Resource and Environmental Economics

If prospective gainers could compensate (any) prospective losers and leave no one worse off, a project/policy should be implemented --> NPV > 0

• how to measure costs & benefits
• how to choose discount rate r and observation period T
• how to deal with uncertainties
• consideration of distribution and fairness
• ethical consideration

• Avoidance cost approach: measure money spent in order to avoid negative environmental issues
  e.g. installation of air filters, construction of dams
  Problem: those goods also generate other benefits --> difficult to distinguish
• Travel cost approach: measure amount demanded at a certain price and fit demand curve
  e.g. to measure benefit of a clean beach, measure costs tourists are willing to pay
  Problem: accounting for substitutes (e.g. park near the beach), sample selection problem (over-representation of regular users)
• Hedonic prices: measure the correlation between environmental quality and house prices
  e.g. impact of aircraft noise on house prices near an airport
  Problem: models are extremely complex, missing important attributes can lead to considerable biases
• Contingent valuation method: measure willingness to pay for certain environmental goods
  e.g. by survey
  Problem: contradictory responses, influence of current events

• Fixed costs: construction costs, costs for change of processes etc.
• Variable costs: maintenance costs, operating costs etc.

• Stochastic risks: dependent on chance
• Systematic risks: dependent on circumstances (e.g. risk of getting cancer by smoking)

• Weakness of basic methods (travel cost, hedonic cost etc.)
• Consumer preferences are probably not the right benchmark for social decisions
• Maybe not only humans but also animals and plants should be considered

Stock based definitions:

• Weak sustainability: maintenance of aggregate productive capacity, substitution between natural & accumulated capital
• Strong sustainability: preserving the stock as it is, no substitution between natural & accumulated capital, but between natural resource types

Ecological thresholds:

• Keep safe minimal standards for all species --> natural capital stock is not allowed to fall below a certain secure threshold
• Meet conditions for ecosystem resilience

Flow based definitions:

• Obtaining constant yield of natural resources
• Nondeclining utility over time

Form of weak sustainability. Expands traditional saving definition by investment in other types of productive capital (human capital, R&D, social capital) and extraction of natural resources and pollution damages

Genuine savings = gross savings
+ educational savings
- depreciation of fixed capital
- depletion of natural resources
- pollution damages

Problem: no focus on future, monetary estimation of natural goods without market price

• Genuine savings
• Environmental Performance Index (EPI)
• Index of Sustainable Economic Welfare (ISEW)
• Ecological Footprint

Problems of those indicators:
- how to weight differnet aspects
- how to convert different indicators into a single unit of measurement

• Multidimensional index with focus on ecology
• 2 main objectives, both weighted 50%:
  - environmental health & ecosystem vitality
  - natural resource management
• fixed target setting for all indicators --> target achievement measured

Problem: even though focus on ecology, most indicators are connected to wealth & income (air pollution, drinking water quality, child mortality)

Socio-economic indicator

ISEW = personal consumption
+ welfare improving contributions
- inequality index
- defensive expenditures

Problem: unnecessary, as it is an economic indicator intended to replace GDP

Coonverts resource usage by consumption and waste into total necessary area of land and water in order to compare

Problem: countries with high area per population ratio are generally better off

If one country lowers environmental standards in order to boost its economy, others will follow to react to the competitive advantage of the former country.
Environmental standards will sink to the level of the country with the lowest standards

Counter arguments:

• environmental policies often lead to positive externalities
• environmental protection is often only a fraction of production costs
• einvornmental taxes are revenue to the government

• Rise of sea level (50cm until 2100 predicted)
• Extreme weather phenomenon
• Health effects (increasing suffering from tropical diseases like Malaria)
• Reduction of wheat harvest in most tropical and subtropical regions
• Energy consumption due to air-conditioning

• Stock S(t) gets depleted over time (not fully)
• Aggregate pollution P(S) increases with increasing stock depletion
• Damage D(P) increases with increasing aggregate pollution and time

• Entered into force 2005
• Annex I countries reduce GHG emissions until 2012 by an avg. of 5.2% below 1990 levels
• Countries of a state-community are regarded as single country (EU)
• Joint implementation: Annex I countries can pay for reduction in other Annex I countries and can get credit for this
• Clean development mechanism: Annex I countries can pay for reductions in developing countries, but only for projects that would not be imple mented otherwise

Difficulties:

• Free-riding
• Uncertainty about costs & benefits from non-abatement
• Efficiency of Clean development mechanism

Missed to include all major emitters in a meaningful way

• Signed by 195 countries
• Entered into force in November 2016 (55 countries accounting for 55% of global GHG emissions needed to ratify)
• Goal: keep temperature rise below 2°C compared to pre-industrialization

Aggreement tried to solve efficiency and equity problem of the Kyoto Protocol, by...

