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Economics of Environmental Quality. Economics of Environmental Quality. Different types of pollutants call for different types of policy Optimal pollution modeled as simple tradeoff: Reducing emissions reduces damages Reducing emissions involves opportunity costs. Environmental Damages.

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economics of environmental quality1
Economics of Environmental Quality
  • Different types of pollutants call for different types of policy
  • Optimal pollution modeled as simple tradeoff:
    • Reducing emissions reduces damages
    • Reducing emissions involves opportunity costs
environmental damages
Environmental Damages
  • All negative impacts that resource users experience from environmental degradation
    • Greater the emissions, the greater the damages
    • Examples:
      • Lung diseases
      • Contaminated water
      • Loss of biodiversity
      • Loss of recreational uses
      • “defensive” expenditures
marginal damage function

$

$

Emissions (tons/yr)

Emissions (tons/yr)

$

$

Ambient (ppm)

Ambient (ppm)

Marginal Damage Function
  • Emissions function:
    • Damage = f(quantity of residual)
  • Ambient function:
    • Damage = f(concentration of pollutant)

Noise

SO2

Toxic chemicals

“threshold” effects

marginal damage function1
Marginal Damage Function
  • Total Damages = sum of marginal damages
    • TD1 = (10)(100)(.5) = $500
    • TD2 = (25)(100)(.5) = $1250
  • What accounts for differences in MD1 and MD2?
    • Urban vs rural areas
    • Different seasons

$

MD2

MD1

$25

$10

50

150

Emissions

slide6

Suppose the marginal damage function is given as MD = 8(E - 200), where E measures the emissions of gunk, measured in tons. What is the total damage if E = 260?

  • $480
  • $14,400
  • $28,800
  • $62,400
abatement costs
Abatement Costs
  • Costs incurred to reduce pollution emissions
    • Marginal Abatement Costs (MAC) rise as emissions are reduced

$

MAC2

$50

MAC1

Unregulated Emissions

$20

240

500

Emissions

  • Total Abatement Cost = sum of marginal abatement costs
    • TAC1 = (20)(260)(.5) = $2600
    • TAC2 = (50)(260)(.5) = $6500
  • What accounts for differences in MAC1 and MAC2?
    • Different plant technologies (old vs new)
    • Different time periods
slide8

Suppose the marginal abatement cost function is given as MAC = 350 – 5E, where E measures the emissions of gunk, measured in tons. What is the total abatement cost if E = 30?

  • $200
  • $4,000
  • $6,000
  • $12,000
optimal emissions
Optimal Emissions
  • Optimal level is one which minimizes total social costs
    • Occurs where MD = MAC

$

MD1

MAC1

$18

$10

TD1

TAC1

Emissions

75

200

450

TD1 = (10)(125)(.5) = $625

TAC1 = (10)(250)(.5) = $1250

Total Social Cost = TD + TAC = $1875

optimal gunk
Optimal Gunk

MD = .25(E – 100)

MAC = 90 - 0.15E

  • What is optimal emissions?
  • What are marginal damages at the optimal level?
  • What are TD?
  • What are TAC?
  • What is Total Social Cost?
  • What is Total Social Cost if E = 0?
  • What is Total Social Cost if emissions are unregulated?
optimal emissions1
Optimal Emissions

$

  • What happens to optimal emissions if:
    • MD rises?
    • MAC falls?
  • What would the graph look like that shows E* = 0?
  • What happens to optimal emissions if enforcement is costly?

MAC1 + C

MD2

MD1

MAC1

MAC2

E2

E1

E3

Emissions

E* falls

E* falls

E* rises

problem set 2
Problem Set 2
  • Question #3
equimarginal principle revisited
Equimarginal Principle: Revisited
  • What is TAC of a uniform 50% reduction from the unregulated level?
  • What is TAC of the equimarginal reduction of 14 tons/week?

TAC = $14,900

TAC = $14,400

$33,600

$49,600

types of analyses

Vilfredo Pareto

Types of Analyses
  • Impact Analysis
    • Enviro IA:
    • Economic IA:
  • Cost-effectiveness Analysis
    • Estimate cost of alternatives with a certain objective in mind; benefits not considered
  • Damage Assessment
    • Estimate value of damages to injured resource so that the amount can be recovered in court
    • CERCLA (Superfund)
  • Benefit-Cost Analysis

Identification and study of all enviro repercussions from actions; natural scientists

Ramifications of enviro regulations for specific econ variable; economists

Ex: Williamstown wetlands and economic development

Pareto improvement: A policy that makes one person better off and no one else worse off

benefit cost analysis
Benefit-Cost Analysis
  • Specify clearly the project/program
    • Location, timing, affected groups
  • Describe quantitatively the inputs/outputs of project
    • Involves engineers
  • Estimate social benefits/costs of inputs/outputs
    • Use monetary metric
  • Compare benefits and costs
    • Net benefits?
    • Benefit-cost ratio?
benefit cost analysis1
E0 is current emissions

Proposal to reduce emissions to E2

TB = a + b

TC = b

Net benefits = a

Maximum net benefits occur at E*

Net benefits = a + d

B-C Ratio

At E2: (a+b)/b

At E*: (a+b+c+d)/(b+c)

Benefit-Cost Analysis

$

MD1

MAC1

d

a

c

b

Emissions

E*

E2

E0

benefit cost analysis2
Benefit-Cost Analysis
  • Present Value Calculation
    • Net PV =
    • The higher the discount rate, r, the lower the PV
    • What discount rate to use?
      • Personal time preference?
      • Marginal productivity approach?
        • Real or nominal interest rate?

