Economics of Environmental Quality

1
Economics of Environmental Quality
2
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

3
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

4
Marginal Damage Function

• Emissions function
• Damage f(quantity of residual)
• Ambient function
• Damage f(concentration of pollutant)

Noise SO2 Toxic chemicals
threshold effects
5
Marginal Damage Function

MD2
MD1
25
10
Emissions
150
50

• 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

6
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

7
Abatement Costs

• Costs incurred to reduce pollution emissions
• Marginal Abatement Costs (MAC) rise as emissions
  are reduced

MAC2
50
MAC1
Unregulated Emissions
20
Emissions
240
500

• 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

8
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

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Optimal Emissions

• Optimal level is one which minimizes total social
  costs
• Occurs where MD MAC

MD1
MAC1
18
10
TD1
TAC1
Emissions
200
75
450
TD1 (10)(125)(.5) 625
TAC1 (10)(250)(.5) 1250
Total Social Cost TD TAC 1875
10
Southern Miss Office of Sustainability

• Eco Eagle Bike program

"We were all expecting this," said Larry Lee,
chief sustainability officer, "we just weren't
expecting it in a week."
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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?

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Optimal Emissions

MD2
MAC1 C
MD1
MAC1
MAC2
Emissions
E1
E2
E3

• 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?

E falls
E falls
E rises
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Problem Set 2

• Question 3

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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
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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
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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?

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Benefit-Cost Analysis

MD1
MAC1
a
d
c
b
Emissions
E
E2
E0

• 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 (ab)/b
• At E (abcd)/(bc)

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Benefit-Cost Analysis
Benefits
time
today
Costs

• 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?

Interest rate on savings accounts
Interest rate on borrowing money
OMB r 7 CBO r 2
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Benefit-Cost Analysis

• Future generations?
• Discounting downgrades future damages
• Policies with short run benefits and long run
  costs are preferred by todays 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

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Benefit-Cost Analysis
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Measuring the Benefits of EQ

• Direct Damages
• Willingness-to-Pay Approach
• Revealed Preferences
• Stated Preferences

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Direct Damages

• Health damages
• Health f(life style, diet, genetics, age, AQ)
• Medical expenditures
• Lost income due to illness/death

cost of illness study
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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.
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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
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Indirect WTP Methods

• Value of Health thru Averting Costs
• Expenditures made to avoid bad outcomes
• Value of Life thru Wage Rate Differentials
• statistical life

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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
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Value of a Statistical Life Estimates
Source Table 7.2, p. 145, Field and Field (2006)
28
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.
29
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.
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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

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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

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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.)
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Sample CV Questions

• First, lets 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. Lets 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.)
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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.
35
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

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Direct WTP Methods

• Problems with CV
• Hypothetical nature of questions
• Truthfulness/free-rider problem
• Framing issues
• WTP vs WTA

37
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
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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

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Concepts of Cost
Social Costs Private Costs External Costs

• Explicit Cost
• Capital Costs plant and equipment (replacement
  and expansion)
• Operating Costs production, maintenance,
  abatement process (labor, materials, RD)
• Enforcement Costs monitoring, administration
• Implicit Costs
• Higher product prices/reduced consumption
• Inconvenience of using public transportation/carpo
  ols
• Media switching
• Illegal dumping

40
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
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Single Projects

• Examples
• Waste treatment plants
• Flood-control
• Solid waste handling
• Beach restoration
• Public park
• Wildlife refuge

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Projected Costs of a Small Wastewater Treatment
Plant (1,000)
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Costs of a Local Regulation

S2
S1
P
Market price
Apples
q1
q2

• 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

Why is the lost income not necessarily a social
cost?
44
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
S2
P2
a
c
b
S1
P1
D
q2
q1
output
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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
46
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.