.
8. and the role of technological change in determining future levels of pollution control. Such methods have come under serious attack by some as at best biased and at worst vacuous. 5. different amounts of information processed by polluters and the government. it indicates that the economy is shrinking as a result of a decline in its most efficient allocation of resources and optimal production capability. It refers to the "best that could be achieved without disadvantaging at least one group”. 12 . Stated preference methods involve directly asking people how they value the environment. Pareto optimality is a situation which exists when economic resources and output have been allocated in such a way that no-one can be made better off without sacrificing the well-being of at least one person. A shrinking economy could be a result of a decrease in supplies or a deficiency in technology. Measuring this demand has become central to many public debates over environmental quality. 7. There is another set of issues surrounding regulation of environmental goods. A very active area of current research is the theory underlying methods for measuring demand for environmental goods as well as empirical methods for doing so. However. 9.When the PPF shifts out. especially in the tropics Land degradation Fresh water pollution and scarcities Marine Treats. 9. we know there is growth in an economy. A typical definition of Pareto efficiency would he: "A given economic arrangement is efficient if there can be no arrangement which will leave someone better off without worsening the position of others. 6. Alternatively. Excessive nitrogen production and overfertilisation Important Issues in Environmental Economics One of the most important contributions of environmental economics to economics generally has been in the area of measuring the demand for non-market goods. Ten Major Challenges 1. Acid rain and regional scale air pollution Ozone depletion by CFCs and other industrial and agricultural chemicals Global warming and climate change due to GHGs in the atmosphere Deforestation. 3. These difficulties have to do with incentives. services through loss of ecosystems and spices 10. 4. Others argue they are valid and of tremendous importance." Thus any exchange or reallocation of resources is only Pareto optimal if the exchange or reallocation will not harm somebody. some methods of measuring demand have been the subject of great controversy. including overfishing Threats to human health from organic pollutants and heavy metals Decline in biodiversity and ecosystem. Pareto Optimality Named after Italian sociologist and economist Vilfredo Pareto. 2. The basic problem is that economic incentives need significant refining before they can be relied on to solve many real environmental problems. when the PPF shifts inwards.
and theoretical issues of regulatory design. including institutional design. Are differential environmental regulations compatible with free trade? Does free trade tend to exploit the environments of developing countries due to their less developed institutions for environmental protection? 13 .This work takes place at various levels. There are a number of international issues of environmental regulation that are not fully resolved. One major problem is in understanding how environmental regulations interact with trade restrictions. determining empirical properties of different regulatory mechanisms.
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