Economy and Environment Program for Southeast Asia

ENVIRONMENTAL ECONOMICS

A

TEACHERS’ MANUAL

Undergraduate Level

By

Herminia A. Francisco Bui Dung The Pham Khanh Nam

August 2005

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PREFACE

This manual was written to support the teaching of undergraduate environmental economics course in Vietnam Universities. Some time in 2003, a number of senior researchers of the Economy and Environment Program for Southeast Asia (EEPSEA) requested that EEPSEA offers a 3-week training course for teachers of Environmental Economics in the country. The request in turn was precipitated by the new mandate from the Ministry of Education in Vietnam that makes Environmental Economics a required course in all Bachelors’ Degree in Economics and Management for all colleges and universities. Aware that the capacity of teachers to teach Environmental Economics varies across the country as training of teachers varies also from self-study, short-term training, to a formal course in an undergraduate/graduate degree from local universities or abroad, EEPSEA acceded to the request and offered the course in August 2005. The course though can be used also in other colleges and universities in Southeast Asia.

The training course was designed to teach both the subject matter contained in an

internationally-comparable undergraduate environmental course and to enhance teachers’ skills in teaching this subject. A teachers’ manual was developed to support the teaching of the training course, but the intended use was to support the Environmental Economics teachers in their job. The manual was refined during the training course based on feedbacks from the teachers' trainees and teachers’ experiences on the use of the manual.

The manual follows the course outline for Environmental Economics given as part of this manual. For each lecture topic, the teaching objective for the topic was indicated, along with the main points that teachers should stress during the lecture, and a proposed topical outline. Each lecture chapter was supplemented with a set of discussion questions/problem sets with solutions. The proposed course outline is for a 4-unit teaching load (60 hours teaching). It could be modified to a 3-unit teaching course in two ways: deleting the Natural resource Economics Section OR deleting the Cost-Benefit Analysis section, particularly if a separate course on Natural resource economics or Cost-Benefit Analysis is offered as part of the students’ curriculum in the College or University. It is understood that this manual is not to be given to students at any time but should be used solely by instructors teaching this course. The answers to questions and problem sets in the Manual can be found in a separate file accompanying this manual.

This course manual relied heavily on the Instructors' Manual developed by Forsdyke,

Field, and Olewiler (2002), which in turn was used to support the use the textbook: Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition. Needless to say, many chapters of this book are used as recommended teaching materials for the course, along with the books by Pearce, Turner and Bateman (1995) and many other references (see Course Outline). A number of the discussion questions and the problems were also taken from the book on Natural Resource and Environmental Economics (2003-3rd edition) by Perman, Ma, McGilvray, and Common, downloaded from their website. Relevant chapters of other books in environmental and natural resource economics and EEPSEA research reports as case study materials have also been translated into the local language.

The training course, manual development, and translation of materials were funded by

the Economy, Environment, and Program for Southeast Asia (EEPSEA). Special thank goes to Dr. Nancy Olewiler for providing technical guidance in the development of the course outline, review of the manual and for granting access to F, F, and O (2002) manual. This EE Teachers’ Manual was developed by Herminia A. Francisco, Bui Dung The, and Pham Khanh Nam, with inputs on certain section from Pham Thi Giac Tam.

EEPSEA Secretariat

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PROPOSED COURSE OUTLINE ENVIRONMENTAL ECONOMICS

I. Course Description & Prerequisite

Environmental economics is designed to enable students to understand the linkages between economic activities and the environment and vice versa. It discusses the theories and the tools that can be used to understand and measure said relationships so that appropriate decisions on how best to manage the environment and the natural resources can be identified. Prerequisite: Microeconomics

II. Course Objectives

At the end of the course, the students are expected to have:

1. Understood the linkages between the various environmental (E) & natural resource (NR) problems and the economic activities that affect them;

2. Learned how these E & NR problems could be addressed using appropriate economic instruments and institutional/property rights reforms;

3. Gained familiarity on the various valuation techniques that could be used to monetize environmental impacts of economic activities/ programs/ policies; and

4. Appreciated how benefit cost analysis can be applied in evaluating various resource/environmental management options.

III. Course Content No. of Hours

Lecture 1: Introduction: what is environmental economics……...……………2 hrs

A. Definition of what environmental economics covers. B. The economic view on what causes environmental problems. C. Role of incentives in explaining the environmental problem D. Role of property rights E. Economic manifestations of environmental degradation F. The concept of Sustainable Development and growth G. Benefit-cost analysis as a framework

Basic Reference:

Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 1. Additional Readings: Panayotou, T. 1993. Green Markets: The Economics of Sustainable Development. Chapter 1. The magnitude of the problem. pp. 1-38.

Lecture 2: Economy-Environment Linkages & Overview of Environmental/ Natural Resource Issues

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Topic 1: Economy-Environment Linkages…...1 hr Topic 2: Overview of Environmental and Natural Resource

Issues in Vietnam ……………………………………………………3 hrs

A. Water and Air Pollution B. Land Degradation C. Resource Depletion: Forest, Fish, and Minerals D. Global Concerns: Climate change and Biodiversity E. Sustainable Development

Basic Reference: Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 2. WB. 2001. Vietnam Report. Chapter 4: Trends in the Environment Additional Reading: Tietenberg, T. 2003. Environment and Natural Resource Economics. 6th edition. Chapters 1 & 2: pp 1-19.

Lecture 3: Causes of Environmental Problems…….………………… 3 Hrs

A. Market failures C. Property rights D. Policy failures E. Implications on the approaches to control environmental degradation:

Basic References: Turner, Pearce and Bateman. Environmental Economics: An Elementary Introduction.1994. Chapters 5, 6, 15 (Box 15.3) and 23. Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 3 & Chapter 4 Panayotou, T. 1993. Green Markets: The Economics of Sustainable Development. Chapters 2 and 3. Lecture 4: Brief Review of Welfare Economics Concepts Topic 1: Economic efficiency and markets: Benefits (Demand) and Costs (Supply) ………………………………………… 3 hrs Basic reference:

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Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 3. Topic 2: Defining and Measuring Welfare Changes …... 3hrs Basic Reference: Freeman, Myrick.A. 2003. The Measurement of Environmental and Resource Values: Theory and Methods. 2nd edition. Chapter 3. “Defining and Measuring Welfare Changes, Basic Theory”, pp 43-70, 85-89. Lecture 5: Pollution Economics Topic 1: Optimal Level of Pollution………..………………………………… 3hrs Basic References: Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 5) Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 5. Topic 2: Coase Theorem and Property Rights ………………………………..2hrs Basic References: Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 10) Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. (Chapter 10)

Topic 3: Environmental Standards ……………………………………………. 2hrs Basic Reference: Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. (Chapter 11) Topic 4: Taxes and Subsidies ………………………….………………………...2hrs Basic References: Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. (Chapter 12) Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 12)

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Topic 5: Transferable Discharge Permits…...2 hrs Basic Reference: Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. (Chapter 13)

Topic 6: Evaluating Environmental Policy Instruments……..…………….. 2hrs Basic Reference Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. (Chapter 9 and 14) Lecture 6: Environmental Valuation Topic 1: Why Value the Environment and the

Concept of Total Economic value …….…………………….………….1 hr Basic References: J.T. Winpeny. Values for the Environment. 1991. Chapter 1: Introduction: Why Value the Environment? OECD. 1995. The Economic Appraisal of Environmental Projects and Policies: A Practical Guide. Chapter 1: Introduction. Turner, Pearce and Bateman. Environmental Economics: An Elementary Introduction.1994. Chapter 8: Valuing Concern for Nature. Topic 2: Steps in Valuation & Overview of Valuation Techniques……………1h30

Basic References: OECD. 1995. The Economic Appraisal of Environmental Projects and Policies: A Practical Guide. Chapter 3 &4 Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 8 ADB. 1996. Economic Evaluation of Environmental Impact - A Workbook. Environment Division, Asian Development Bank. Manila. Suggested Readings: Dixon, John A; Louise Fallon Scura, Richard A Carpenter and Paul B Sherman. 1994. Economic Analysis of Environmental Impacts. Chapters 1, 3 & 4. Topic 3: Market-based techniques ………………….………………………….2 hrs

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Basic References: Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 7) Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 7 Sinden J. and Thampapillai, DJ. 1995. Introduction to Cost-Benefit Analysis. Longman. Melbourne. Chapter 6 Topic 4: Travel Cost Method ………….…………………………………………2 hrs

Basic References: Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 7 Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. Chapter 6 Sinden J. and Thampapillai, DJ. 1995. Introduction to Cost-Benefit Analysis. Longman. Melbourne. Chapter 6 Topic 5: Hedonic Pricing Method…………………………………………….…2 hrs Basic References: Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 8) Sinden J. and Thampapillai, DJ. 1995. Introduction to Cost-Benefit Analysis. Longman. Melbourne. Chapter 6 Markandya A, Harou, P., Bellu, L, and Cistulli, V. 2002. Environmental Economics for Sustainable Growth: A Handbook for Practitioners. Edward Elgar. Chapter 11. Topic 6: Contingent Valuation Method (CVM) …………………..……………. 2 hrs Basic References: Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 7 Additional Readings: Callan, Scott J. and Janet M. Thomas. 2000. Environmental Economics and Management: Theory, Policy and Application. Chapter 8: Assessing Benefits for Environmental Decision Making.

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Dixon, John A; Louise Fallon Scura, Richard A Carpenter and Paul B Sherman. 1994. Economic Analysis of Environmental Impacts. Chapter 5. Bateman, I.J, Carson, R, Day, B., Hanemann, N, Hett, T. Hanley, N., Jones-Lee, M. Loomis, G., Mourato, S., Ece Ozdemiroglu. 2004. Economic Valuation with Stated Preference Techniques: A Manual. Edward Elgar Publishing. UK. Topic 7: Benefit Transfer Techniques…………………………………………0.5 hr Basic References: Stale Navrud. 1996. The Benefits Transfer Approach to Environmental Valuation. EEPSEA paper. Lecture 7: Cost-Benefit analysis as a tool in Environmental/ NR Management…………………………………….………………………………………. 8 hrs

A. Overview of Cost-Benefit Analysis B. Steps in Cost-Benefit Analysis C. Issues in Cost-Benefit Analysis

Basic References: Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 6, p.106-122 Sinden J. and Thampapillai, DJ. 1995. Introduction to Cost-Benefit Analysis. Longman. Melbourne. Chapter 8. Boardman, A.E., Greenberg, D.H., Vining, A.R., and D.L. Weimer. 1996. Cost Benefit Analysis: Concepts and Practice. Prentice Hall. New York. Chapter 1.

Lecture 8: Natural Resource Economics Topic 1: Introduction to natural resource use,

Property rights, rent, and land value………………………..………… 1 hr Hartwick, J. and N. Olewiler. 1998. The Economics of Natural Resource Use, 2nd edition: Chapters 1 and 3 (pp57-73). Topic 2: Non-renewable Resources............ …………………………………..…. 2 hrs Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. Chapter 16 Hartwick, J. and N. Olewiler. 1998. The Economics of Natural Resource Use, 2nd edition: Chapter 8 Topic 3: Renewable Resources: Fishery and Forestry……………………….… 6 hrs

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A. The fishery B. The forestry: a simple model

Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. Chapter 15 Hartwick, J. and N. Olewiler. 1998. The Economics of Natural Resource Use, 2nd edition: Chapters 4 and 10

Lecture 9: Application of Environmental Policy in Vietnam………………………………………………………….. 4 hrs

A. Framework Laws of Environmental Protection and Provisions in Vietnam. B. Institutional Arrangements: Organization Structures of government;

Environmental institutions; environmental legislations; C. Applications of environmental legislation in Vietnam: achievements and

constraints. D. Environmental Problems where economic instruments are/could be useful.

Basic References: www.luatvietnam.com.vn; www.monre.gov.vn; www.nea.gov.vn

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ENVIRONMENTAL ECONOMICS (TEACHERS’ COURSE MANUAL)

LECTURE 1: INTRODUCTION

TOPIC: What is Environmental Economics? Objective: To give students an overview of the type of problems confronting environmental economists and how said problems may be addressed using basic analytic tools of microeconomics. The students are expected to get a glimpse of what the various topics of environmental economics are in this first lecture. Main Points: The main ideas that are critical to teach students in this topic are:

1) The critical role of incentives and property rights (or lack thereof) in producing environmental degradation and in designing environmental policies.

2) The tradeoffs between economic growth and environmental quality, both in the

short and long term.

3) The need to analyze short- and long-term benefits and costs of environmental improvements and how benefit cost analysis could play a role in such an analysis.

Teaching Hour: 2 hours Suggested Topical Outline:

A. What environmental economics is and explain how it is similar and different from other economic subjects.

B. The Economic approach to explaining what causes environmental problems. C. Role of incentives in explaining the environmental problem by way of

examples—at the household & firm levels. D. How property rights could also be used to explain why environmental

problems exist. E. The economic manifestations of environmental degradation F. The concept of Sustainable Development by showing tradeoffs resulting from

economy & environment linkages G. Benefit-cost analysis as a framework for analyzing the tradeoffs between

economy and environment and in policy analysis. Introduce role of valuation here.