Benefits

today

time

Costs

Interest rate on savings accounts

Interest rate on borrowing money

OMB: r = 7%

CBO: r = 2%

benefit cost analysis3

Benefits

today

time

Costs

Benefits

today

time

Costs

Benefit-Cost Analysis
  • Future generations?
    • Discounting downgrades future damages
    • Policies with short run benefits and long run costs are preferred by today’s generation
    • Sustainability criteria as alternative
  • Distributional concerns?
    • Horizontal equity: treating similarly situated people the same way
    • Vertical equity: treating people in different situations differently
  • Risk Analysis?
    • Uncertainty about the future makes for a probabilistic world
measuring the benefits of eq
Measuring the Benefits of EQ
  • Direct Damages
  • Willingness-to-Pay Approach
    • Revealed Preferences
    • Stated Preferences
direct damages
Direct Damages
  • Health damages

Health = f(life style, diet, genetics, age, AQ)

    • Medical expenditures
    • Lost income due to illness/death

“cost of illness study”

estimated cost of adult asthma in the us
Estimated Cost of Adult Asthma in the US

Source: M.G. Cisternas et al., “A Comprehensive Study of the Direct and Indirect Costs of Adult Asthma,” Journal of Allergy and Clinical Immunology, June 2003.

direct damages1
Direct Damages
  • Health damages

Health = f(life style, diet, genetics, age, AQ)

    • Medical expenditures
    • Lost income due to illness/death
  • Materials damages
    • Increased maintenance costs
  • Effect of pollution on production costs
    • Reduced yields on crops

“cost of illness study”

indirect wtp methods
Indirect WTP Methods
  • Value of Health thru Averting Costs
    • Expenditures made to avoid bad outcomes
  • Value of Life thru Wage Rate Differentials
    • “statistical life”
value of a statistical life
Value of a Statistical Life
  • How much would you be WTP to reduce probability of death by ?
  • If you are rational, you will take precautions up to the point where MB = MC.
  • Suppose it will cost $30 to reduce the chance of your death by

$30 = (V)( )

V = $3,000,000

MC

MB

value of a statistical life estimates
Value of a Statistical Life Estimates

Source: Table 7.2, p. 145, Field and Field (2006)

fatality risk in the us
Fatality Risk in the US

Source: Kip Viscusi, “The Value of Risks to Life and Health,” December 1993 Journal of Economic Literature (13):1912-1946.

cost of risk reducing regulations
Cost of Risk-Reducing Regulations

* Millions of 1984 $

104 = 10,000

105 = 100,000

106 = 1,000,000

107 = 10,000,000

108 = 100,000,000

Source: Kip Viscusi, “Economic Foundations of the Current Regulatory Reform Efforts,” The Journal of Economic Perspectives 10 (1996): Tables 1 and 2, 124-125.

indirect wtp methods1
Indirect WTP Methods
  • Hedonic Pricing
    • Value of EQ thru Housing Prices
    • Value of EQ thru Intercity Wage Differentials
  • Travel Costs for Amenities
    • Time and travel costs represent “price” of access
    • Problem Set 2: #11
  • Southold, Long Island, NY
  • Calculate value of preserving open spaces
  • 10 acre open parcel surrounded by 15 avg properties = $410,000
  • Property values next to:
  • Open Space: + 12.8%
  • Farmland: - 13.3%
  • Major Roads: - 16.2%
  • Zoning: + 16.7%
  • Hells Canyon on the Snake River
  • Recreation vs Hydropower
    • Cost savings of hydropower at Hells Canyon: $80,000
    • Recreational value of Hells Canyon: $900,000
direct wtp methods
Direct WTP Methods
  • Political Referendum
    • Qualitative assessment only
  • Contingent Valuation
    • Survey method used to elicit use and non-use values
      • Total WTP = Use value + Nonuse value + Option value
    • Approach
      • Choice scenario must provide accurate and clear description of the change in environmental services
      • Open-ended or closed-ended choice format
      • Must specify payment mechanism and opportunity costs
sample cv questions
Sample CV Questions
  • There are less than 1,000 American Crocodiles left. Habitat necessary for the American Crocodile is rapidly being bought for development. The Nature Conservancy is considering buying land in an effort to save this species. What would you be willing to pay in the form of an annual donation in order to buy enough habitat to save 100 crocodiles?

