Chapter 21 The EnvironmentChapter OutlineYou Are HereHow Clean is Clean EnoughThe Dirty Room ExampleModeling Environmental CleanupThe Externalities ApproachWhen the Market Works for EveryoneWhen Externalities are PresentWhen the Market Does Not Work for EveryoneThe Property Rights ApproachWhy Coase’s Theorem Makes SenseProblems with Coase’s TheoremNatural Resources and Property RightsVarious Environmental Problems and their SolutionsLegal vs. Economic SolutionsTaxation as an Economic SolutionOther Economic SolutionsWhen There is No Authority to Tax or RegulateEconomic Consequences of Kyoto (if it were implemented)Chapter 21The EnvironmentCopyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin21-2Chapter Outline•HOW CLEAN IS CLEAN ENOUGH?•THE EXTERNALITIES APPROACH•THE PROPERTY RIGHTS APPROACH•ENVIRONMENTAL PROBLEMS AND THEIR ECONOMIC SOLUTIONS21-3You Are Here21-4How Clean is Clean Enough•Economists answer most “how much is enough” questions with the same answer: “until the marginal benefit equals the marginal cost.”•The right level of environmental cleanliness is achieved when the value of cleaning the environment a little more equals the cost of doing so.21-5The Dirty Room Example•Cleaning your room (dorm room or your own bedroom) can be done to many degrees–A short time can be spent getting things off the floor (high marginal benefit, low marginal cost).–More time can be spent with vacuuming and straightening (moderate marginal benefit, moderate marginal cost).–Even more time can be spent deep cleaning, removing stains from carpets, dusting all shelves and moving furniture so as to clean behind them (for most low marginal benefit and high marginal cost.)21-6Modeling Environmental CleanupMarginal BenefitMarginal CostEnvironmental QualityMarginal Cost Marginal BenefitEQ*21-7The Externalities Approach•Externalities are the effects of a transaction that hurt or help people who are not a part of that transaction.•When a product affects someone other than the consumer of producer in a negative way, such as pollution, economists suggest that the market has failed.21-8When the Market Works for EveryoneSupplyDemandQ*P*PQ/tABC0•Value to the Consumer: •0ACQ*•Consumers Pay Producers: •OP*CQ*•The Variable Cost to Producers: •OBCQ*•Consumer Surplus: •P*AC•Producer Surplus: •BP*C21-9When Externalities are Present•If there are externalities then there is overproduction of a good.•The total cost of a good to society (called social cost) includes the costs of production incurred by the firm as well as the external costs.21-10When the Market Does Not Work for EveryoneSMarginal CostD(Marginal Benefit)Q*P*PQ/t0Social CostExternal CostQ’P’21-11The Property Rights Approach•Coase’s Theorem–If there are no costs of bargaining between people and polluters then by assigning a property right (either the right of the firm to pollute or the right of people to be free from pollution) people and firms can negotiate to the correct level of production.21-12Why Coase’s Theorem Makes Sense•People do not pollute up their own private property nearly as much as they pollute Common Property. –Common Property is not owned by any individual but is owned by government or has some other collective ownership property.•This is because when they do they are removing value from themselves.21-13Problems with Coase’s Theorem•It is impossible for companies to negotiate with millions of citizens affected by their pollution.•The system picks a winner and a loser when it establishes the property right.21-14Natural Resources and Property Rights•Uses the concept of present value•Choose the rate of exploitation that maximizes profit.•The rate of exploitation that maximizes profit depends on whether the firm owns the property (or at least the long term right to exploit it.)21-15Various Environmental Problems and their Solutions•Problems of –Water pollution, Air Pollution, Extinction of Species, Acid Rain, Global Warming•Legal Solutions–Clean Water Act–Clean Air Act–Endangered Species Act21-16Legal vs. Economic Solutions•Legal solutions to environment problems typically limit or make illegal activities that harm the environment.•Economic solutions to environmental problems tend to discourage activities that harm the environment by making the people doing the harm recognize the cost of that harm.21-17Taxation as an Economic SolutionSMarginal CostD(Marginal Benefit)Q*P*PQ/t0S+taxtaxQ’P’21-18Other Economic Solutions•Cap-and-trade: Any policy that imposes a limit on the total amount of emissions and allows for the free exchange of emission permits within that cap.–Emission permits for SO2 in the Clean Air Act of 1990. –Obama preferred limits on GHGs•California’s old-car purchases•Cash for Clunkers21-19When There is No Authority to Tax or Regulate•Global Warming crosses governmental boundaries.•There is no motivation for an individual country to limit pollution that contributes to global warming.•No government can enforce the Kyoto Protocol21-20Economic Consequences of Kyoto (if it were implemented)•The United States is 25% above its Kyoto target for Greenhouse gasses. •Estimates vary of how much energy prices would have to rise in order to reduce US GHG production to the Kyoto targets.–Low-end estimates: 25%–High-end