Teaching Ideas:

• This section should set a positive tone that environmental economics is NOT anti-environment, something that some environmentalists might be thinking as they think of economists in general. Instead—the instructor should emphasize how

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environmental economics can in fact be used to design appropriate environmental policies. Its usefulness in evaluating the merits of economic policies by bringing into the picture the value of the environment should also be highlighted. Yet—as the usefulness of environmental economics is emphasized, one should also highlight the limitations in the use of the tool—which is brought about mainly by the limitations in our understanding about the economy-environment linkages and by the limitations in the data available to understand these relationships.

• The use of local environmental problems to highlight the role of incentives and property rights situation should be used and students should be encouraged to participate in the analysis of why these problems exist.

• At this stage, the teachers may be wondering why we are introducing such concepts like sustainable development and benefit cost analysis-- please be reminded that the discussions at this stage are only brief and are made only to provide students a glimpse of the key concepts in environmental economics, which will be discussed in greater detail as the course progresses.

Basic Reference: Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 1: What is environmental economics? pp 2-19.

Additional Readings: Panayotou, T. 1993. Green Markets: The Economics of Sustainable Development. Chapter 1. The magnitude of the problem. pp. 1-38.

Discussion Questions: Cf: F & O (2005) and F, O, & F (2002)

Q1. Why should a tax on gasoline provide a larger incentive to reduce air emissions from motor vehicles than an annual tax on owning a vehicle?

Q2. What factors influence the trade-offs illustrated in the production possibility frontier? How can environmental policy affect these trade-offs?

Q3. Show how technological change could allow firms to produce goods and services with less pollution. Show the answer graphically using the PPF.

Q4. Can you think of any incentives that you face that encourage you to behave in ways consistent with sustainability? Can you think of any that have the opposite effects? How could the latter be changed?

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LECTURE 2: ECONOMY-ENVIRONMENT LINKAGES & OVERVIEW OF

ENVIRONMENTAL/NATURAL RESOURCE ISSUES

TOPIC 1: Economy-Environment Linkages Objective: The students should gain a clear understanding of how the economic system is linked to the natural environment and what concepts are relevant in analyzing pollution problem. Main Points: This section discusses the material/energy balance relationship as the main basis for the link between the economy and the environment. It then shows the ways by which one may aim to reduce the residuals resulting from said linkage as targets of environmental policies. Finally, the different concepts related to discussion of pollution/pollutants are discussed. Teaching Hour: 1 hour Suggested Topical Outline:

A. Diagram of relationship between the economic system and the natural environment is explained.

B. The law of thermodynamics as they explain the ability of natural resource system to absorb wastes.

C. How is environmental economics different from natural resource economics? D. Where are the residuals from economy-environment linkage coming from and

how these may be reduced? E. Sustainable Development: Balancing Growth with Environment F. Emissions, Ambient Quality and Damages Linkages G. Types of Pollutants

Teaching Ideas:

• The use of power point/overhead presentation of Figure 2.1 in F & O book is encouraged.

• The analysis of the economy-environment linkages should emphasize the relationships between the raw material inputs coming from nature and the residuals discharged to the environment—using law of thermodynamics. In addition, one should also discuss that these inputs and outputs need not be damaging in a state of ecological equilibrium. This happens when some of the residuals get used as inputs as well—e.g. manure and compost as natural fertilizers and recycling of some waste materials. One should also mention that organisms other than humans could also pollute or damage the ecosystem. The example cited is unicellular organisms that affect the ability of photosynthesis thus producing oxygen as by-product, which could accumulate to kill many organisms.

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• The notion of Sustainable Development could be brought in here—as a way to reduce environmental damages while pursuing economic growth.

Basic Reference: Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 2: Linkages between the Economy and Environment: Taxonomy Additional Reading: Tietenberg, T. 2003. Environment and Natural Resource Economics. 6th edition. Chapters 1 & 2: pp 1-19. Discussion Questions: (Cf: F & O, chapter 2; and F, O, & F 2002) Q1: How does population growth affect the balance of flows shown in Figure 2.1? Q2: If all goods can be changed overnight so that they lasted twice as long as before, how would this change the flows shown in Figure 2.1 in the short and long runs? Q3: A given quantity of a residual discharged at one time and place can be a pollutant; if it is discharged at another time or place, it may not constitute a pollutant. Why is this true? Q4: Why are long-lived cumulative pollutants so much harder to manage than short-lived, non-accumulative pollutants? Q5. Suppose that we observe that emissions of pollutants have decreased but that environmental quality has not increased—what might be the explanation? Q6. “An examination of natural resource matters ought to recognize technical/scientific, economic, and socio-political considerations.” Explain (Perman, Ma, McGilvray, and Common, 2003)

TOPIC 2: Overview of Environmental and Natural Resource Issues in Vietnam Objective: The main goal of this topic is to provide students an overview of the environmental and natural resource issues/problems and challenges faced by the country—something that students have to bear in mind as the course discusses how environmental economics tools could be used to help address these problems. Main points: This lecture should provide an overview of the major environmental and resource problems associated with: Water and Air Pollution, Land Degradation, Resource Depletion: Forest, Fish, and Minerals, and Global Concerns: Climate change and

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Biodiversity. Finally, the idea behind the concept of Sustainable Development should likewise be discussed. Teaching Hour: 3 hrs Topical Outline:

A. Water and Air Pollution B. Land Degradation C. Resource Depletion: Forest, Fish, and Minerals D. Global Concerns: Climate change and Biodiversity E. Sustainable Development

Teaching idea: This topic is best discussed as an assigned topic to group of students. They should be assigned to prepare a term paper of these topics by group and to report on them in the class. This means that the assignment should be given at least 2 weeks in advance. Each sub-topic or resource issues should be further subdivided into three sub-groups, with each group assigned to cover any one of the following research areas: a) Situationer in terms of status of the natural resource/environmental resource; b) Extent of the environmental problem/natural resource depletion; and c) Measures currently in place to address the problems and major challenges facing the government in as far as that specific sector/resource is concerned. The students should be encouraged to look up at the most recent publications on this topic. The allotted lecture time could be used for students to provide information/report on the topics assigned to them. The class should be encouraged to ask questions on the reported topics.

Basic Reference: WB. 2001. Vietnam Report. Chapter 4: Trends in the Environment.

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LECTURE 3: CAUSES OF ENVIRONMENTAL PROBLEMS

TOPIC: What are the major causes of environmental problems in the world? Objectives: The students should be able to explain the various underlying causes of environmental degradation and understand how these causes may be addressed to reduce the problems. Main points: The three major causes of environmental degradation are categorized into market failures, property rights failures and policy failures. How these failures come about should be explained to the students. Likewise, the ways in which they could bring about negative effects on the environment should be discussed. The concept of economic efficiency in a perfectly functioning competitive market system will be a good way to start up discussion on market failures. The discussion should define the baseline conditions—from which situations with market failures could be compared. In here, the divergence between private and social costs is highlighted, resulting mainly from the existence of external effects that markets are not able to capture. Illustration of real life cases where such divergence exists should be used to make the concepts concrete.

The discussion on property rights failures should make clear the distinction between open-access situations and those with private and common-property rights. One should drive the point that open access situation leads to faster resource extraction and hence, should be addressed.

Policy failures can come about from policies directed to some other goals but have unintended side effects on the environment or could come from government interventions to mitigate market failures. Illustrations on cases of said policy failures could be used to explain how they could cause environmental degradation.

Proposed Topical Outlines:

A. Market failures:

1. Concepts of Market Failures. 2. Externalities as a source of market failure: External costs and external benefits. 3. The divergence between economic efficiency and social efficiency.

B. Property rights:

1. Concepts and types of ownership structures 2. Characteristics of well-defined Property rights 3. Public goods and the problem of free rider.

C Policy failures:

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1. What are policy failures and what are their causes 2. Types of policy failures 3. Illustrations of policy failures

D. Implications on the approaches to control environmental degradation:

(Turner et al, p. 143-144) Teaching Hours: 3 hours Teaching ideas:

• The various types of externalities could be discussed with students, both from consumption and production, and both positive and negative. It should be emphasized as well to the students that pecuniary externality which is an external effect transmitted through altered prices do not cause market failure. I wouldn’t even discuss pecuniary externalities….just confuses my students.

• The discussion on property rights can be opened up by asking students the different types of property rights that exist in the country and in their locality, from private ownership to open-access situations. The various forms of property rights can then be discussed and compared in terms of the characteristics that define a non-attenuated/well-defined property rights (i.e., exclusivity, transferability, etc). The situation prevailing under open-access condition should then be elaborated with some examples on where this system prevails.

• In discussing the strength and weakness of the various types of property rights, one should point that while one may think that one property right regime may be better than the others in protecting the environment, this may not be true for all instances. For instance, private ownership is impossible to impose when dealing with public goods. In addition, it is worthwhile emphasizing that neither private ownership in an unregulated market nor state ownership with poor-informed regulatory agencies would assure one of a better environment.

• The discussion of policy failures should be put in the context of the outright thinking of some to call for government interventions in the face of market failures. In particular, one should send the clear message that government interventions may be another cause of environmental problems. Further, the introduction of the policy failures should emphasize that ignorance on unintended or side effects of a public policy could also bring about environmental problems. Government intervention should not be taken even it can achieve successfully the goals if the costs of these interventions exceed the benefits it may bring in.

Basic References: Turner, Pearce and Bateman. Environmental Economics: An Elementary Introduction.1994. Chapters 5, 6, 15 (Box 15.3) and 23. Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 3 & Chapter 4

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Panayotou, T. 1993. Green Markets: The Economics of Sustainable Development. Chapters 2 and 3.

Discussion questions and Exercises (cf: Analytical problems in Field& Olewiler, p.84, F, O & F, 2002)

Exercises

E1. Below are portions of the demand curves of three individuals for air quality in their neighborhood. Air quality (integer value only) is measured in term of µg/m3 (micrograms of SO2 per cubic meter of air). If the marginal cost of reducing ambient SO2 is $40 per µg/m3, what is the socially efficient level of air quality, assuming that “society” in this case consists of just these three people?

Quantity Demanded Costs of Sulphur Removal (dollars per microgram/m3)

A B C

60 50 40 30 20 10 0

1,400 1,300 1,200 1,100 1,000 900 800

1,200 1,100 1,000 900 800 700 600

1,500 1,400 1,300 1,200 1,100 1,000 900

E2. For the exercise in 1, prove that the socially efficient level of air quality maximizes the net social value.

Discussion Questions (Perman, Ma, McGilvray, and Common, 2003)

Q1. What is the relationship between public goods and open-access resources?

Q2. Some seemingly public goods, such as radio waves, lighthouse services, and even police and sanitation services, can be supply by private firms. Why is this so? Are there differences between these public goods and environmental services? If so, what are they? Q3. Discuss the relevance and application of the concept of externalities in environmental economics. Q4. Economists see pollution problems as examples of the class of adverse externality phenomena. An adverse externality is said to occur when the decisions of one agent harm another in an unintended way, and when no compensation occurs. Does this mean that if a pollution source, such as a power station compensates those affected by its emissions, then, there is no pollution problem? Q5. While some economists argue for the creation of private property rights to protect the environment, many of those concerned for the environment find this approach abhorrent. What are the essential issues in this dispute?

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Q6. “A clean environment is a public good whose benefits cannot be privately appropriated. Therefore, private industry which is run for private gain will always be the enemy of a clean environment.” Comment on this proposition.

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LECTURE 4: BRIEF REVIEW OF WELFARE ECONOMICS CONCEPTS

TOPIC 1: Market Efficiency: Benefits (demand) and Costs (supply) Objectives: The students are expected to view demand and supply concepts now in terms of benefits and costs measures. The use of demand and supply curves in environmental valuation, in benefit cost analysis and in analyzing pollution problem should be made clear to students. Main Points: The concepts of willingness to pay to measure benefits and opportunity costs to measure costs should be explained well in this section. It is also important to distinguish between aggregate and marginal measures of benefits and costs. Finally, the equimarginal principle should be discussed as an important topic in relation to discussion on economics of pollution. Teaching Hour: 3hrs Suggested Topical Outline:

A. Review of what demand and supply represent in your basic economics course. B. Relate WTP to demand measure and distinguish between Total WTP and

Marginal WTP. Relate benefits to Demand. C. Review Supply concept in relation to Marginal cost concept and distinguish

between Aggregate Supply and Marginal Cost (MC). D. Discuss how technology shifts MC functions E. Introduce equimarginal principle in relation to goal of minimizing total cost of

producing a given quantity of output. Basic reference: Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 3. Teaching Ideas:

• This section should rely heavily on graphical representation of two-by-two relationships (e.g. Price and Demand/Supply) but students should be reminded that this is a static analysis—that assumes other things are constant. However, the real world is so complex but we could only work by presenting these concepts in terms of building blocks to help understand abstract principles and relationships.

• A quick review of what the students have learned in their microeconomics course on would be a good way to start the discussion on this topic. Specifically, students could be asked what are the characteristics of perfectly competitive market structure, the concept of market demand and supply, and what the equilibrium price and quantity represent. The point to make clear is that the intersection of

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demand and supply curves defines an economic efficient point—corresponding to where social welfare is maximum.

• One should then define the non-optimal points resulting from the presence of market failures---with some examples on how these market failures can come about. The graphical illustration of the resulting level of production—when externality effects are not considered should be shown graphically. Real-life examples of cases that students can identify with most easily should be used to understand how market failures could bring about resource/environmental degradation.

