Making public environmental decisions

What is environmental economics?

• Environmental Resources:– Air, water, marketed species (fisheries, timber), non-marketed

species (birds, frogs), natural areas, exhaustible resources

• Economy and Environment– People gain well-being from environment– Environment absorbs waste– Firms use environment to produce goods & services– Firms and individuals subject to environmental regs– People gain well-being from goods & services

• Environmental Economics: study of interaction between economy and natural environment

Market Failure

• For private goods, markets generally work fine without any interferences

• Environmental problems are different – markets may fail – Externalities: what firms do inadvertently affect

others negatively (pollution)– Public Goods: benefit everyone (species

preservation)

• Government intervention generally necessary to “fix” market failure – regulation or direct action

Introduction to Project Analysis

Cost-effectivenessCost-BenefitMulti-criteriaSustainabilty

Precautionary Principle/Safe Minimum Standard

Why are we studying this?

• All group projects are fundamentally about making decisions about how to best solve an environmental problem

• Our goal today: look at ways of evaluating different solutions to environmental problems: “project evaluation”

Two Basic Kinds of Questions

• Positive: describes what will happen or why something happened– Why did US drop out of Kyoto?– What firms will leave LA if air regs are tightened?

• Normative: describes what should happen– How much habitat should be set aside for Gnatcatcher?– What is the level of GHG emission control that balances costs

and benefits of control?• Economists generally conduct positive analysis• Policy making is supported by normative analysis

Economic Problems

• Economics is the study of what to do when things are scarce: allocation of scarce resources

• All economic problems have a “tension”.• Recipe

1. Identify the tension (what happens if you move too far in one direction or another).

2. Develop a formal approach for carefully considering the tension.

3. Use model to balance the tension & make policy recommendation.

Identifying the “tension”

• Climate change control requires reducing emissions of GHG’s worldwide. Which countries should reduce, and by how much?

• How much will housing prices rise from Gnatcatcher habitat protection?

• Recovery of Snake River Chinook salmon required habitat restoration. Which recovery efforts are most efficient? Should the Lower Granite Dam be removed to provide access to historic spawning beds?

Examples cont’d

• Small furniture strippers in LA emit VOC’s. The SCAQMD imposes tighter regs. Will the strippers move to Arizona/Mexico or stay in LA?

• The ANWR is a nearly pristine artic preserve, but it also contains large oil reserves. Should we drill for oil in ANWR?

• A tax on gasoline is one method for reducing domestic oil consumption and reducing pollution. What should the gasoline tax be?

• One way to reduce local air pollution is to reduce sulfur burning. Should the EPA require sulfur-free diesel fuel in trucks?

Project Evaluation

• How to make judgments about the advisability of public actions– Proposed regulations (eg, air regulations)– Proposed projects (eg, habitat acquisition)

• Project evaluation is a normative issue because we are judging what should happen, not just what will happen.

Example: Gnatcatcher

• Gnatcatcher lives on California Coast• To protect species, must set aside coastal habitat and

protect from urbanization• Questions to ask:

– How much land to set aside?– Who should pay for land set-aside?

• How to answer questions (ie, make social decisions)– Vote? Who should vote? Majority rules?

• Coastal residents, LA residents, State of CA, US? Future generations?

– Look at overall benefits and costs?– Other methods to decide?

Methods for project evaluation

• Cost-effectiveness – cheapest way to achieve a pre-determined goal

• Cost-benefit – balance pluses and minuses of project• Multi-criteria – looks at ways of achieving multiple goals• Precautionary Principle – one approach for how to act

faced with great uncertainty*• Sustainability – only do things that can be continued in

perpetuity*

*Difficult to implement, difficult to define

Cost effectiveness vs. Cost benefit

• Cost effectiveness analysis: – Start with a goal (e.g., 5% reduction in GHG emissions)– What is the least-cost way of achieving it?– Note: Cost effectiveness says nothing about the

appropriateness of the goal.

• Cost benefit analysis: Weighs costs and benefits to determine the optimal (i.e. most efficient) level. (e.g. by what % should GHGs be reduced?)

Cost effectiveness not as obvious as you might think

• Suppose each student is a polluting firm, each emits 100 tons of NOx per year.

• 60 students x 100 tons = 6000 tons.• 2 types of polluters: 30 high abatement cost

($1000/ton), 30 low cost ($100/ton). • Arnold wants to reduce (abate) NOx

emissions by 50%, down to 3,000 tons.• What policy should Arnold use?

Evaluate 2 options

• Option A: Everyone reduces by 50%.– Low cost firms: 30 firms*50 tons*$100/ton =

$150,000.

– High cost firms: 30 firms*50 tons*$1,000/ton = $1,500,000.

– Total Cost = $1,650,000.

• Option B: Low cost firms shut down.– Total cost = 30 firms*100 tons*$100/ton = $300,000.

• Option B achieves the goal at a much lower cost!

Characteristics of most social investments

1. Dynamic – benefits and/or costs accrue over time, often over space too.

2. Benefits & costs accrue to different parties.3. Public goods – 2 characteristics

1. Non-rival: my use doesn’t diminish your use.2. Non-exclusive: nobody can be excluded.

4. Rely on public provision (and in few cases private provision).

5. Uncertainty about future costs or benefits, risk, irreversibility.

“Cookbook” conceptual approach to evaluating public projects

1. Identify affected parties – whose benefits and costs should be counted?

2. Determine physical impacts (+ and -).3. Predict quantitative impacts over life of project.4. Monetize impacts, where possible.5. Choose time horizon, discount.6. Add up benefits and costs.7. Conduct sensitivity analysis.8. Examine distibutional consequences9. Examine political feasibility10. Make recommendation with assumptions explicit.

Readings this week

• Fullerton & Stavins: “How economists see the environment”– Myth of universal market, market solutions, market

prices, efficiency.

• Kolstad: Ch 3 in Environmental Economics– Difficulty in making social decisions about

environment

• Ando: “Species Distributions,…”– Relevant to first assignment