Unit 20 ECONOMICS OF THE ENVIRONMENT - PowerPoint Presentation

Slide1

Unit 20

ECONOMICS OF THE ENVIRONMENT

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Introduction

Abatement: How much

?Abatement policiesFuture technologies and lifestyles

OUTLINE

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A. Introduction

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The Context for This Unit

L

iving standards increased significantly due to technological progress and adoption of capitalism.

However, this rapid economic growth has negatively affected

the environment and natural resources e.g. overfishing, pollution.

What are the future consequences of our actions?

How can we lessen our impact on the environment?What are the limitations of these approaches?

(Units 1 & 16)

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This Unit

The supply of

natural resources (raw materials in the Earth’s crust) is vast.

That is why world

commodity prices (

inflation adjusted

) have not changed much over the long run – growing demand pushes prices up, but cheaper extraction technology pushes prices down.

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This Unit

Economic growth is a challenge to natural resource management.

Changes (e.g. overfishing, deforestation) may become self-reinforcing due to

positive feedback processes

.

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This Unit

The issue of climate change: Using economic models to explain why environmental degradation occurs.

Discuss and evaluate environmental policies

Measuring costs and benefits: methods and limitations

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B. Abatement: How much?

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Climate Change

Capping emissions is not enough (stock of CO2 matters, not the flow)

May be irreversible

Requires global cooperation

Conflicts of interest (between/within countries and generations)

Worst-case scenario is

catastrophic

Climate change is a particularly difficult environmental problem to handle, for various reasons:

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Abatement cost curve

Abatement policies

can address climate change. The degree of abatement chosen depends on the relative costs and benefits.

The

abatement cost curve

shows the

per-unit cost of abating greenhouse gas emissions using abatement policies, ranked from the most cost-effective to the least (the marginal cost curve).

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Least-cost abatement curve

This curve shows all the combinations of environmental quality (E) and cost of abatement, when the abatement technologies are adopted in ascending order of cost.

Point A is

dominated

by points A’ and A’’, but may still be chosen if abatement policies are inefficient e.g. adopting more costly methods first.

Flipping this curve horizontally gives the feasible set (next slide).

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Choice of abatement level

MRT = marginal productivity of abatement expenditures

MRS = opportunity cost of abatement expenditure

Policymaker’s optimal abatement choice is where

MRS = MRT

The feasible set shows the tradeoff

between

consumption

and environmental

quality.

Optimal choice

depends on 1. Citizens’ value for the

environment (affects MRS), and 2

. Costs of abatement

(affects MRT).

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Conflicts of interest

Polluter pays principle

: those responsible for external effects should pay for these

damages.

This is not always the best policy:

Fairness – polluters may be low-income families e.g. burning wood.

Effectiveness – subsidies/taxes may be less costly than tracking down the polluters.

Costs of abatement are not equally shared across

society.

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Conflicts of interest

Citizen’s MRS = tradeoff between wages and environmental quality (leave-town condition)

Firm’s MRT = slope of

isocost

with 0 economic profit (shut-down condition)

Pareto efficiency curve

gives all Pareto-optimal outcomes.

Benefits of abatement are also not equally shared across

society.

Unlike citizens, polluters may not have to experience pollution.

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Conflicts of interest

Bargaining power depends on:

Enforcement capacity

Verifiable information (ability to detect pollution)

Consensus among citizens about environmental quality

Lobbying by the firm

Legal entitlement to pollute e.g. pollution permits

Distribution of mutual gains from abatement depends on relative bargaining power of

groups.

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C. Abatement policies

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Types of abatement policies

Policymaker’s aim: Achieve the desired amount of effective abatement (e.g. units of CO

2) at minimum cost.

There are 2 types of abatement policies:

1.

Price

-based policies use taxes and subsidies to affect pricesAim to

internalise

the external effects of individual choices

2.

Quantity

-based policies

use bans,

caps,

and

regulations

How can we achieve the desired level of abatement?

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Cap and Trade

Environmental external effects arise because of missing markets.

Cap and trade

creates a market for emissions:

Government sets a limit (cap) on pollution and creates enough permits to meet this cap.

Governments allocate permits (e.g. via auction), and firms buy/sell permits amongst themselves.