• Since this section is just a review—one should try to get students actively involved in class discussions. Selected students could be chosen to recall why they have learned in their basic economics class.

Discussion Questions: F & O (2002), and F, O, and F (2002) Q1: What happens to aggregate demand curves when consumers expect the price of the good to rise (or fall) in the future? Would this situation undermine the theory developed in the chapter? Q2. The logic of equating benefits with willingness to pay could lead us to the conclusion that cleaning the air to which low-income people are exposed would probably create fewer benefits than if it were done for high income people. Does this undermine the idea of defining benefits as equal to willingness to pay? How should economists deal with this potential dilemma? Q3. Explain to a non-economist why marginal values are so important in economic analysis. How would you counter the argument of a non-economist that he or she never makes decisions based on a marginal valuation? Q4. Why should we care about attaining social efficiency? Q5. Are socially efficient outcomes necessarily equitable? Should they be?

TOPIC 2: Defining and Measuring Welfare Changes Objectives: The students are expected to be able to show and measure welfare impacts resulting from price changes due to changes in environmental quality. The link of these measures to the valuation and benefit-cost analysis part of this course should be emphasized to students. Main points: This topic should orient students with how environmental quality changes could bring about changes in welfare to consumers. The different welfare measures resulting from price changes should be illustratively explained and compared. The students should be able to relate compensating and equivalent variation measures of welfare to willingness to pay and willingness to accept measures commonly referred to in the environmental

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economics literature. Finally, the use of these measures in evaluating social policy should be discussed. Teaching hour: 3hrs Proposed Topical Outline:

A. How changes in environmental quality can affect individual’s welfare. B. Review of basic theory of individual preferences and demand: utility function of

individuals, properties of non-satiation and substitutability, and derivation of Marshallian demand curve.

C. Marshallian and Hicksian surplus measures (Consumer surplus, compensating and equivalent variation and compensating and equivalent surplus) for changes in prices

D. Relationships of CV and EV to WTP and WTA measures Basic Reference: Freeman, Myrick.A. 2003. The Measurement of Environmental and Resource Values: Theory and Methods. 2nd edition. Chapter 3. “Defining and Measuring Welfare Changes, Basic Theory”, pp 43-70, 85-89. Teaching Ideas:

• The book of Freeman has both mathematical and graphical approach to the topic—but the use of graphical measures to illustrate the various welfare measures is suggested for undergraduate class. The underlying assumptions need to be made clear, however. For instance, we usually assume a two-good world when making graphical presentation—but students could be reminded that these could be bundles of goods so that the good depicted in the graph is actually a composite good, that can be treated as an index of the consumption levels of all other goods, except the one being analyzed. This assumption though is valid only if we assume also that the prices of these other goods move in the same proportion or that there are no changes in the relative prices of the goods that make up the composite good.

• It is important to keep in mind that the price changes being analyzed could be linked to changes in environmental quality—to keep the students into the ‘environmental economics-thinking mode’.

• In the comparison of CS, CV and EV, instructor must emphasize that only CV and EV do represent the welfare relevant measures, even if CS has intuitive appeal as a welfare indicator.

• The students need to distinguish compensating variation (CV) and equivalent variation (EV) measures and to relate these to willingness to accept and willingness to pay values. The use of illustrative example that students can relate to is suggested.

Exercises/Analytical Problems (cf: F & O, 2002, chapter 3)

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Q1. Alvin’s demand for bottled water is given by the equation Qd

A = 8 – 0.5P. Betty’s demand function is Qd

B =6 –P. Calculate Alvin and Betty’s marginal and total willingness to pay for four bottles of water and illustrate graphically. Q2. With the same equations as given in question 1, compute the aggregate demand for bottled water, assuming Alvin and Betty are the only consumers. Derive aggregate demand curve if there were five people with Alvin’s demand curve and 5 people like Betty. Q3. A person’s demand for bottled water is given by the following equation: Q= 6- 0.5p + 0.0001I Where Q is the quantity demanded at price p when the person’s income is I. Assume initially that the person’s income is $40,000.

a) At what price will demand fall to zero? This is sometimes called the choke price because it is the price that chokes off demand.

b) If the market price of bottled water is $10, how many will be demanded? c) At the price of $10, what is the price elasticity of demand for bottled water? d) At the price of $10, what is the consumer surplus? e) If the price rises to $12, how much consumer surplus is lost? f) If income were $60,000, what would be the consumer surplus loss from a

price rise from $10 to $12?

Q4. Suppose that an individual has the utility function: U = E0.25 + Y 0.75 Where E is some index of environmental quality and Y is income. From an initial situation where E =1 and Y=100, calculate CS and ES for an increase in E to 2 and for a decrease in E to 0.5. Q5. ‘Only the highest standards of environmental quality will do if society’s welfare is to be maximized.” Discuss

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LECTURE 5: POLLUTION ECONOMICS

TOPIC 1: Optimal Level of Pollution Objective: The objective of this topic is to explain to the students what the optimal level of pollution is and how identify the optimal level of pollution theoretically. One should also demonstrate how changes in market conditions and in the production and abatement technology would change the optimal level of pollution that the society desires. Main points: The optimal level of pollution is the pollution level associated with certain level of production and consumption that allows the society to attain the maximum net social benefit. It needs to stress that having no pollution is not an optimal situation. The identification of optimal pollution level is based on the equimaginal principle that the marginal cost of abatement (either through output reduction or using abatement technology) must equal the marginal benefit of pollution control (the marginal damage). Abatement cost will change as changes in market conditions and production and abatement technology take play. This will result in a new level of optimal pollution. Teaching hour: 3 hours Proposed Topical outline:

A. Definition of optimal pollution B. Identification of optimal pollution

o When output reduction as the only way to reduce pollution load o When using abatement technology

C. Factors affecting optimal pollution level D. Class examples and exercises

Teaching ideas:

• It is necessary to make clarification that in identifying optimal pollution level for simplicity first we assume that reducing output level is the only way to reduce pollution load. It is suggested to use a numerical example and graphical illustration to explain to the students several related concepts such as MNPB, MEC and MNSB and ask student to take part in the process of identifying optimal level of pollution where MNPB equal MEC.

• We can then relax some of the earlier set of assumptions, say by, introducing the use of abatement technology to reduce the pollution load. The society now can use either output-reduction measure or abatement technology. Suppose it is cheaper to use the technology, and then optimal level of pollution is where MAC equals MD/MEC.

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• Putting the two curves MAC and MNPB in the same diagram. The relative position of the two curves would show which of the two measures (output reduction and abatement technology) is the cheaper solution. You may wish to ask students, which measure the society, will prefer and what is the optimal level of pollution.

• It is possible expand this topic and relate it to other issues. For example, we can ask students to measure the benefit to the society of the abatement technology and then ask them if the pollution level we have now in the real world is optimal? Why or why not? We can also raise a number of questions as an introduction to the next related topics such as “Can we attain optimal pollution level through market mechanism/bargaining?” “What government can do to attain the optimal level of pollution?” But we do not expect their answer for these questions at this stage but it is important to get them thinking along these lines.

Basic References: Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 5) Field B. and N. Olewiler. 2005 Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. (Chapter 5) Discussion Questions and Exercises: (F, O, and F, 2002) Q1. Let MNPB = 1000-10Q and MEC = 10Q. Suppose for every unit of output produced one pollution unit will be generated. Please identify optimal level of output and the optimal level of pollution in terms of damage or external cost.

Q2. What sort of factors will influence the shape of marginal cost curves? Will they differ substantially within industries? Q3. Suppose that a wood pulp mill is situated on a bank of Mekong River. The private marginal cost (MC) of producing wood pulp (in $/ton) is given by the function: MC = 10 + 0.5 Y Where Y is tons of wood pulp produced. In addition to this private marginal cost, an external cost is incurred. Each ton of wood pulp produces pollutant flows into the river, which cause damage valued at $10. This is an external cost, as it is borne by the wider community but not by the polluting firm itself. The marginal benefit (MB) to society of each ton of produced pulp, in $, is given by: MB = 30 – 0.5 Y

a) Draw a diagram illustrating the marginal costs (MC), marginal benefit (MB), external marginal cost (EMC), and social marginal cost functions.

b) Find the profit maximizing output of pulp wood, assuming the seller can obtain

marginal revenue equal to the marginal benefit to society derived from pulp wood.

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c) Find the pulp output which maximizes social net benefits

d) How large would the marginal external cost have to be in order for it to be socially desirable that no wood pulp is produced?

TOPIC 2: Coase Theorem and Property Rights Objective: The aim of this topic is to show students that optimal pollution is automatically attained through market mechanism, when property rights are well defined, transactions cost is zero, and when there is no informational asymmetries (i.e., everyone knows the curves) and no asymmetry in bargaining power. Unfortunately, transaction cost is hardly zero in real work and the assumption of perfect information and no asymmetry in bargaining power hardly exist in reality. Main points: The message of the theorem should be made clear to the students: When property right is non-attenuated and the transaction cost is trivial, the bargaining between polluter and pollutee will always take place. The bargaining will lead to the same solution, given the assumptions cited earlier. The Coase theorem has several limitations, however. Particularly, its two assumptions do not hold in the real world. High transaction cost and ill-defined property right as well as the transboundary and transgeneration nature of the pollution problem prevent bargaining to take place. And even if bargaining takes place the outcome is unlikely to be the optimal pollution because it is very difficult to identity MNPB/MAC and MEC/MD. The implication of the theorem is that strengthening property right is one important measure to improve pollution outcome. The limitations of the theorem, however, justify government interventions in pollution control. Teaching hours: 2 hours Proposed Topical outline:

A. The assignment of property right and bargaining 1. Property right with the pollutee 2. Property right with the polluter

B. Coase theorem

1. The theorem 2. Its limitations

C. Implications: applicability of property rights to environmental problem Teaching ideas:

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• It is important to explain clearly the assignment of the property right in each of the two bargaining scenarios. When the pollutee holds the property right MNPB and MEC are MB and MC of polluter in the bargaining, respectively. When the polluter holds property rights MEC and MNPB are MB and MC of the pollutee in the bargaining, respectively. That is why the pollution outcome of the two scenarios is the same, where MNPB = MEC. It should be noted that MNPB could be used instead of MEC if the polluter uses abatement technology.

• Start the discussion on the limitations of the theorem by asking students “what are assumptions we have made for the bargaining between polluter and pollutee to take place?” Relate the answer to the questions also to the justification for the government intervention. This could serves as an introduction to the next topic on pollution control instruments. At this point, the teacher could ask the students how well they bargain and whether they think outcomes are dependent on who knows more about the product they are bargaining over.

• It is possible to expand the topic by introducing transaction cost to the bargaining process and to ask students how transaction cost could affect the bargaining outcome. The distribution of transaction costs and benefits of the bargaining will affect the two curves (MNPB and MEC), shifting these curves. This will change the bargaining outcome.

Basic References: Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 10) Field B. and N. Olewiler. 2005 Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. (Chapter 10) Discussion Questions & Exercise: (cf: F, O, and F, 2002; (Perman, Ma, McGilvray,

and Common, 2003)) Q1. Suppose the polluter has property rights and the pollutee bears all the transaction cost. What would be the pollution level as compared with the case of zero transaction cost? Q2. Under what situation the bargaining is likely to take place and help lead to efficient level of pollution? Q3. Distinguish between private and public goods externalities. Discuss the likelihood of bargaining leading to an efficient allocation of resources in each case.

TOPIC 3: Environmental Standards Objective: A primary objective of this topic is to show students that the use of standards, while deceptively simple and apparently straightforward in application, is more difficult to manage and problematic in terms of results than is often thought. The topic discussion

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stresses that standards have weaknesses in terms of short- and long-run cost-effectiveness, but that they have advantages in terms of compliance monitoring. Main points: There are three main types of environmental standards: ambient, emission, and technology based (also called design or engineering standards). The economics of standards includes several aspects such as the level of the standard, uniform standards, and incentive impact of standards. Environmental standards should set where marginal benefits equal marginal abatement costs. This implies that they should be set at different levels where these circumstances differ. However, when the economic circumstances are heterogeneous (numerous polluters with different MACs); regulators often do not set individual standards but set uniform standards, which often lead to inefficiency. In terms of incentive effects the problem with standards is that when they are being met there is no incentive to do better than the standards. Another issue with standards is enforcement. Effective enforcement is really important to ensure that set standards are met. The enforcement costs are high meanwhile regulators have limited enforcement budget. Teaching hours: 2 hours Proposed Topical outline:

A. What are environmental standards? B. Types of standards

1. Ambient standards 2. Emission standards 3. Technology standards

C. The economics of standards 1. Setting level of standards 2. Uniformity of standards 3. Standards and equimarginal principle

D. Incentive effects of standards E. The economics of enforcement

Teaching ideas:

• We are surrounded by publicly prescribed standards including environmental standards. Take this advantage by asking the students to list out a number of standards especially environmental standards. Group the listed environmental standards by type and explain to the students the different types of standards.

• Ask the students why regulators set environmental standards and how the level of the standard should be set. Facilitate the discussion process by introducing an example and using graphical illustration to discuss how the standard level should be set. It is necessary to stress that in the real world there are many polluters with different MACs. Therefore, it is impossible to set a single standard that meets the

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equimarginal principle for all pollution sources. Ask students to compare individual and uniform standards in terms of efficiency and cost effectiveness.

