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Economics of the Environment

Economics of the Environment. 1. The economics of pollution 2. Valuation of externalities 3. The optimal level of pollution 4. Methods of pollution control 5. EU & UK policy. Background. Pollution chemical wastes - rivers noise pollution thermal pollution carbon emissions - air

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Economics of the Environment

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  1. Economics of the Environment 1. The economics of pollution 2. Valuation of externalities 3. The optimal level of pollution 4. Methods of pollution control 5. EU & UK policy

  2. Background • Pollution • chemical wastes - rivers • noise pollution • thermal pollution • carbon emissions - air • industrial use • road users • Table 1

  3. Fig 1 The interaction between the economy & environment Consumption system Production system Environmental system Wastes Reclaimed materials

  4. 1. The economics of pollution • Negative externality • spillover effect of consumption\ production • third party is effected - social costs • Price mechanism? • e.g. air is free • e.g. water - very low price • Over-consumption • consumers\business - private costs • society - social costs

  5. Economics of pollution • Private costs  social costs • Policy objective • change consumers\business behaviour • pay full social costs • internalise the externality to reduce pollution • Policies • standards, taxes, permits • … valuation of a negative externality

  6. 2. Valuation: A case study • Road traffic congestion • Road use increased dramatically • private (…and freight) • Policy - how to ration a scarce resource? • Road use generates several externalities • e.g. Global warming, e.g. Air pollution • e.g.Congestion • How big are these social costs?

  7. Valuation methods • 1. Direct Approaches • Contingent valuation methods • questionnaire & survey • WTP or WTAC • value of externality = mean WTP or WTAC • 2. Indirect Methods • e.g. Hedonic pricing model e.g. house prices, lifetime wages • e.g.Total economic value = use value + option value + existence value

  8. Valuation of road transport externalities, 1993 • Externality & cost (£billions) • Global warming = 0.1 • Air pollution = 19.7 • Noise = 2.6-3.1 • Road damage = 1.5 • Accidents = 2.9-9.4 • Congestion = 19.1 • TOTAL = 45.9-52.9 • Revenue from road use = £16.4b

  9. Policies to correct road transport externalites • Marginal road user pays about a third of true cost of a journey • Government intervention • build more roads - no! • improve public transport - yes • tax - yes • road pricing - yes • Taxes & pricing depend crucially on value of externalities

  10. 3. The optimal level of pollution • How much pollution should Government tolerate? • Not zero pollution. Why? • …because pollution increases with output • …growth of output increases welfare

  11. 3. The optimal level of pollution • Quantity of pollution is positively related to output • Social costs increase with output • But, the costs of clean-up rise as pollution falls • What is the socially optimal level of pollution? • See Figure 2

  12. Fig 2: The optimal level of pollution Costs of pollution Social costs More untreated waste, the higher the social cost If pollution= 0, output would fall. Welfare? C2 C1 0 Q1 Q2 Quantity of pollution

  13. Fig 2: The optimal level of pollution Costs of pollution control Costs of pollution control at each level of discharge B C2 Costs of clean-up rise A C1 0 Q2 Q1 Quantity of pollution

  14. Fig 2: The optimal level of pollution Costs Social costs Assume that industry output is fixed Y X Pollution control costs 0 R Quantity of pollution

  15. The optimal level of pollution • Thinking marginally, optimality is • “…the cost of an extra unit of pollution is just equal to the cost of reducing pollution by an extra unit.” • Point ‘R’ on figure 2 • pollution is not zero! • How can Government achieve this?

  16. 4. Methods of pollution control • No incentive for business & consumers • Government should correct the market failure • Methods • (a) standards & regulations • (b) Pollution tax • (c) Tradeable permits

  17. 4. Methods of pollution control • (a) Standards & regulations • Traditional approach • Set emissions target • if targets are too strict - point X • if targets are too lenient - point Y • correct targets - point R • Penalties if business is caught in violation of target

  18. (a) Standards & regulations • Disadvantages • (i) Costly • (ii) Information requirements • (iii) Vague & imprecise • (iv) If fines are low, no incentive to comply • (v) Conflict of standards • Advantages • (i) If all businesses comply - very effective • (ii) No alternative in some cases

  19. (b) Pollution tax • E.g. fuel tax, effluent taxes • Tax is a fee consumers\producers pay • Control via price • Tax per unit of output • Cleaner production process - lower tax • See Figure 3

  20. Fig 3: The pollution tax MSC Costs, Revenue MPC + tax S = MPC Pr Pp Pt D = MSB Qr Qp Output R Y Quantity of pollution

  21. (b) Pollution taxes • Advantages • (i) Cheaper than standards • reduce discharge: clean-up cost = pollution tax • (ii) Less information required • meters & charges • (iii) Polluter Pays Principle • price environmental services • sustainable development

  22. Advantages • (iv) Raises revenue • (v) Widespread compliance • (vi) Market-based approach • (vii) Producer & consumer share the cost • Disadvantages • (i) Valuation? Tax rate? • (ii) Absence of market failure e.g. monopoly • (iii) Assumes Government knows the firms costs

  23. (c) Transferable pollution permits • Second-hand market in pollution • Regulator sets pollution target • Issue pollution permit • license to pollute to a certain level • e.g. emissions • Firms buy & sell permits • Firms have a choice • incur the cost of clean-up • buy a permit & continue polluting

  24. (c) Permits • High clean-up costs - buy permits • Outcome • Some pollution is allowed • Remaining pollution is cleaned up at low cost • Control pollution - quantity

  25. (c) Permits • Advantages • (I) Market-based approach • (ii) Low cost • (iii) Flexible - regular can buy permits • Disadvantages • (I) Valuation? Number of permits • (ii) Initial allocation is important

  26. 5. EU & UK policy • Traditional approach - set standards • EU sets standards on • quality of water - bathing, drinking, emissions • waste management - sewage, toxic substances • atmospheric pollution - agreed to reduce CO2 emissions by 2012 (8%)

  27. EU reduction targets for greenhouse gases (% change)

  28. 5. EU policy • How will this be achieved? • ‘…markets [will] be harnessed to generate the most efficient method of achieving desired pollution reuctions.’ • Government set targets • Taxes & permits used to find the best method

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