Cap and trade is a combined (quantity- and price-based) policy.

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Cap and Trade: Model

Example: Firm A has a lower marginal private cost of abatement (MPCA) than Firm B.

Both firms benefit from buying/selling permits until the MPCA is equalized across firms.

Objective of cap and trade = abatement is done by the firms for which this is least costly.

Firms trade

until permit price = MC of abatement (Pareto-efficient

).

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Cap and Trade: Issues

Policymakers need to set the correct total

level of

abatement (the cap) – not easy to determine

Putting a price on pollution

m

ay send the wrong signal to firms e.g. making production profitableExample: EU Emissions Trading

Scheme set too large a cap. The price fell dramatically after the 2008 crisis, providing little incentive to abate.

A price floor on permits can mitigate this issue (e.g. UK).

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Measuring environmental costs/benefits

1.

Contingent valuation: Use surveys

to assess the value of nonmarket

resources

A

stated preference approach - assumes respondent’s statements indicate their true preferences2. Hedonic pricing:

Uses prices of market goods to infer the economic value of

unpriced

attributes e.g. environmental qualities

A

revealed preference

approach – uses

behaviour

as an indication of preferences

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D. Future technologies and lifestyles

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Effect of technological improvement

Technological improvement increases the

marginal productivity of abatement expenditure (MRT of consumption into abatement), making the feasible frontier steeper.

Technological

improvements can enlarge

the feasible set by making abatement more efficient or reducing the environmental costs of

consumption.

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Example: Renewable energy production

Subsidies to firms that produce solar panels has helped fund R&D in alternative energy sources.

Growing demand for solar panels led to a sharp decrease in their price, thanks to

l

earning by doing

in the production process.

Innovation rents can drive progress, leading to technological breakthroughs that deliver substitutes for non-renewable resources.

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Taxing firms

Example: Without a tax, the coal-intensive technology is cheaper (red).

A

t

ax on coal makes solar-intensive technology cheaper (blue lines).

Taxes on firms may make renewable sources of energy relatively more profitable, but also make adoption necessary to stay competitive.

Taxes can create innovation rents by changing relative prices, which promotes private-sector

innovation.

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Taxing consumers

Taxes can create lifestyle changes that improve well-being by changing how much consumers value goods.

Example: A tax on air travel reduces the feasible set (

income effect

) and encourages greater consumption of free time (

substitution effect

).

Overall effect = income effect + substitution

effect

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Modelling environmental dynamics

A healthy environment and degraded environment are both equilibria. The

disequilibrium process

is the movement from one equilibrium to another.

Environmental tipping

point

:

On one side, processes of environmental degradation are self-limiting.

On the other side, positive feedbacks lead to self-reinforcing degradation.

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Example: Arctic sea ice

There are two stable equilibria (a lot of ice or no ice), separated by an unstable equilibrium at A (tipping point).

Climate change shifts the entire S-shaped EDC down, which at some point will make the good equilibrium and tipping point disappear. The system is locked in the bad (no ice) equilibrium.

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Addressing climate c

hange: Challenges

Addressing climate change is difficult because:

1 People value the economy more than the environment

Lack of adequate information and conflicts of interest

2. Requires international cooperation (Prisoner’s Dilemma, Unit 4)

Countries have committed to emissions cuts and submitted plans for doing so, but these plans are not consistent with the temperature stabilization goal.

3. Future generations are unrepresented

Discounting

: how much should we value the costs/benefits of our actions on future generations?

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Win-win policies

There is not always a tradeoff between consumption and environmental quality.

Some technologies are

cost-saving

e.g. fuel-efficient vehicles, insulation in houses.

This abatement potential means that part of the feasible frontier has a positive slope. These unexploited mutual gains suggest more is needed than market incentives.

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Summary

Climate change: Why it is an issue and how to address it

Price-based and/or demand-based policies

e.g. cap and trade, taxes, subsidies

Measuring environmental costs and benefits

Modelling

environmental dynamics2. Problems when addressing climate change

Conflicts of interest – how to divide costs and benefits

International cooperation required

How to discount effects on future

generations

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In the next unit

Innovation: successful innovation systems, and sources of market failure

The effects of innovation on inequality

The role of public policy in innovation markets