• It is necessary to stress the savings in implementation costs that uniform standards might entail, relative to policy approaches that treat sources differently. Most of arguments for uniform standards are based on two ideas: equity, through treating everyone alike, and “leveling the economic playing field,” through requiring that very source meets the same environment requirements.

• A point that is perhaps not stressed enough is the perverse incentive that an agency might produce if it sought to set standards so as to equalize marginal abatement costs. This means that firms with lower marginal abatement costs will be required to reduce the emission more than firms with high MACs. This could create a disincentive for firms to search for ways of lowering their abatement costs.

Basic Reference: Field B. and N. Olewiler. 2005 Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. (Chapter 11) Discussion Questions & Exercises: (F, O, and F, 2002; (Perman, Ma, McGilvray, and

Common, 2003)) Q1. List and explain, using graph to assist your answer, three problems with technology based standards. Q2: What kind standards would you use for a non-point pollution source (e. g., run-off of pesticides from agriculture use) where pollution per polluter cannot be measured? Explain why? Q3. Suppose a regulator agency has a limited budget for enforcement. It is better from society viewpoint to use its limited resources to monitor sources that emit large amounts pollution and prosecute vigorously if they violate the standards, or to monitor all polluters? Defend your viewpoint. Q4. People have suggested that it would be equitable for all countries to adopt the same emission standards. If, for example, the United State has higher standards than Vietnam, then, Vietnam could be able to produce pollution-intensive goods more cheaply, gaining an advantage in the world marketplace, and also might become a pollution haven. From what you have covered in this topic, do you agree with this suggestion? What are the pros and cons from an economic standpoint? Q5. Consider the figure below. It shows two marginal damage functions. MDU and MDR are marginal damage functions for urban and rural areas respectively.

MDR = 5ER; MDU = 10EU and MAC = 600 – 5E

Solve for the two efficient equilibria for the two MD functions for carbon monoxide pollution. Suppose the regulator imposes a uniform standard at the emission level

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midway between the two efficient emission levels. What are the excess damages from under-control in the urban area and over-control of damages in the rural area?

TOPIC 4: Taxes and Subsidies Objective: The objective of this topic is to show students the way environmental taxes and subsidies work and to examine the advantages and disadvantages of using taxes and subsidies to achieve improvements in environmental quality. Main points: Pigovian tax is an optimal tax. The level of the Pigovian tax per unit of pollution is equal to marginal damage/marginal external cost associated with optimal level of pollution. To identify the optimal tax we need to know MNPB/MAC and MEC/MD. The essence of tax approach is to provide an incentive for the polluter themselves to find the best way to reduce pollution, rather than having a central authority determine how it should be done. In case of imperfect information, however, the socially efficient level of tax and standards may not be achieved. This brings about policy failures. Total private cost of compliance of an emission tax is different form the social cost of compliance. The former includes abatement cost and tax bill for the polluter. But, the latter includes only the real resources used to meet the environmental target. When MACs differ among polluters, social compliance costs are lower under a tax than a uniform standard meeting the same target level of emissions because the tax is cost-effective the uniform standard is not. Emission subsidies would have the same incentive effect on individual polluters, but they could lead to increases in total emission levels. One place where subsidies have been used effectively is in deposit-refund systems, which are essentially tax and subsidy systems in combination.

0 40 60 120 Emission of carbon monoxide (kg/month)

MAC MDU

MDR

$ 600

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Teaching hours: 2 hours Proposed Topical outline:

A. Pigovian tax 1. What is Pigovian tax 2. Pigovian tax and property right

B. Emission tax 1. The basic economics of emission taxes 2. Emission tax and cost effectiveness 3. Emission tax versus standards 4. Emission taxes and non-uniform mixing of emission 5. Emission tax and the incentive to innovate 6. Emission tax, enforcement cost & distributional impacts 7. Subsidies: abatement subsidies and deposit-refund systems

Teaching ideas:

• Start the discussion by recalling the limitations of Coase theorem and problems with using property right as a means of pollution control as the justifications for government interventions. It is suggested to use the graph and numerical example in the “Optimal pollution” topic to explain how a tax should be to achieve the optimal level of pollution.

• It is important for students to see that taxes involve the firms in two types of costs: abatement costs and tax costs, and that firm will try to minimize the total of these. This means that firms will try to equate marginal abatement costs and the tax.

• How to determine the best rate of the tax is one complicated problem in this topic. This requires information on the true marginal damage function—which is not easy to get. This fact should be emphasized to the students as they are introduced to the general field of valuation in the latter part of the course.

• Likewise, the difficulty of getting information on the marginal abatement costs from the various firms should be mentioned—although it is worth citing that there are some studies on this topic by a number of WB economists.

• A common reaction from beginning students is that polluters will simply pay the tax, pass burden on to consumers through higher prices and continue emitting the same quantities as before. Have them work through the diagrams to see that this is unlikely unless the MAC curve is very steep. A firm that does not produce where the tax = MAC will be inefficient (higher cost solution) and in a competitive market, will lose out to others who are incurring lower costs. One could also tell a tax incidence story – the tax is shifted forward to consumers in the form of higher prices or backwards to shareholders in the form of lower return on their investment. This part will have to explain the distribution impacts of taxes and should focus on the standard conclusion regarding the regressive effects of price increases due to tax. The discussion relating to looking at emission taxes more as ‘sin taxes’ (e.g. taxes on alcohol and cigarettes) should be brought in here also.

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• One should also point here that the tax revenues can be used by the government to pursue different objectives, which could include encouraging investment in pollution control measures by firms that paid the tax. The tax revenue also creates an opportunity for tax shifting. This means that there will be lower taxes (e.g. income taxes) decreasing distortions elsewhere or providing revenue for other public goods. This may serve to attract labor to the region serving to help the industry. It is important to note, however, that these effects are diffused throughout the economy, while the pollution tax burden falls squarely on the polluters.

• The various ways to prevent polluters from leaving the region, by way of incentives include deposit-refund systems or lump-sum rebates to the polluters in question. This may be a good time to introduce the discussion on pollution haven argument.

• On the subsidies—one should point out that this needs short-term tax increases or expenditure cuts elsewhere, with uncertain long-term impacts on the economy.

Basic References: Field B. and N. Olewiler. 2005 Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. (Chapter 12) Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 12) Questions & Exercises: (F, O and F, 2002) Q1. Suppose that we institute an emission tax on a particular pollutant, and we use the proceeds of the tax to help subsidize the short-term capital costs by firms in the same industry of installing emission – reduction equipments. Will this approach upset the incentive effects of the emission tax? Q2. Suppose the government proposes a tax on SO2 emissions. The tax is to be levied on the sulfur content of the fuel used by utilities and other industries because emissions from these sources are difficult to measure. But cases where firms have ways of measuring the SO2 content of the exhaust gases, the tax will be levied on the SO2 content of the gases. Will this system lead to a socially efficient equilibrium? (You will need to make some specific assumptions to answer the question). Q3. Opponents of emission charges argue that polluter will be simply pay the taxes and pass the cost on to consumers without reducing emissions. Is this correct? Explain. Q4. For the figure below and the equations MAC1 = 200 – 5E and MAC2 = 160 – 4E, compute the cost savings to the polluter if it adopts the new technology (MAC2) after the introduction of an emission tax of $100 per tonne. Compute the cost saving under a standard that is set at 20 tonnes, Explain why the tax provides a larger incentive to innovate than does the standard.

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TOPIC 5: Transferable Discharge Permits Objective: The aim of this topic is to acquaint students with the rudiments of transferable discharge permits (TDP) as a cost effective approach to pollution control and to help students to understand the strength and weaknesses of the approach. Main points: A transferable discharge permit (TDP) creates a transferable property right to emit a specified amount of pollution. The TDP system operates like a hybrid between imposing standards and using taxation to reach a target. Because the total number of permits is fixed, there is effectively a standard that cannot be exceeded. But because the permits are transferable, the market will achieve uniform price at which polluters’ marginal costs of abatement are equal. Like a tax, transferable permits that traded in a competitive market are a cost-effective policy. A role playing exercise on Transferable Discharge Permits available at www.eepsea.org is a handy illustration to explain to students how a TDP system works. There are several issues in setting up a TDP market. These include the initial right allocation, establishing trading rules, non-uniformly mixed emissions, competition and enforcement. The major point to emphasize in each of these issues should be discussed with the students. Teaching hours: 2 hours Proposed Topical outline:

A. General principles: 1. TDPs 2. Demand and supply of TDPs

Emission (tonnes per year)

Tax =100 per tonnes

0 15 20 40

$ 200 160

MAC1 MAC2

e d b

c a

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B. Issues in setting up a TDP market 1. The initial rights allocation 2. Establishing trading rules 3. Non-uniformly mixed pollution 4. TDPs and problems of competition 5. TDP program and enforcement 6. TDP and the incentive for R&D

Teaching ideas:

• This is a complicated topic. Since the TDP approach is based on the functioning of markets, it is important to stress the basic principles of market operation and the factors that are critical to their success or failure. Those that are often glossed over when discussing basic market principles but are critical to this topic are: the need to have a clear and reasonably stable rules and laws to govern trade/exchange and expectations that the market will not be subject to excessive political manipulations in the future, among others. However, market for discharge permits is still new and regulators are still developing new rules and regulations governing trade. How different rules will affect trade and the efficiency of the TDP system is one topic that is open for investigation.

• An important issue in this topic is how public authorities can affect the total number of permits in circulation and what factors do affect the uncertainty in the market and its ability to function efficiently. These issues should be discussed as these would lead to better understanding of how the system is meant to work by students. The ways by which the government could control total number of permits—either by buying them in the open market or expropriating them regularly or even retiring them through time could be discussed.

• An illustration to show how the initial allocation of permits (give away and auction) would affect the market equilibrium price of the permit and the number of permits that each market participant uses could also be discussed here.

• After the basic permit system is described, the instructor can stress that in theory TDPs look great; however in practice there are lots of problems. Permit trading games offer a concrete way to introduce this quite abstract topic.

• The issue of permit trading for greenhouse gases is sure to generate student interest based on the huge controversies and moderate amount of media attention given to the issue of using TDPs in the Kyoto Protocol. The instructor will want to emphasize that TPDs are being used more and more in the real world with varied success.

Basic Reference: Field B. and N. Olewiler. 2005 Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. (Chapter 13) Questions & Exercises: (cf: F, O, and F 2002)

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Q1. The government has set up a TDP system where it gives away permits to the polluters then asks them trade thereafter. How this system responds to new firms that enter the industry and have positive level of pollution? Do you foresee any problem? Explain. Q2. What are the pros and cons of letting anybody (e.g., bank, private citizens, environmental groups, government agencies) buy and sell transferable discharge permits in addition to the pollution sources themselves. Q3. Suggestion has been made to set up a transferable permit system for wildlife preservation and habitat protection. How might this work? Q4. Two polluting firms can control pollution of a pollutant by incurring the following marginal abatement costs:

MAC1 = $300 – 10 E1 and MAC2 = $90 – 5 E1

Assume the target level of pollution is 30 units. We do not know if this is the socially efficient level or not.

(a) Compute the level of emission per firm that is cost-effective for society. (b) Explain how a tradable discharge system could be applied to achieve the

target level of emission. Assume the regulator initially assigns 15 permits to each polluter. The government gives these permits to the firms without charge. Solve for the number of permits each firm holds after a permit market operates, the price of the permit and total private cost of the permit system. How would the private costs to each polluter change if the government initially auctioned to the polluters?

Q5. Which policy instrument uniform standard, individual standard, emission tax, or TDP provides the largest incentive to invest in R&D to lower MACs? Prove your answer graphically.

TOPIC 6: Evaluating Environmental Policy Instruments Objective: The objective of the topic is to discuss with students the various criteria used in evaluating environmental policies/instruments. They should be taught how to use these criteria to evaluate the instruments/policies that have been discussed in previous topics. Main points: There are five important criteria for the evaluating environmental policy instruments. These are efficiency and cost effectiveness, fairness, incentives for innovation, enforceability, and moral consideration. It is important to differentiate efficiency and cost effectiveness.

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Economic instruments often lead to cost effectiveness as they allow the profit maximizing agents to choose the ways to respond. Therefore the equimarginal principle is met for each pollution sources. Furthermore, economic instruments provide more incentives for innovations. Teaching hours: 2 hours Proposed Topical outline:

A. Criteria for evaluating environmental policy instrument

1. Efficiency and cost effectiveness 2. Fairness 3. Incentive for innovation 4. Enforceability 5. Moral consideration

B. Contrasting policy instruments:

1. Uniform standard 2. Individual standard 3. Uniform tax 4. TDPs (given away) 5. TDPs (auctioned)

Teaching ideas:

• There may be other criteria that one wishes to discuss, though we have tried to set the criteria broadly enough so they will incorporate other as special cases. One possibility, for example, is whether policies incorporate perverse incentives that tend to undermine their objectives, but this can be presumably be included in the first criterion (factors leading away from efficiency), or perhaps the fourth (factors leading to attempts to hide emission or inflate base level emission rates, etc.).

• Political acceptability is obviously a criterion of importance, but we have not included it in the discussion. This is an extremely slippery factor that we think is best left to political science discussion. What are politically acceptable changes from one time to another, depending critically on the shifting strategic situation and the resources that policy makers are willing and able to spend. While political factors are of obvious importance in the real world, our feeling is that the discussion of this topic should focus on economic factors.

