Lecture note 3: Market failure and environmental economics

Lecture note 3 MARKET FAILURE AND ENVIRONMENTAL ECONOMICS THE ECONOMIC THEORY OF POLLUTION CONTROL SOME ENVIRONMENTAL PROBLEM AREAS Global climate change greenhouse gases ozone depletion International air pollution acid rain Water pollution nitrate spill-over, pesticide run off Water scarcity intensive agriculture Miscellaneous Loss of biodiversity Soil fertility losses EXTERNALITIES An externality occurs when an activity generates unintended effects on others for which no payment or compensation is made. Externalities arise because of the absence of private property rights – if they existed payment/compensation would occur. They are an example of market failure. Externalities can be thought of as “missing markets”. Or, as unpriced goods and services. Externalities may be beneficial or harmful In the absence of corrective policy, the level of an activity that gives rise to a harmful/beneficial externality will be too high/low. Common property and the economic problem A clearly defined ownership of a resource: Completely specified: quantitative, quality, boundaries Completely exclusive: benefits and costs accrue to the owner Transferable: can be exchanged, donate,... Enforceable: legally protected Common property: non-exclusiveness, non rivalry SPECTRUM OF GOODS Pure private goods Pure public goods Quasi private goods Quasi Public goods Exclusive, divisible Non- Exclusive, divisible Non-Exclusive, Partially divisible Non- Exclusive, indivisible Public goods/bads have two characteristics Non-rivalry – consumption by one agent does not reduce the amount available to others Non-excludability – if provided for one agent, others cannot be excluded from consumption Examples of public goods – national defence, water pollution abatement. Examples of public bads – air pollution External effects often have the characteristics of public goods/bads Examples of externalities Positive externality Social benefits=private benefits + External benefit And external benefit >0 Therefore Social benefits > Private benefits Negative externality Social costs =private costs + External cost And external costs > 0 Therefore Social costs > Private costs Economic consequence of an externality P Q S = MPC D = MSB P* Q* MSC P** Q** The efficiency loss due to an externality P Q S = MPC D = MSB Q* MSC P** Q** Consumer and producer surpluses with an externality CS Pollution Control: Two Questions for Public Policy How much pollution should be allowed? What is economic optimal level of pollution? 2. How to affect polluters’ behaviour so as to bring about the desired level of pollution? What policy instrument to use? The economic process and the assimilative capacity of the environment The process of transforming resources in to economic goods and services creating residuals referred to as pollutants (an inevitable by-product of economic activities) When the pollutants excess the absorptive capacity of the environment creating a phenomenon known as pollution The absorptive capacity, self-degrading ability of the environment referred to as assimilative capacity. From the viewpoint of environment management, the quality of a particular environment (e.g. air, water, land) is determined by the extent of its capacity to assimilate (degrade) waste. The assimilative capacity of the environment is limited X= Economic activity Wo Assimilative capacity of the environment W=f (X, t) Xo ecological threshold of economic activity Waste A simple relationship between economic output and waste discharge Main points from the diagram The environment has a limited capacity to degrade waste: Degradable pollutants: sewage, food waste, papers Persistent or stock pollutants: plastics, glass, chemicals, radioactive substances A certain minimum amount of goods and services can be produced without causing damage to the environment, therefore ‘zero’ pollution is purely ecological consideration, unnecessary goal to pursue. The waste discharge function should be nonlinear because of the tendency to reduce the assimilative capacity. Revenue & cost/unit Q MC Pm Qm Amount of profit made on quantity produced The MC and Net private benefit MNPB curve MR Marginal NPB/unit Quantity produced Qm Amount of profit made on quantity produced The MC and Net private benefit MNPB curve MNPB curve Pollution emitted over quantity produced Pollution damages All the negative impacts that users of the environment experience as a result of the degradation of that environment (Field, 1994) Damages are of many types and vary from one environmental asset to another Water pollution: affecting downstream fishers, recreation activities (sailing, swimming), more cost of water treatment for water supply company, higher change of picking of waterborne diseases Air pollution: impacts to human health (lung cancer, respiratory system), degradation of materials (outdoor sculpture), deterioration of visual environment. Quantity produced Wo Assimilative capacity of the environment Total damage cost function Qo ecological threshold of economic activity Damage costs Total damage cost of pollution Cm Qm Quantity produced Wo Assimilative capacity of the environment Marginal external cost MEC Qo ecological threshold of economic activity Marginal external cost per unit Marginal external cost of pollution damage Qm MNPB & MEC Quantity produced Qm Socially optimal level of output Qs MNPB = MEC MNPB curve Qo MEC Qs Qx MNPB & MEC Quantity produced Qm MNPB curve Qo MEC Qs Qx Optimal level of pollution Es Important notes It is not appropriate for many toxic, non-biodegradeable and persistent pollution, other dangerous substances which accumulate over time. It assumes the release of a single pollutant. In reality a mix of pollutants found, therefore greatly increasing the damage impact. It assumes pollution damage only occurs when individuals recognize a loss of welfare. Low doses of pollution may not result in easily identifiable impacts until it is too late to respond adequately. Zero pollution is technically not really feasible as a policy objective