• reaching temperature targets at lowest economic cost
• fairly share burden between countries

• Efficiency: achieve target at lowest economic cost --> apply uniform carbon price or emission trading system
• Equity: fair burden sharing --> acceptance of agreement, raise ambitious to reach efficient target

Responsibilities are shared by all, but everyone needs to compensate in an individual way

• Ability to pay: countires with larger economic capacity should contribute more
• Policy cost sharing: countries with low implementing costs should contribute more
• Merit principle: the bigger the effort of a country, the more it should be rewarded
• Comparing like with like: emissions in times of plenty alternative energy sources are weighted differently from emissions at times with few alternatives

• Focus on individual rights and freedom
• Private property is legitimate if acquired under generally accepted rules
• Role of economic policy: guarantee property rights and market access, provide public goods, correct market failure

• Focus on individual utility, welfare and happiness
  narrow form - utility is individual
  extended form - utility includes utility of other individuals and value of nature
• Social welfare is a function of individual utilities
• Government should maximize social welfare
• No concept of justice

• Social welfare: aggregation of individual utilities
• Intertemporal welfare: welfare over the future, discounted with the utiliy's discount rate
  \(\displaystyle{W}=\displaystyle\sum_{t=0}^\infty \frac{U_t}{(1+\rho)^t}\) or \(W=\displaystyle\int_0^\infty U_te^{-\rho t}dt\)
  \(U_t\): utility at time t
  \(\rho\): discount rate of utility

• individual benefits from natural resources
• central ecological functions of natural resources
• costs of utilization and exhaustion of natural resources

Fair distribution is reached by a concensus of free and rational individuals who decide under a veil of ignorance referring to generation, position, attitude etc. A unequal distribution will only occur if:

• it improves everyone's position - e.g. people creating positive externalities will receive more
• it is connected to specific positions - people with high responsibility

• Economic: externalitites, public goods, monopolies
• Non-economic: illegal trade with restricted goods, undermining of governmental or state controls, ethical concerns

Change incentives such that individuals take account for externalities

• taxation of negative externalities
• subsidization of positive externalities
• Industrial policy (e.g. protection of patents)

Tax that targets the internalization of negative externalities by taxing them.

Supply curve shifts upwards, price for consumers increase, quantity supplied & demanded decreases, deadweight loss occurs

Gross benefit (avoided area) = grey+orange area ABCD
Cost = grey area ABD
Net benefit = gross benefit - cost = orange area BCD
Tax income (transfer, not cost) = yellow area

Possibility for externalities to be internalized without government intervention --> bargaining between generator of externalities and parties affected at no charge --> efficient

Assumptions:

• no transaction costs
• perfect information (about all utility functions)
• perfect communication

• Flow-damage pollution: damage results only from the flow of residuals and immediately drops to zero if emission flows stop (e.g. noise, light)
• Stock-damage pollution: damages only depend on the stock of the pollutant (e.g. heavy metals)
• Stock-flow pollution: mixe of both types (e.g. CO2, waste emissions)

Optimal level of pollution: marginal benefits = marginal cost --> \(\frac{dB(M)}{dM}=\frac{dD(M)}{dM}\)

• Campaign: influence behavior of individuals without creating mandatory rules
• Direct production of environmental quality. nature reserves, waste water treatment, aeration of lakes
• Prevention of pollution: support new technologies, cooperation of universities and private sector
• Command and control insturments: standards on input, technology, pollution etc., making excessive pollution illegal
• Economic incentives: set incentives to enhance individual optimization (tax, subsidies, tradable permits)

Advantages:

• cheaper if monitoring costs are high
• easier if optimal abatement level is zero or close to zero (very toxic substances)

Disadvantages:

• uncertainty about level of intended standards (e.g. efficiency: marginal costs = marginal damage)
• same standards applied everywhere or vary regionally
• regulations create little incentives for innovation ones standard is reached
• if abatement costs vary, command & control instruments do not minimize total social abatement costs

• Pigouvian tax sets pollution price, pollution quantity results from demand curve
  --> pollution targets might be missed, if demand curve is estimated falsly
• Pollution certificates set maximum pollution quantity, price for certificates results from demand curve
  --> pollution targets are met for sure

• Ambient pllution standards: regulate the quantity of matter in the ambient environment
  e.g. parts per million, ozone concentration
• Emission standards: regulate level of permitted emissions
  e.g. rate of emission, total amount of emitted pollutant
• Technology standards: require a certain technology, practice or production process
  e.g. catalytic converters in cars, lead-free gasoline, energy labelling (A,B,C,D,E,F)

• Elimination of technical and economic inefficiency (e.g. energy usage)
• Trigger for technological change
• Positive side-effects (e.g. reduction of GHG reduces environmental warming and as side-effect improving health
• Double dividend: tax revenue of emission tax can be used to reduce marginal tax rate of other taxes --> substitution of taxes; if other tax have a distortion effect, the reduction of this tax will increase efficiency
  this turned out to not work properly

Cobb-douglas output function:

\(Y=K^{\alpha}R^{1-\alpha}\)

\(K\): physical capital
\(R\): non-renewable resource use

Extracting and selling a resource and investing the resulting profit in bonds with interest rate r

\(\pi ^R\): rent, per unit resource profit --> \(\pi ^R=\text{price}-\text{per unit extraction cost}\)

Three possibilities:

• \({\pi _1^R \over \pi_0^R}>1+r\) --> keep resource stock fully in the ground
• \({\pi _1^R \over \pi_0^R}<1+r\) --> sell the whole resource stock
• \({\pi _1^R \over \pi_0^R}=1+r\) --> equilibrium (no arbitrage possible)

\({p_{t+1}^R - c_{t+1}^R \over p_t^R - c_t^R} = 1+r \to r = {{d(p^R - c^R) \over dt} \over p^R - c^R} = {{d\pi ^R \over dt} \over \pi^R}\) --> in order to have profit when leaving the resource in the stock, the rent must increase