• In contrasting the instruments, it is advisable to use graph and numerical example to illustrate the cost (social and private) of achieving the same pollution target using different instruments. It is also important to compare incentives for innovation that different instruments provide polluters.

Basic Reference

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Field B. and N. Olewiler. 2005 Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. (Chapter 9 and 14) Discussion Questions & Exercises: (cf: F, O, and F, 2002)

Q1. How do market-based policies differ from command and control policies with regards to incentive created by the policy to reveal information about the polluter’s MAC curve to the regulator? Q2. Why is cost effectiveness a desirable goal of environmental policy? How is it achieved? Q3. Why do pollution taxes have a more uncertain impact on the level of pollution than does a standard? Q4. Suppose you are a government regulator that is trying to design a pollution control for a non-degradable water pollutant such as dioxin. Your objective is to get an immediate reduction in the emission plus provide an incentive to firm to switch to production technologies that yield fewer emissions of these compounds. Which one of the following three policies would you recommend, and why? The policies are uniform standards, uniform tax, or individual standard. Support your answer graphically and/or algebraically.

Q5. Suppose there are two polluters with different MAC curves. Show how the regulator would aggregate these MAC curves and then use them to determine the socially efficient equilibrium level of emission, E*. Once E* is determined, how would the regulator ensure that the sum of emission form each polluter total E*? (Hint: Aggregation should reflect the equimarginal principle). Q6. Compare and contrast the cost-effectiveness of:

a) a sulphur dioxide emission tax b) a sulphur dioxide emission tax levied at the same rate as in a), together with an arrangement by which emission tax revenues are used to subsidize capital equipment designed to ‘scrub’ sulphur from industrial and power generation emissions.

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LECTURE 6: ENVIRONMENTAL VALUATION

TOPIC 1: Why Value the Environment and the Concept of Total Economic Value Objective: To explain to students the importance of undertaking environmental valuation and to introduce the concept of total economic value. Main Points: The concept of total economic value stresses the point that value results not only from use of the resource but from the many other roles/functions of the resource that are not necessarily link to use value. In particular, the non-use value of the resource, consisting of existence, bequest, and option values and those that are indirect in use (ecological values, biodiversity value, etc.) are quite important components of the total economic value of the resource/environment.

Teaching Hour: 1 hour

Proposed Topical Outline:

A. The importance of valuing the environment B. The Total Economic Value: Use and Non-Use Values C. Limitations of Valuation

Teaching Ideas:

• The rationale for resource/environmental valuation is explained by discussing how the absence of such valuation limits decision making, both in the economic and environmental arena.

• The concept of total economic value is then introduced. Teaching of the concept can be facilitated by applying the total economic value concept to value a particular resource. Students could then be asked to identify total economic value components for the particular resource on their own. It should be emphasized that valuation is held by people (anthropocentric) while the intrinsic value (or non-use value) is inherent to or resides in the good. The limitations of anthropocentric valuation should be highlighted. Specifically, one should emphasize the need to respect rights of non-human beings.

Basic References: J.T. Winpeny. Values for the Environment. 1991. Chapter 1: Introduction: Why Value the Environment? OECD. 1995. The Economic Appraisal of Environmental Projects and Policies: A Practical Guide. Chapter 1: Introduction. Turner, Pearce and Bateman. Environmental Economics: An Elementary Introduction.1994. Chapter 8: Valuing Concern for Nature.

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Discussion Questions: (Perman, Ma, McGilvray, and Common, 2003) Q1. Imagine a wilderness area of 200 miles in Cu Phuong Park. How would you expect each of the following factors to affect people’s willingness to pay for its preservation?

a) Size of the wilderness area still remaining in the Cu Phuong Park. b) Presence of rare species in this particular area. c) The level of national wealth.

Q2. An analyst wishing to estimate the benefits of preserving a wetland has combined information obtained from two methods. First, she surveyed those who visited the wetland—fishers, bird watchers, etc—to determine their willingness to pay for these uses. Second, she surveyed a sample of residents throughout the state about their WTP to preserve the wetland. This second survey focused exclusively on nonuse values of the wetland. Then, she added her estimate of use benefits and nonuse benefits to get an estimate of the total value of preservation of wetlands. Is this a reasonable approach? (Assume that respondents in two surveys do not overlap). Q3. Is the loss of a species of plant or animal necessarily of economic concern? Is this true for every species that currently exists? Do we now suffer as a consequence of earlier extinctions? Q4. “If the market puts a lower value on trees as preserved resources than as sources of timber for construction, then, those trees should be felled for timber?” Comment

TOPIC 2: Overview of Valuation Techniques and Steps in Valuation Objective: To give students a practical skill on how to conduct an economic valuation and to give them an overview of the different methods to value environmental benefits/costs. Main Points: A sequence of steps to be conducted for valuation will be presented. The objective of this sequence is to clearly define how to identify the environmental impacts and values that need to be subjected to valuation. The choice of the valuation techniques should also be discussed. The various considerations in the choice of the environmental impacts to be included in the valuation process and the considerations in the choice of the techniques should be made clear to the students. There are numerous valuation techniques that are available to the analysts. An overview of what these valuation techniques are should be discussed in class. The lecture should emphasize that the choice of the technique depends primarily on appropriateness of the technique to the environmental good/bad to be valued but also considers availability of information and the cost of collecting the information.

There are several ways to classify and group different valuation techniques. A general approach, however, is to group them into direct approach (or Market based Method) and Indirect approach (or Revealed Preferences and Stated Preferences).

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The Direct approach measures the benefits/costs based upon the linkage between a contaminant and its associated damages that are expressed by market values. This approach has the weakness of underestimating total economic value as it is often limited to measuring use values only. The technique also may not be applicable if the physical linkage cannot be defined or measured.

The correct measure of benefits/cost is the change in consumer surplus, which can derive from either the shift of demand curve, or the change in prices. This in turn calls for the imputation of willingness-to pay.

The Indirect approach consists of various techniques aimed at imputing willingness-to-pay. These include preventive expenditures, hedonic method, travel cost and contingent valuation methods. Teaching Hour: 1h30 minutes Proposed Topical Outline: A. Overview of valuation methods

1. Direct methods 2. Indirect methods

B. Steps in valuation 1. Identifying environmental impacts 2. Impact screening 3. Choice of valuation methods. 4. Undertaking the valuation with chosen methods

Teaching Ideas:

• One can start discussion of this topic by presenting an economic project such as dam construction. Then, the economic and environmental impacts of this project could be identified and presented to the class. It is worth mentioning here that identification of the various environmental impacts is a major concern in any Environmental Impact Assessment (EIA) process. This process is expected to result in a long list of environmental impacts. The need to screen these impacts and basis for the screening should then be discussed in class. One should emphasize that while it is ideal to measure and consider all the environmental impacts into consideration—doing so is costly and may not be optimal. An effect that is expected to have very small impact on overall project outcome but which may be very costly to value should not be valued at all. Not only are their effects expected not to make any difference in project decision making, but valuing them would also compete with the use of the limited resources.

• The major economic impacts of a change in environmental quality are reduction in productivity; health care costs and loss of human capital; reduction in amenity (recreational benefits, aesthetic); and the loss of unique habitat or species (existence value). Alternatively, one could also value the impacts in terms of costs of providing substitutes for the lost environmental goods and services--this cost can be very large.

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• One way to classify all possible economic and environmental impacts is to categorize them into on-site and off site effects, positive and negative effects and even into: with and without market values.

• The different valuation techniques that could be used to value the environmental effects should then be presented. One should start by making a broad distinction between market-based techniques; an example of direct estimation is presented for the illustration of how it is applied and what weakness it produces. This opens way to discuss the second approach- indirect approach to impute willingness-to-pay.

Basic References: ADB. 1996. Economic Evaluation of Environmental Impact - A Workbook. Environment Division, Asian Development Bank. Manila. Field B. and N. Olewiler. 2005 Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 8 OECD. 1995. The Economic Appraisal of Environmental Projects and Policies: A Practical Guide. Chapter 1: Introduction. Suggested Readings: Dixon, John A; Louise Fallon Scura, Richard A Carpenter and Paul B Sherman. 1994. Economic Analysis of Environmental Impacts. Chapters 1, 3 & 4. Discussion Questions: (Perman, Ma, McGilvray, and Common, 2003) Q1. What valuation technique would you use to measure the value of preserving a tropical rainforest? Why? Q2. Discuss the arguments for and against the exclusion, or deduction, of defensive or preventive environmental expenditure from GDP. Identify other components of GDP, which could be excluded for identical or similar reasons. Q3. Given the valuation problems inherent in assessing many forms of environmental damage or degradation, is it better to concentrate efforts on developing a comprehensive system of physical environmental accounts, rather than attempt to incorporate environmental costs and benefits in the conventional system of national accounts?

TOPIC 3: Market-based Techniques Objectives: The main objective is to provide students with an overview of the various approaches that can use market prices to reflect WTP. The lecture also aims to show students the uses of these market-based techniques and what their strengths and weaknesses are.

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Main points: A change in the environment may alter economic activities resulting in changes in monetary revenues and costs from/of these activities. The changes in these revenues and costs thus can sometimes be used to value the change in the environment. The range of techniques that uses changes in market values of economic activities/goods or services include: Change-in-Productivity, Cost of Illness, and cost-based approaches like replacement cost technique and defensive expenditures. The change in productivity measures the loss productivity of an ecosystem that was subjected to environmental deterioration or gain, in the case of environmental improvements. This loss (gain) is values using market price (properly adjusted to reflect net price or less of all production cost, marketing cost, and margin for profit). The cost of illness approach measures the hospitalization cost (inclusive of cost of treatment and associated cost for clinic visits) and forgone income due to work-loss days or reduced activity days as a consequence of exposure to environmental ‘bads’. An example of an environmental bad is intake of polluted water or exposure to polluted air that brings about health impacts. The cost-based techniques measure the cost of replacing a damaged ecosystem (e.g., reforestation cost for deforested areas; value of inorganic fertilizers for eroded fertile soils, etc); or preventing the harm from taking place (e.g. cost of buying bottled water to avoid intake of polluted water, etc). The limitation of the cost-based approaches in the sense that they do not really measure the value of environmental benefits foregone should be emphasized. Teaching hours: 2 hrs Proposed Topical Outline: The lecture should give an overview of each of the various market-based techniques, describing the situations when the technique is found applicable, the basic approach, and the strengths and weaknesses of the approach.

A. General steps for measuring impacts. B. Change in productivity. C. Cost of Illness Approach D. Cost-based techniques: Replacement cost and Defensive expenditures

Teaching ideas:

• Given that there are various techniques to be covered in this short period of time, the use of case studies to demonstrate use of each of these techniques will be useful. EEPSEA has a number of these case studies from its list of research reports---including those that are done in Vietnam. The students may be assigned by group to do a case analysis cum presentation in class of these case studies.

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Basic References: Turner, R. K; D. Pearce; and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. Chapter 7. Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 7. Sinden J. and Thampapillai, DJ. 1995. Introduction to Cost-Benefit Analysis. Longman. Melbourne. Chapter 6 Discussion Questions & Exercises: (Perman, Ma, McGilvray, and Common, 2003) Q1. Why don’t total expenditures on a good represent the net benefits from purchasing that good? Why are increases in output due to lower levels of pollution likely to be an overestimate of benefits? Q2. One cost to society of preserving native forests is the loss in timber output following preservation. How to measure this loss? Q3. Suppose the government wants to launch a sulphur oxide control campaign. Theoretically, show how Change in Income technique can be used to estimate the benefits to health from the policy.

TOPIC 4: Travel Cost Method Objective: The main objective is to show the fundamentals of TCM and to demonstrate how this method has been used to measure the economic use value of a recreation area. Main Points: This is a surrogate market technique because actual behavior of a rational individual will show how she weighs up the costs of a recreational visit against the benefits of the visit. The basic premise of the TCM is that the time and travel cost expenses that people incur to visit a site represent the “price” of access to the site. Thus, peoples’ willingness to pay to visit the site can be estimated based on the number of trips that they make at different travel costs. This is analogous to estimating peoples’ willingness to pay for a marketed good based on the quantity demanded at different prices. The trip demand function is very important for students to understand how the method has been used to measure the recreational value of a site. From the general function, the ITCM and ZTCM functions are developed. It is also important to differentiate ZTCM and ITCM: from theory to practice. Teaching hours: 2 hours Proposed Topical Outline:

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A. Fundamental insight of the method. B. Zonal Travel Cost Method (ZTCM). C. Individual Travel Cost Method (ITCM). D. Strengths of TCM and difficulties encountered in TCM.

Teaching ideas:

• One possible way of starting the lecture is to tell students about the origin of the TCM. That is a letter of the U.S park system director to economists asking them for the value of park recreation which would be used to justify the required costs of the parks. Only Hotelling answered with an idea of which is now known as ZTCM.

• One needs to explain what constitutes travel costs. Travel costs basically include 3 things: transportation cost (or gasoline cost), opportunity cost of time and other costs (souvenir, accommodation, foods and drinks etc.).

• The next step is to talk about the quantity of visit/demand for visit. Lecturer may ask them how many ways to express the quantity of visit (basically two ways: number of trips an individual make to the site yearly, and number of trip/visit from a region to the site)

• Remember to remind students that the recreational demand depends not only on travel costs but on other factors like income, age; sex etc. (may ask students to list these factors). Don’t forget substitute sites as an important factor.

