Policy Instrument Comparisons

So far we've pointed out just a few of the differences between CAC and EI policies, including the potentially large cost advantages 2Robert Stavins, Experience with Market-based Environmental Policy Instruments, Discussion Paper 01-58 (Washington, DC Resources for the Future, 2001). The 1990 Clean Air Act Amendment created the first large-scale tradable permit program in the United States. Its goal was to reduce sulfur dioxide emissions by 10 million tons below 1980 levels. The program was...

Private Property

Just as in the case of markets, where certain conditions must be satisfied in order for markets to be efficient under perfect competition, there are four conditions that ensure efficiency with respect to private property. And just as in the case of markets (where they never really live up to the ideal of perfect competition), the ideal conditions for unattenuated, or complete and efficient, private property rights also run into complications in the real world. The four conditions for efficient...

Short Run versus Long Run Substitutions

For many policy issues, there is an important distinction between the short-run and the long-run responses by firms and individuals. For economists, the short run is a period when firms and individuals are locked in to some past decisions, so that they have fixed costs that they cannot avoid. If gas becomes more expensive on a Monday, you don't trade in your gas-guzzling car on Tuesday. But over a period of months or years, individuals might respond to price changes by buying more...

Globalization and the Race to the Bottom

There are many issues related to trade and globalization that have economic dimensions, but many of these topics go beyond economics. One issue frequently raised is the concern that globalization, trade, and foreign investment lead to a race to the bottom for both environmental protection and the wages of workers. In the case of environmental protection, this idea is also referred to as the pollution havens hypothesis, suggesting that as poor countries try to attract foreign investments they...

Rent Seeking

The theory of rent seeking has two parts. The first part involves the well-known idea that monopolies have the ability to influence prices in a way that increases profits for the monopolist at the expense of consumers. This monopolistic behavior can create large transfers from consumer surplus to producer (monopolist) surplus and will also create a deadweight loss. The second part of the theory focuses on what self-interested entrepreneurs will be willing to do to secure these large transfers....

Hedonic Pricing Analysis

The second major revealed preference technique is called he-donic analysis or the hedonic pricing method. The basic idea is that people are willing to pay different amounts for market goods with different characteristics. If some of these characteristics are related to the environment, we can gain an indirect measure of the value of the environment by looking at the differences in revealed preference for goods with without a particular characteristic. For example, while residential housing...

Recommended Readings and References

The quotation at the start of this chapter is from Harry G. Johnson, Towards a Generalized Capital Accumulation Approach to Economic Development in The Residual Factor and Economic Growth, OECD Study Group in the Economics of Education Paris Organization for Economic Cooperation and Development, 1964 . For a textbook on the economics of developing countries, see Dwight H. Perkins, Malcolm Gillis, Steven Radelet, Michael Roemer, and Donald Snodgrass, Economics of Development New York W. W....

Gains from Trade

Gains From Trade Consumers

Figure 8.1 represents a country that does not trade. The domestic market equilibrium is given by the quantity demanded, which equals the quantity supplied QD QS at price PD. The net benefits from the rice market i.e., the net social value to the economy is the shaded area, which can be divided up into the benefits to consumers, the consumer surplus triangle CS, and the benefits to producers, the producer surplus triangle PS.3 Figure 8.1 represents a country that does not trade. The domestic...

Capand Trade Safety Valves

Implementing emissions trading policies, like tradable carbon permits, faces many obstacles, including strong disagreements 5Stavins, Experience with Market-based Environmental Policy Instruments. about how costly it would be for industry to comply with the desired reductions. If the marginal abatement cost curve is steep, then a higher level of permits and emissions would be appropriate than if the MAC curve is flat. With no solid estimates of costs, policymakers are often caught between...

Limits to Growth and the Environmental Kuznets Curve

Many observers believe that continued economic growth will only lead to worsening environmental problems as production of more commodities uses up the earth's natural resources, and as the economy generates ever-increasing amounts of waste byproducts and pollution. Other, more optimistic observers expect solutions for scarcity to be found in human ingenuity and technology. One line of reasoning has been the argument that poverty is an important cause of environmental degradation, and that as...

Production Profit and Supply

The supply side of a market is just the reverse of the demand side. While demand is based on marginal benefit, which determines consumers' willingness to pay, supply is based on marginal cost, which determines producers' willingness to sell. In a market, supply comes from firms or producers that combine inputs to make the goods and services that consumers will buy. Economists sometimes refer to these inputs as factors of production, meaning labor, capital, and land, as well as other more...