$_______________

  • If you said $0, please tell me why?

(From: Environmental Economics & Policy (2007, 5e) by TomTietenberg.)

sample cv questions1
Sample CV Questions
  • First, let’s assume that visitors to the Glen Canyon National Recreation Area are to finance environmental improvements by paying an entrance fee to be admitted into the recreation area. This will be the only way to finance such improvements in the area. Let’s also assume that all visitors to the area will pay the same daily fee as you, and all the money collected will be used to finance the environmental improvements shown in the photos.
  • Would you be willing to pay a $1.00 per day fee to prevent Situation C from occurring, thus preserving Situation A? $2.00 per day?

[Increment by $1.00 per day until a negative response is obtained, then decrease the bid by 25 cents per day until a positive response is obtained, and record the amount.]_________$/day

(From: Using Surveys to Value Public Goods: The Contingent Valuation Method. Mitchell, Robert Cameron, and Carson, Richard T. 1989. Resources for the Future, Washington, D.C. Pp 4-5.)

mono lake california
Mono Lake, California
  • LA water consumers vs nesting/migratory birds
  • Average WTP on water bill was $13/mo (or $156/year)

 TB exceeded $26m cost of replacing water supply by a factor of 50

Wegge,T., W. Michael Hanemann, and John Loomis. 1996.  "Comparing Benefits and Costs of Water Resource Allocation  Policies for California's Mono Basin,"  in Advances In The Economics of Enviornmental Resources, (ed.) Darwin C. Hill, Volume 1, 1996.

exxon valdez oil spill 1989
Exxon Valdez Oil Spill (1989)
  • 11 million gallons
  • Mean WTP for a program to reduce the risk of similar damage was a one-time tax payment of $31 per household
  • Estimated TB = $2.8 billion
  • Exxon paid $0.5 billion in damages + $2 billion in cleanup
direct wtp methods1
Direct WTP Methods
  • Problems with CV
    • Hypothetical nature of questions
    • Truthfulness/free-rider problem
    • Framing issues
      • WTP vs WTA
value of a headache
Value of a headache
  • What is the maximum dollar amount you are willing to pay to avoid a headache?
  • What is the minimum dollar amount you would accept to have a headache?

WTA is not constrained by income

measuring abatement costs
Measuring Abatement Costs
  • Level of analysis
    • Single firm/community/project
    • Industry/region
    • National economy
    • Global
  • With/Without Principle
    • Production costs:
      • Before Regulation: $100m
      • Future w/o Regulation: $120m
      • Future w/ Regulation: $150m

 true marginal cost = $30m

concepts of cost
Concepts of Cost
  • Explicit Cost
    • Capital Costs: plant and equipment (replacement and expansion)
    • Operating Costs: production, maintenance, abatement process (labor, materials, R&D)
    • Enforcement Costs: monitoring, administration
  • Implicit Costs
    • Higher product prices/reduced consumption
    • Inconvenience of using public transportation/carpools
    • Media switching
    • Illegal dumping

Social Costs = Private Costs + External Costs

us pollution control expenditures 2005
US Pollution Control Expenditures: 2005

U.S. Census Bureau, Pollution Abatement Costs and Expenditures: 2005, MA200(05), U.S. Government Printing Office, Washington, DC, 2008. Online: http://www.census.gov/prod/2008pubs/ma200-05.pdf

single projects
Single Projects
  • Examples
    • Waste treatment plants
    • Flood-control
    • Solid waste handling
    • Beach restoration
    • Public park
    • Wildlife refuge
costs of a local regulation
Costs of a Local Regulation

$

  • Costly regulation imposed on local apple grower
    • Raises costs of production: supply shifts to S2
  • What does apple grower do?
    • Continue producing same quantity?
      • unlikely if apples are sold competitively
    • Cut production to q2?
      • lost income to grower, workers, community

S2

S1

P

Market price

q2

q1

Apples

Why is the lost income not necessarily a social cost?

cost of regulating an industry
Cost of Regulating an Industry
  • Higher production costs are social costs when they cause CS to fall
  • Estimate cost of “average” firm
  • Rely on cost surveys
    • Self-reported
    • Uses past data

$

a + b = lost consumer surplus = “true” social cost

P2

S2

a

c

b

P1

S1

D

q2

q1

output

costs at the national level
Costs at the National Level
  • Macroeconomic modeling
    • Short Run
      • PPF model suggests tradeoff between market output and EQ
    • Long Run
      • GDP = F(L, K, Tech)
      • PACE diverts resources from these factors
      • But, environmental degradation reduces resources

Market Goods

EQ

pace as percent of gdp
PACE as Percent of GDP

Source: OECD, “Pollution Abatement and Control Expenditure in OECD Countries,” ENV/EPOC/SE(2003)1, Paris, 17 July 2003, p32.