• When teaching the Zonal Travel Cost Method, let’s start by simply saying that if the quantity of visit in figure 1 is number of trip/visit from a region to the site, we have the ZTCM. Tell students that in ZTCM we estimate travel cost of a trip from a zone and quantity of visit for a zone, not for an individual visitor/consumer as usually seen.

• Draw circles around a centric point. The point represents for the site and each ring represents a zone. The zones are different in distances to the site then different in travel costs then different in number of visits.

• Explain the components of the function. Can ask students why using the Vj/Pi, not the Vj. And then ask them describe what variables are potentially relevant to Xi.

• Regarding the ITCM, stress that ITCM bases on individual information, which is visitor’s travel costs, number of visit, and socio-economic factors.

• Regarding critique on TCM, lecturer may require students to look at the recreational demand function again and imagine how information on dependent variable and explanatory variables should be collected and processed. Tell students to remember their own trips and relate it to the function to find out any problems that can be occurred in an actual TCM research.

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• Then tell them some difficulties encountered in the TCM: Multi-purpose visits; multi-site visits utility/disutility from traveling, sampling biases in surveys.

Possible Extension: There may be two possible extensions:

• The first one is if time permits, lecturer may show main steps in carrying out a TCM study to provide students how a TCM should be done in practice. There are five steps. It’s good to use a case study to illustrate the steps. May distribute the case and ask student to read it before the lecture. The steps are as follows. Lecturer is free to re-organize it as a table or figure and then show students.

Step 1: Identification of recreational sites: (1) Assessment of recreational potential of the site; and (2) Secondary data collection (tourists flows…)

Step 2: Questionnaire design: (1) Introduction; (2) Socio-economics information and (3) Questions on the dependent variable and explanatory variables. Can distribute a sample questionnaire here!

Step 3: Survey of sampled visitors: (1) Sampling technique; (2) Survey strategy: how, when and where to run interviews; (3) Training of enumerators; and (4) Pretest survey.

Lecturer may focus on sampling technique and survey strategy. Ask students why they are important.

Step 4: Database creation and data analysis: (1) Verification of data; (2) Elimination of invalid questionnaires; (3) Derived variables building; and (4) Data analysis.

Lecturer may show how data can be structured (coding…).

Step 5: WTP estimation: (1) Choice of ZTCM or ITCM; (2) Implement model; and (3) Annual individual or zonal average WTP

Lecturer should remind students that estimated WTPs for recreation here are just for one year. Researchers can derive annual net benefits and then discount these values to get the NPV of recreation.

• The second one is if time permits, in point 2 and 3, lecturers may present formulas and procedures to calculate CS.

Basic References:

Field B. and N. Olewiler. 2002. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 7

Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 6).

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Sinden J. and Thampapillai, DJ. 1995. Introduction to Cost-Benefit Analysis. Longman. Melbourne. chapter 6

Discussion Questions & Exercises: Q1. Would the travel cost approach be a good technique in valuing a policy to increase coral cover in the Hon Mun MPA? Defend your answer. Q2. What happens with the ITCM when the recreational site is not a popular one (in remote areas, strange recreational products? Q3. Could you suggest solutions for the multi-site visits problem? Exercises: Exercise 1: The entrance fee to Cat Tien National Park is $10 per person for a one-day pass. If the daily demand curve for recreation at this park is given by Q = 40 – ½ P, then the consumer surplus for visitors to the park will be $1225 per day. True or false? Explain your answer. Exercise 2: You are given the following survey data concerning hikers on the Bruce Trail:

Distant Travel (km)

Travel Cost ($)

Population (in thousands) at that distance

Hiking daysVisitation rate Cost of travel

0-50 25,000 500 20,000

51-100 50,000 2500 75,000

101-150 75,000 5000 100,000

151-200 100,000 3000 30,000

(a) Graph the implied demand for hiking on the Bruce Trail. (b) fit a straight line equation to your data (graphically or algebraically) (c) Compute the total benefit derived from the Bruce Trail by the residents of the areas reported. (d) Assume that people further away from the Bruce Trail have more nearby substitutes for hiking. How would this bias your estimated total benefit of the Bruce Trail?

TOPIC 5: Hedonic Pricing Method Objectives: The students are expected to understand the basic approach in estimating environmental value using Hedonic Property Price Method (HPM). Main points: The HPM falls within the category of surrogate market technique (or revealed preference technique). The discussion of conceptual framework will help to know the reasons. The price paid for a property directly reflects the benefits of the characteristics of the

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property. In this way, environmental characteristics such as clean air, peace, quiet and beauty are traded in property market. The HPM derives the value for a particular characteristic from the price paid for the property. The discussion of the HPM covers the two points:

• Identify how much of a property differential is due to a particular environmental difference between properties. This requires estimation of the house (or hedonic)

price function. It is noted that economic theory does not provide much information on the shape of the hedonic price function. A possible hedonic price function, which is suggested by Freeman (1993), is concave from below.

• Infer how much people are willing to pay for an improvement in the environmental quality and what the social value of the improvement is. Because the hedonic price function itself cannot permit estimation of WTP, a common procedure to infer WTP is a “two-stage procedure” which includes calculation of the ‘implicit marginal price’ of the environmental good for each observation and estimation of the implicit inverse demand function of the environmental attribute.

For illustration of the method, a numerical example should be presented. Teaching hours: 2 hours Proposed Topical Outline:

A. The conceptual framework. 1. The intuitive concept.

2. The house price function. 3. The implicit price function. 4. Estimation of consumer surplus.

B. A numerical example of the HPM C. Discussions of strengths and weaknesses.

Teaching ideas:

• The house price function may be illustrated by a graph. The graph is essential to show the relationship between the house price and the environmental attribute.

• Given the vast amount of theoretical and empirical work recently in HPM, this topic represents just a very brief excursion into the subject. Some lecturers may want to just give the students intuitive concepts of the method and then show some very simple examples of how value of environmental attribute is extracted from house price. In some classes, when students ask for more elaboration to understand the model, lecturers have to show them the statistical models. Students often ask for more just simply because with the intuitive introduction they think they can do something with the model, which is about what they feel familiar like price of house, house structure and so on.

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• The intuitive concept of the HPM can be described as follows. The price paid for a property directly reflects the benefits of the characteristics of the property. In this way, environmental characteristics such as clean air, peace, quite and beauty are traded in property market. The HPM derives the value for a particular characteristic from the price paid for the property. Data are collected on prices paid and characteristics of the property. The amount of the price attributable to the characteristics is then identified through statistical analysis. In essence, if two houses differ in only one characteristic, the difference in price is the value of that characteristic.

• A good numerical example can be found in Markandya, Harou, Bellu and Cistulli (2002).

Basic References: Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 8). Sinden J. and Thampapillai, DJ. 1995. Introduction to Cost-Benefit Analysis. Longman. Melbourne. chapter 6 Markandya A, Harou, P., Bellu, L, and Cistulli, V. 2002. Environmental Economics for Sustainable Growth: A Handbook for Practitioners. Edward Elgar. Chapter 11. Discussion Questions & Exercises: Q1. A worker, who is typical in all respects, works for a wage of $40,000 a year in a perfectly safe occupation. Another typical worker does a job requiring exactly the same skills as the first worker, but in a risky occupation with a known death probability of 1 in 1,000 per year, and receives a way of $44,000 a year. What value of a human life for workers with these characteristics should a cost-benefit analyst use? Exercise 1: Cost of noise. Assume that everybody near an airport owns similar houses. If a new runway were established, houses in area A will gain in value because they become quieter. But houses in area B, under the new flight path, lose value because they become noisier. The table below gives the number of houses and changes in value in each area. Complete the right hand column to calculate the changes in land value.

Values $’000 Houses

Before After

Number of houses

Change $m

A Quieter 250 280 10,000 ? B Noisier 250 210 5,000 ?

a. What are the benefit, cost and net benefit from changes? b. For simplicity, assume that changes in noise are the only source of benefit or cost.

Under what conditions is the new runway and actual Pareto improvement? A potential Pareto improvement?

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Exercise 2: Benefits of a water-supply pipeline. The benefits of installing a new water supply to farms should be captured in the extra price buyers will pay for farms with a pipeline. Some farms in a district are already on a pipeline and some are not. A survey and analysis of these farms yields the following hedonic model to relate price paid to characteristics of the farms. Land value = 500 + 200 SCHEME – 0.2 AREA + 1.8 RAIN Where mean property size (AREA) in the district is 1000 hectares and mean rainfall (RAIN) is 150 millimeters, and land value is dollars per hectare. SCHEME is defined as 1 = with the pipeline scheme, 0 = without. Calculate the benefits of the scheme with hedonic pricing, by following this procedure.

a. Insert the mean values of AREA and RAIN in the equation, and re-express it as follows. Land value = Constant + 200 SCHEME

b. Calculate land values per hectare with and without the scheme. What is the increase in value per hectare, with the scheme?

c. Calculate the increase in value per property, with the scheme.

TOPIC 6: Contingent Valuation Method (CVM) Objective: To introduce to students to the use of contingent valuation method by way of an illustration of its application. Main Points: Contingent Valuation Method has the advantage of being able to measure total economic value and is often the only means available for measuring non-use values. Contingent Valuation Method uses surveys to inquire about individuals’ willingness-to-pay for some environmental initiative based upon hypothetical market conditions. The results are, therefore; dependent or contingent upon the hypothetical market. The success of CVM depends to a large extent on the design of the questionnaires. This process needs to rely heavily on results of focus group discussions and series of pre-tests to ensure that the hypothetical market is clearly understood by the respondents and to derive the bid levels that will closely approximate the bid levels of the target respondents. There are major biases that one has to watch for in the design and implementation stage of this study. Students need to be aware of these biases and must understand fully well that a poorly designed CVM could yield results that are wrong. Strategies on how said biases could be minimized need to be discussed also. Teaching Hour: 2 hrs Proposed Topical Outline:

A. What is Contingent Valuation Technique? B. Steps in CVM analysis C. The contingent valuation questionnaires

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D. Applications of the CVM E. Critique of CVM

Teaching Ideas:

• Sample CVM questionnaires should be introduced to point out the main structure in a CVM survey. Some examples of mistakes in wording that would create biases in responses.

• Presenting different methods that can be used to elicit respondents’ willingness-to-pay: Bidding games, Payment card, Open-ended questions and Close ended question (Dichotomous choice or Referendum will be emphasized).

• In designing CVM questionnaires, one should keep in mind that the purpose is to give information about the goods or services in hypothetical conditions as much clearly as possible in order to get the true willingness to pay as if the respondent really pays for the offered goods/ services. The purpose is not to persuade the respondent to “buy’ it, therefore; the provided information must be clear, adequate and truly reflected.

Basic References: Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 7 Additional Readings: Callan, Scott J, and Janet M. Thomas. 2000. Environmental Economics and Management: Theory, Policy and Application. Chapter 8: Assessing Benefits for Environmental Decision Making. Dixon, John A; Louise Fallon Scura, Richard A Carpenter and Paul B Sherman. 1994. Economic Analysis of Environmental Impacts. Chapter 5. Bateman, I.J, Carson, R, Day, B., Hanemann, N, Hett, T. Hanley, N., Jones-Lee, M. Loomis, G., Mourato, S., Ece Ozdemiroglu. 2004. Economic Valuation with Stated Preference Techniques: A Manual. Edward Elgar Publishing. UK. Discussion Questions Q1. Suppose the researchers estimated demand curves from the CVM questionnaires illustrated in the chapter. Show graphically and explain how these demand curves would measure WTP for improving air quality for each of the scenarios. Q2. Critique the contingent valuation example in the chapter. What sort of biases might the analyst has introduced? Is the scenario too hypothetical? Would respondents have any incentive to misrepresent their preferences?

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Q3. The construction of a dam that would provide hydroelectric power would result in the loss of two streams: one that is now used for sport fishing and another that does not support game fish but is part of a wilderness area.

a) Imagine that a contingent valuation method is used to estimate the social cost

of the loss of each of these streams. Would you be equally confident in the two sets of estimates?

b) Consider two general approaches to asking contingent valuation questions

about the streams. The first approach attempts to elicit how much compensation people would require to give up the streams. The second approach attempts to elicit how much people would be willing to pay to keep the streams. Which approach would you recommend and why?

TOPIC 7: Benefit Transfer Techniques Objective: To introduce to students the Benefit Transfer Techniques and its application. Main Points: The benefit transfer method is a procedure wherein environmental values derived elsewhere are transferred or used to the study area, after some adjustments to reflect local conditions. This method is advocated when there are limited time and financial resources to undertake primary valuation studies. Several agencies have built benefits transfer databases, such as ENVALUE, EVRI, and VALUASIA. The latter was developed specifically for conditions in Asia. The instructor should demonstrate the basic adjustments that need to be done and the various ways of transferring environmental values. Specifically, there are three approaches to transfer values: a) Transferring mean unit values; b) Transferring adjusted unit values; and c) Transferring demand functions. There are limitations to this approach and these should likewise be discussed. In particular, the weakness of this method lies in the comparability of the study site with the policy site, i.e., where the environmental values were taken. Teaching Hour: 0.5 hr Proposed Topical Outline:

A. What is Benefit Transfer method? B. Three approaches to benefit transfer method. C. Adjustments that need to be done to undertake benefits transfer D. Weakness and cautions when using Benefit Transfer method

Teaching Ideas:

• One should start by discussing what circumstances could lead to the use of benefits transfer. The need to make adjustments to the ‘transferred values’ to make it applicable to the study sites should be discussed. On this end, the

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VALUASIA website developed by Saplaco (2002) will be a useful tool to illustrate these various adjustments.