The Market for Funds

These transactions across time involve the market for funds, like at a bank. To simplify just a bit, let's assume that the supply curve in figure 4.1 reflects people's willingness to postpone consumption of their income until a later period. The demand curve in figure 4.1 represents people wanting to borrow to make productive investments. Investors' willingness to pay a premium to borrow money for their investments depends primarily on the expected return on their investments. As in earlier...

Congestion Pricing

Let's put some of these ideas to work on a common externality problem, highway congestion. A highway is a congestible public good, which means that it is nonrival with low numbers of users Even when direct policies are impractical, economic reasoning and market incentives can help identify creative solutions to difficult problems. Here's an example. Poachers of ivory and rhino horn kill the animals in the process, which creates an externality problem because of concerns over the possible...

Tradable Pollution Permits

Tradable Permits Marginal Abatement Cost

Tradable pollution permits, also referred to as emissions allowances, represent an important innovation with a number of potential advantages over other approaches. In some respects tradable permits are like a CAC approach because emissions are 1Martin L. Weitzman, Prices vs. Quantities, Review of Economic Studies 41 1974 477-491. limited to a predetermined quantity permits are issued for only a limited level of emissions , but they also have the advantages of a pollution tax because the...

Economic Incentive Policies

Equal Marginal Abatement Costs Taxes

An alternative to the regulatory, or CAC, approach is an economic incentive, or EI, policy. Unlike the more rigid CAC approach, EI instruments discourage pollution with monetary incentives penalties and rewards such as taxes, user fees, or subsidies. Firms and households are not told how much they can pollute or what technology they must use, but their choices will have financial consequences and this will influence the choices they make. Let's begin with a simple example of a pollution charge...

Trade Offs Efficiency and Demand

Elasticity High Economics

We can live without diamonds, yet they have a very high price. We cannot live without water, yet it typically has a very low price. Does this suggest something is terribly wrong Economic reasoning says no. Understanding this diamond-water paradox is just one of the goals of this chapter and the next one, where the essential building blocks for economic analysis are developed step by step. Central to this economic reasoning is marginal analysis the evaluation of trade-offs between marginal...

From Efficiency to Market Distortions

Government Revenue Deadweight Loss

The main attraction of markets in economics is that they can achieve significant, even dramatic, net benefits through voluntary exchange between buyers and sellers, producers and consumers. If these markets exhibit what economists call perfect competition, they will maximize net benefits and be Pareto optimal. For perfect competition, however, there must be a many small suppliers so that they cannot influence price , b many consumers also so that they cannot influence price , c producers able...

The Coase Theorem

Key Concept Reciprocal externalities The Coase Theorem refers to an important point made by Nobel laureate Ronald Coase in a 1960 paper called The Problem of Social Cost. The most important point Coase made is not particularly controversial. Coase points out that from an economic perspective, externalities are reciprocal they can go either way from A to B or from B to A depending on how the property right or liability is defined. He uses an example of a doctor's office located next to a...

Policy Distortions and Derived Externalities

Incentives for farmers to produce food rather than export cash crops , and food production fell, actually making it more difficult to feed the poor. In another example, policies to encourage food production have sometimes included subsidies on fertilizer and chemicals, which in turn has led to overuse and worsened water pollution problems. Cheap coal in China and below-cost timber sales in the United States and many other countries are examples that show that one policy goal can be promoted at...

Travel Cost Method

Average Travel Cost Consumer Surplus

The travel cost method looks at how far people are willing to travel to enjoy an environmental nonmarket good such as a beach, lake, river, or wilderness area. Travel is costly in terms of time, fuel, and other expenses. We expect people who live closer to a pristine lake to visit it more often, on average, than people who live far away, just as we expect people to buy more pizza when the price is low than when the price is high. So, if we can estimate a demand curve for pizza using its price,...

Production Possibilities

Trade Off Frontier

Up to now we've looked at consumers choosing among goods and producers choosing among inputs. The third and final category of choice we need to consider is how much of each good to produce. These choices aren't generally made by one individual, as is the case for a consumer's choices or a firm's choices. Instead, the interactions of consumer choices, producer choices, and market prices determine a set of outputs for all goods and services. Overall efficiency would involve efficient allocation...

Tragedy of the Commons Reciprocal Externalities

One type of market failure is sometimes referred to as a tragedy of the commons, a term ecologist Garrett Hardin popularized in a famous article of the same name in 1968. Many economists and other social scientists no longer like the term tragedy of the commons because it implies that all commons problems necessarily end in tragedy overexploited and degraded resources .1 They don't always end in tragedy as we will see later when discussing common property institutions in chapter 9. Common pool...