• Students could be referred to journal articles where benefit transfer values were compared with values from actual studies. The range of differences in the values obtained should be highlighted to emphasize the need to be cautious in the use of benefits transfer.

Basic References: Stale Navrud. 1996. The Benefits Transfer Approach to Environmental Valuation. EEPSEA paper. Saplaco, Rommel. 2002. EEPSEA website link.

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LECTURE 7: COST-BENEFIT ANALYSIS AS A TOOL IN

ENVIRONMENTAL/NR MANAGEMENT

Objectives: The main objectives are to review the theoretical concepts and empirical issues underlying benefit-cost analysis and to illustrate the application of these principles and methods in real life setting using case studies and exercises. Main points: The lecture presents an overview of benefit and cost analysis and how it is used in evaluating projects/policies. The difference between financial and economic analysis should be explained, particularly in relation to projects/policies dealing/affecting the environment. The uses of benefit cost analysis should likewise be discussed. The steps in conducting BCA should then be presented. The most important elements in each of the steps will be discussed in class. The theoretical discussions will be supplemented with case study illustrated for better appreciation of the various steps.

Finally, the various issues relating to the use of CBA in natural resource and environmental decision-making will be addressed. These issues relate to discounting, risk and uncertainty, and distributional concerns. Teaching hours: 8 hours Proposed Topical Outline:

A. Overview of Cost-Benefit Analysis 1. Definition of Cost-Benefit Analysis 2. Types of Cost-Benefit Analysis 3. Decision criteria

B. Steps in Cost-Benefit Analysis

Step 1: Identify the problem and specify the set of alternative projects to solve it. Step 2: Decide whose benefits and costs count (standing). Step 3: Identify impacts (costs and benefits). Step 4: Predict the impacts quantitatively over the life of the projects. Step 5: Estimate monetary value of all costs and benefits. Step 6: Discount costs and benefits to obtain present values. Step 7: Compute the net present value of each alternative. Step 8: Perform sensitivity analysis. Step 9: Make a recommendation based on the NPV and sensitivity analysis.

C. Issues in Cost-Benefit Analysis 1. Discounting. 2. Distributional issues. 3. Risks and Uncertainty.

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Teaching ideas:

• The lecture needs 8 teaching hours that include theory, concept, exercises and a role-play.

• It is important to emphasize that CBA essentially about identifying and measuring in monetary terms as many relevant costs and benefits as possible relating to a particular plan, programme or project. The goal is to evaluate in efficiency grounds the net gain or loss in welfare terms to society from said projects/policies.

• Note that the decision criterion to use in CBA, which pertains to Pareto optimality condition, Pareto improvement criterion, and the potential Pareto (Kaldor – Hicks) should be differentiated to the students. It is important to note also that while the Kaldor–Hicks compensation is the basis of CBA, the compensation is hypothetical, not actual. Hence, it is still important to address distributional issues in the context of CBA.

• Using a case study to illustrate may be a good way to understand the basics and steps in CBA. In two hours needed for presenting CBA steps, it is quite difficult to make students understand thoroughly all the steps. To optimize the limited time, many lecturers would want to focus on the two key economics steps: valuing costs and benefits and discounting. For valuing costs and benefits, lecturers would remind students to look back at lecture 7. Students may ask what happens if costs or benefits (impacts) cannot be monetized. Normally, it can be treated as constraints upon the project and handled with care. For example, if it is felt that impacts on certain wildlife cannot be monetised then it may be advisable to set ecological limits for acceptable impacts. Many lecturers would remind students that even for costs and benefits those have market prices, CBA researchers always use “shadow prices” to value them. The concept of a shadow price often takes students awhile to grasp, so be sure to give many examples. E.g., what’s the shadow price of an unemployed worker? What’s the shadow price of a good that is subsidized by the government? When we are imputing environmental values through techniques such as CVM, hedonics, etc., we are using shadow prices.

• Among many criticisms of CBA, it is common to believe that discounting, distribution, uncertainty are pretty relevant to discuss given limited time of the lecture. Among environmental advocates it is pretty standard to believe that we should not discount the future heavily, may be even using a zero rate of discount. The appropriate discount value method is contentious. Two common approaches to estimate the social discount rate are time preference approach and opportunity cost approach. The discussions on distributional issues focus mostly on establishing the terminology: regressive, proportional, progressive. We have not gone into exactly how distributional issues should be handled, except to say that we need to be more aware of how benefits and costs are distributed. The discussion on uncertainty is about the idea that many outcomes are probabilistic, and to introduce the concept of expected values and attitudes toward risk. Risk analysis is discussed.

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• It also seems hard to make students understand the mechanics of discounting, the problem of what discount to use and the effects of different discount rates on the decisions. Students may know the mechanics of discounting beforehand from other course. It is important to differentiate private discount rate and social discount rate, which is used in CBA. Many lecturers will find that the best way to illustrate the effects of discounting is through an example with data.

Basic References: Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 6, p.106-122 Sinden J. and Thampapillai, DJ. 1995. Introduction to Cost-Benefit Analysis. Longman. Melbourne. Chapters 8. Boardman, A.E., Greenberg, D.H., Vining, A.R., and D.L. Weimer. 1996. Cost Benefit Analysis: Concepts and Practice. Prentice Hall. New York. Chapter 1. Discussion Questions & Exercises: Q1. Are low discount rates “good” or “bad” for the environment? Defend your answer.

Q2. Suppose the government of a municipality is trying to determine how to deal with pesticide contamination of its water supply. It wants to undertake a benefit-cost analysis of two alternative policy options for controlling pesticides:

- Upgrading its municipal water treatment plant to remove the pesticides, or - Banning the use of the offending pesticide in the metropolitan area.

Assume that either technique reduces the pesticides to a level that does not adversely affect human health. The costs of these control options are as follows:

- Municipals treatment upgrades: Capital costs = $20 million. The new plant is constructed over the course of the initial year. It starts operating at the end of this year. Once the plant begins operation, it has operating costs of $1 million per year. One constructed, the plant lasts for five years, and then must be replaced with a new plant.

- Pesticide ban: annual operating costs due to substitution of non-toxic methods of controlling “pests” = $3.5 million each year.

Let the discount rate be 5 percent. The municipality’s planning horizon is 10 years. Suppose the NPV of the benefits of the project are $40 million. Which project should the municipality adopt? Assume now that the benefits differ by the type of treatment option chosen. In particular, they remain at a present value of $40 million for the pesticide ban, but there would be additional benefits in the form of less damage to ecosystems from the treatment plant. How high would these benefits have to be each year to make the government indifferent between choosing the treatment plant or the pesticide ban?

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Q3. The Ministry of Transportation (MOT) is deciding whether to invest in a new tunnel through the mountain, which has an existing mountain pass. MOT has spent $3 million (in 2000 dollars) on a feasibility study and has found that the new tunnel would reduce travel times for the nearly 200,000 commuters who would ride the tunnel. A recent analysis indicates that the tunnel would save the tunnel rider approximately 33 hours of travel time per year. A study conducted in 1992 showed that the commuters value their time at $11 per hour (in 1990 dollars). You can assume that the real value of commuting time is constant. The tunnel would cost $1 billion (in 2000 dollars) to build and will take 6 years to complete. Once the project is completed, the operation and maintenance cost of the tunnel is projected to be $25 million per year (in 2000 dollars). The real cost is believed to remain constant over time. The MOT has agreed to finance the initial construction costs, but the operation and maintenance costs must be covered by an increase in fares.

1. For each perspective, identify whether each entry in the table would be counted as a benefit (B), cost (C) or not counted as either (NC) in determining the net benefit of the project.

MOT Commuter Society

Feasibility Study

Time Saved

Construction Cost

Operation and

Maintenance Cost

Subsidy

Fare Increase

* You could argue that commuters would be paying for the subsidy through higher taxes.

2. What are some of the simplifications in the analysis that limit the accuracy of the

assessment? 3. What are other potentially important costs or benefits that we should consider in

the net benefits assessment?

4. From the societal perspective, what is the present value of the cost of the project in 2000 dollars if the time horizon is 30 years and the annual discount rate is 3 percent? Use the annuity factor to calculate your answer and assume that the payments are due at the beginning of the period.

5. From the societal perspective, what is the present value of the benefits of the project in 2000 dollars if the time horizon is 30 years and the annual discount rate is 3 percent? (Note: Use the CPI given in lecture notes). Again, use the annuity factor to calculate your answer but for simplicity, assume that the benefits are accrued at the end of the year.

6. What is the present value of net benefits in 2000 dollars?

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LECTURE 8: NATURAL RESOURCE ECONOMICS

TOPIC 1: Introduction to Natural Resource Use, Property Rights, Rent,

and Land Value Objectives: This section should provide students a broad overview of the various natural resources available on earth and of the critical factors: time, property rights, and location, as they affect allocation of natural resource use over time. Main Points: An overview of the various types of natural resources available on earth: water, atmosphere and land, including those that lie within the water and on or under land is presented to students. The value/uses of these natural resources as provider of inputs to the economic system is then presented using Figure 1.1 in H & O book. The concept of property rights, rent and location (accessibility) are then introduced and linked to natural resource use. This section also discusses the value of time (through compounding and discounting) since inter-temporal allocation of natural resource use is the key issue in natural resource economics. Teaching Hour: 1 hr Proposed Topical Outline:

A. What are the natural resources available on earth and discuss how time is a critical factor in the analysis of natural resource use. Differentiate renewable from nonrenewable resources.

B. Summarize the role of natural resources in the economic system by way of Figure 1.1. Of H & O (1998) and explain role of economics in this context.

C. Property rights and natural resource use: private property vs. open access situation

D. Decision making over time: compounding, discounting, and present value calculations.

E. Concept and Determinants of Economic Rent and Application Teaching Guides:

• Students could be asked to name the various natural resources they are familiar with and say something briefly about their uses and the current problems that they face. They could also be asked what they consider the single most important natural resource and why? Follow-up question on whether they think their daily life is directly affected by the location of this resource and If so, how, could also be asked

• In the course of discussion—take out those factors that are relevant to the succeeding discussions, such as rapid depletion over time, lack of property rights over them, some resources closer to communities being extracted faster, etc.

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• The concept of time value of money should be made clearly by way of examples and some illustrative calculations but should be kept short, as this topic will be discussed also under discounting. The point to emphasize though is the need to consider present value of these resources in resource allocation decisions.

• The use of Figure 1.1 is meant to fast track discussion on this topic and meant to provide a holistic picture of how natural resource system is linked to economic system. Slide (power point or overhead) for Figure 1.1 should be prepared in advance. Note that a similar presentation was given in Lecture 3 but the focus then was on the flow of residuals to the environment. Make that distinction clear to the students.

• The role of property rights and location can be explained by citing cases where these are clearly seen in this country—forest resources under different management vs. no-management (open-access) and status of natural resources as a function of distance to communities.

• The discussion of rent could be facilitated by the use of graphical illustrations. Main Reference: Hartwick, J. and N. Olewiler. 1998. The Economics of Natural Resource Use, 2nd edition: Chapters 1 and 3 (pp57-73). Discussion Questions: Q1. Suppose that you are considering buying a gold deposit. It will cost $1 million per year to construct a mine over three years so that gold can be extracted beginning in year 4. Each year the mine operates, it will yield a net return (total revenue less total cost) of $800,000. What will you pay for the gold deposit if:

a) Interest rates are 10% and gold can be extracted for 10 years? b) Interest rates are 5% and gold can be extracted for 6 years?

Q2. Are non-renewable resources becoming more or less substitutable by other productive inputs with the passage of time? What are the possible implications for efficient resource use of the elasticity of substitution between non-renewable resources and other inputs becoming a) higher and b) lower, with the passage of time Q3. Assume a world that consists of two time periods. Denote the individuals in period 1 as generation 1 and the individuals in period 2, as generation2. Assume a world of just two goods, cases of beer and boxes of tea. Further, assume that individuals in generation 1 are willing to trade beer for tea at the rate of two cases for one box of tea, and generation 2 is willing to trade beer for tea at the rate of one case for one box of tea. Currently, each generation has 10 cases of beer and 10 boxes of tea. Is the current inter-temporal allocation of beer and tea efficient? Explain. (Assume that tea and beers are divisible—that is, generation 1 would trade one case of beer for one half box of tea and generation 2 would trade half box of tea for a half case of beer).

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Q4. What do you suppose will happen to the prices of clean water and non-perishable food in areas hit by natural disasters? How will markets respond? Will the price changes help or hurt the relief and recovery efforts? Q5. Discuss the contention that it is more appropriate to regard natural forests as non-renewable than as renewable resources. (Perman, Ma, McGilvray, and Common, 2003) Q6. How about a question on rates of time preference and inter-temporal substitution? E.g., I have $1000. If I deposit my money in the bank, it will earn 5% interest per year. If I use that money to buy goods, I’ll have the enjoyment of the goods. What do I do? What factors does this decision depend upon?

TOPIC 2: Non-renewable Resources Objectives: The main objectives are to show how nonrenewable resource differs from reproducible goods and to discuss the underlying economic theory of extraction in determining efficient extraction path of the resource. Main points: The backbone of discussion on nonrenewable resource is the economic theory of depletion. The economic theory of depletion explains the flow of production over time and how quickly the resource stock is exhausted. When discussing the theory of depletion, two main points should be emphasized: a) The Hotelling theorem and b) The effect of changing parameters on the rate of resource extraction. The Hotelling theorem could be posed by way of a question: Given a finite stock of some exhaustible resource, at what rate should that resource be depleted? The general answer is that it should be depleted in such a way that the well being (welfare, utility) generated by using the resource is maximized. More analytically, it should be depleted so as to maximize the present value of the flow of consumption goods coming from the use of the resource. A simple mathematical and graphical model with two-period should be developed to illustrate the derivation of an efficient extraction profile. There are various ways of investigating what happens when there are changes in the factors influencing the rate of resource extraction (for examples a change in discount rate, a change in reserves, a change in cost of extraction etc.). Teaching hours: 2 hrs Proposed Topical Outline:

A. The nonrenewable resources. B. The Hotelling theorem

1. The objective function and the constraint 2. The demand equation 3. Derivation of the Hotelling rule using the Lagrangean multiplier 4. The basic Hotelling equation and the optimal rate of extraction

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5. Some simulations/exercises C. The effect of changing parameters on the rate of resource extraction.

Teaching ideas

• The topic needs at least two hours of lecture including theory and sample exercises. Some lecturers may want to leave the effect of changing parameters as homework and make corrections in the next lecture.

• One should start by showing the features that differentiate nonrenewable resources from reproducible goods. In the case of finite stock of the resources, the usual maximization condition (MR = MC) is modified in 3 fundamental ways: (1) the opportunity cost – the cost of using up the fixed stock at any point in time or being left with smaller remaining reserves; (2) the value of the resource rent over time; and (3) the stock constraint – the total amount of resource extracted over time can not exceed its total stock of reserves.

• The discussion on optimal extraction path usually starts with a two-period model with mathematical and graphical illustrations to explain the Hotelling theorem. For the class discussion, the use of numerical and graphical illustration is recommended. The model is built up in the following sequence:

i. The objective function: U = NSB0 + NSB1/(1 + ρ) ii. The constraint: S = R0 + R1

iii. The demand equation: Pt = a – bRt iv. Derivation of the Hotelling rule using the Lagrangean multiplier:

• L=NSB0 + NSB1/(1 + ρ) - λ[S- R0-R1] or

• L= (aR0+b/2*R02 –cR0)+(aR1+b/2*R1

2 –cR1)/(1 + ρ) - λ[S- R0-R1]

• The basic Hotelling equation: P0 – c = (P1 – c)/ (1 + ρ)

v. Derivation of optimal rate of extraction: R0=(bS+aρ)/b(2+ρ) If assume c=0

vi. Some simulations/exercises vii. Intuition behind the Hotelling rule

viii. The 4-quadrant diagram illustration.

• In the above presentation of the Hotelling theorem, there is a tricky step that many students find it difficult to understand. That is, how one could derive NSB0 = (aR0+b/2*R0

2 – cR0). The instructor may wish to use the demand diagram to

illustrate how one can calculate the NSB (TWTP minus expenditure at the extraction quantity).

• The Hotelling theorem is the most important section of the lecture. So it is common to spend most of the allocated time on this topic. It often looks simple also but the intuition in the theorem should be explained clearly to the students. For instance, it is worth emphasizing that the net price in period 0 equals the discounted value of the net price in period 1. This net price is usually known as resource rent, resource royalty, user cost, or depletion premium. Second, we may

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derive the optimal price for each period. Third, we can reformulate the Hotelling rule in terms of the discount rate. So, the Hotelling rule for the optimal depletion of resources can be formulated in various ways: in terms of price, royalty and the discount rate.

• Make sure you emphasize the role of natural resource rents…the return to the natural resource (netting out all other costs). It is rents that must be equal over time (in present value) which is why price minus marginal cost is positive in each time period for a depletable resource being extracted efficiently. Compare this to efficient production of a reproducible good where price = marginal cost is the efficient solution.

• A possible simulation of the Hotelling Rule may look like this. Let:

S=2500; b = 0.25, a = 500 to give the demand curve P=500-0.25R

ρ=0.05 (i.e. 5%)

We have R0 = [(0.25)*(2500)+(500)*(0.05)]/[0.05 + (0.25)*(0.05)] = 1,268. The value of R1 is immediately derivable from the constraint S = R0+R1 to give R1= 1,232. Notice that the quantity extracted in the second period is less than in the first period.

To find the optimal prices, substitute R in the demand equations: P0 = 500-0.25*(1268) = 500-317 = 183 P1 = 500-0.25*(1231) = 192

As the model predicts, prices rise through time. Note that the discounted value of 192 = 192/(1.05) = 183, which is the price in the first period. Again, this is exactly what we predicted: the present value of the price is the same in every period (if costs were positive, the result would be that the present value of the royalty would stay the same over time).

Basic Reference: Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 16) Hartwick, J. and N. Olewiler. 1998. The Economics of Natural Resource Use, 2nd edition: H & O, chapter 8. Discussion questions Q1. If the discount rate is zero, what is the value of resource rent over the extraction profile of the mine? Q2. True, False, Uncertain. Explain your answer: “The economically efficient allocation of a resource stock over time is the one in which extraction in each year is the same, so that the total net benefit of the resource is maximized”.

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Q3. Name three factors mitigating the scarcity of oil, and on a diagram (or set of diagrams) involving marginal benefit and marginal cost curves (including marginal user cost curves, as presented in class), illustrate how these factors affect the current consumption of oil. Q4. Explain why there is a natural tendency for the price of non-renewable resources to rise over time. Exercise: In 2002, the Unocal Corporation discovered a natural gas mine with an estimated stock of 71 billion tones in the West South Sea of Vietnam. Currently Unocal is making the feasibility plan that is going to exploit the gas mine in 2 periods. Extraction cost, which includes costs of establishing the drilling platform, pipe system costs and operating costs, are estimated at USD200 per tons. Marginal extraction cost is assumed constant. The demand curve for the gas product in two periods is QP 231200 −= , with unit of P is in

USD/billion tons and Q is billion tons. Discount rate is 10%/period. a) Calculate the optimal rate of extraction in each period. b) Suppose government now decides to tax the resource. The tax is USD50/ton.

Recalculate the question a. c) Suppose when approving the Unocal project, the government conducts another

survey to assess the stock again and discover that the stock of natural gas now is 82 billion tons. With the tax of USD50/ton, calculate the optimal rate of extraction in each period.

TOPIC 3: Renewable Resources: Fishery and Forestry Objective: The main objective of this section is to for students to be able to discuss the basic economic models for analyzing renewable resources like fishery and forest extraction. The lecture aims to answer these questions: when should we cut a stand of tree and what is the optimal fish harvest and open access of fishery? Main points: This section will focus on understanding the analytical tools to find out the current state of the renewable resources and how to determine the optimal use of those resources. Two types of resources will be discussed: fisheries and forestry. The basic model of fishery economics to be discussed in class will only consider the one species model. More complex models consider multiple species but that is usually discussed in fishery economics course. The basic model is to maximize the benefits minus the costs of fish harvest subject to the constraint that we maintain a steady-state. In the forestry problem, the critical element is that the growth function is a function of time, not a function of stock. The forestry problem solves for the optimal time to harvest the entire stock, and the solution gives the optimal length of each rotation of stock. A simple model to derive the maximum “mean annual increment” by choosing the rotation T that maximizes the annual value of harvest is first discussed. For simplicity, this model

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ignores discounting. We then expand the model with the Fisher solution, which considers a forest as a capital asset, but assumes no future use for the land. The Faustmann model follows that links the MAI and Fisher models to give a `full' economic approach that considers both discounting and future land use. Teaching hours: 6 hrs Suggested Topical Outline

A. The fishery 1. Characteristics of Fishery Resources 2. Modeling stock growth and Maximum sustainable yield 3. Economics in the fishery: Optimal fish harvest in the steady state and Open Access 4. Conclusions and observations

B. The forestry: a simple model

1. Characteristics of Forestry Resources 2. Mean Annual Increment (MAI) 3. Fisher solution and Faustmann solution 4. Forest Policies

Teaching ideas:

• The fishery models can be presented in both mathematical and diagrammatic approaches. However it is evident that most students feel comfortable with the latter approach. One should be careful in moving from the biological growth curve to the economic curve (with effort in the horizontal axis and revenue in the vertical axis.

• Note that the basic model in fishery economics may not yield socially optimal level because we have not shown that it is socially optimal to be in a steady state or described the conditions under which this premise holds. Thus, the problem we are about to solve is a second-best problem. Nonetheless, it is an important second-best problem because policy-makers and their constituents often want steady-state solutions due to the economic stability and predictability that they provide.

• One should also show clearly the diagram for optimal fish harvest under private property and open access conditions.

• Emphasize that the difference between forests and fish is the following: (1) After an initial harvest of a natural forest, the forest is replanted. Therefore, while the biological characteristics of the forest are important, they are less so than for the fishery because reproduction is controlled by the forest operator. (2) Trees don’t swim, so it is more likely that the forest will be managed under private property or government-set harvesting rights and thus, typically no open access issues. If the forest was open access, then show them that the privately efficient solution would be to cut a natural forest, then move on to the next natural forest. There would be no reforestation.

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• Similarities between fish and forests is that, in principle, they can be managed sustainably over many cycles of planting/harvesting/planting for forests and harvesting a portion of the fish stock, allowing the remaining stock to reproduce and become larger. The basic dynamic equation is the same: harvest when the value of the biological growth (biomass marginal product) equals the opportunity cost of the harvest (harvesting costs, restocking costs, and the opportunity cost of the land in the case of forests). Both types of resources have problems reaching a sustainable equilibrium the longer the life of the species (e.g., slow growing trees or fish species that don’t reproduce until they are 20 years old). Uncertainty about future prices, interest rates, costs, makes the management problem more difficult.

• One can also point out that the fish models can apply to the management of other types of wildlife (e.g., hunting wild species versus preserving them for future hunting or wildlife viewing.

Basic References: Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 15) Hartwick, J. and N. Olewiler. 1998. The Economics of Natural Resource Use, 2nd edition: Chapters 4 and 10. Discussion questions & Exercises: Q1. How does the biological growth of each of these resources influence how each is harvested? Q2. Why is it that fishery management looks at how much to harvest and forestry management looks at when to harvest even though both are renewable resources?

Q3. Discuss how the level of effort in fishing affects the efficiency of harvesting fish.

Q4. Consider the effort/revenue curve for a fishery. Suppose the fishery is currently at the open access point where TR=TC.

a. What does it mean for the implied shadow price to be zero at this point? Why is this undesirable?

b. Is this point sustainable? Explain. c. Give three reasons why the MSY level of effort might be preferred to the open-access level of effort. d. Why might ESY be preferred to MSY?

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Q5. In what circumstances, and on what criterion, can the conversion of tropical forestry into agricultural land be justified? Q6. Demonstrate that a tax imposed on each unit of timber felled will increase the optimal period of rotation (that is, the age of trees at harvesting) in an infinite rotation model of forestry. What effect would there be on the optimal rotation length if the expected demand for timber were to rise? Q7. How would the optimal rotation interval be changed as a result of”

a) an increase in planting costs b) an increase in harvesting costs c) an increase in the gross price of timber d) an increase in the discount rate e) an increase in the productivity of agricultural land

Discussion question: What are some of the causes of deforestation in Vietnam, why do they arise, and what can be done about it?

LECTURE 9: APPLICATION OF ENVIRONMENTAL POLICY IN YOUR COUNTRY

Objective: To introduce to students the legal structure of environmental planning in Vietnam and to discuss the major environmental policies currently existing in Vietnam. Cases wherein economic instruments have been used to address the country’s problems will also be discussed. Proposed Topics for Term Papers:

� Environmental Protection Law � Laws on Forestry Protection and Development (2004) � Mines Laws (1996) � Oil and Gas Laws (1996 amended in 2000) � Water Resource Laws ( 1999) � Aquaculture Laws (2003) � Land Laws (2003)

Teaching Hour: 4 hrs Proposed Topical Outline for the Assigned Term Paper:

A. Framework Laws of Environmental Protection and Provisions in your country.

B. Institutional Arrangements: Organization Structures of government;

Environmental institutions; environmental legislations.

C. Applications of environmental legislation in the country: achievements and constraints.

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D. Environmental Problems where economic instruments are applied.

Teaching Ideas:

• This topic will largely be a term paper to be assigned to group of students. The assignment should be given middle of the semester of the course to give students ample time for research works.

• The students will be asked to provide a brief overview of the environmental/natural resource laws and relevant provisions as they affect environmental policy making in the country

• Students could also be encouraged to compare organizational structures of the environment department in your country vis-à-vis other countries in the region.

• Cases on the applications of environmental policies in the country should also be included in the term paper and report, to emphasize: achievements, obstacles and lessons learnt, as well as future directions.

Basic References: Students should visit website of the various offices responsible for these topics. They could also visit these offices for some materials. Library materials in your University should also be explored.

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