Energy, Environmental Economics Energy Modelling Lab. Department of Energy Studies, Energy Systems...

Energy, Environmental Economics

Energy Modelling Lab.Department of Energy Studies,

Energy Systems Division, Ajou University Prof. Suduk Kim

[email protected]

The Production Opportunities of the Farmer and Rancher

Test of Hypothesis by its Realism of Assumption?

The Circular Flow Diagram

Test of Hypothesis by its Realism of Assumption?

Positive Economics

The essence of science is the scientific method the dispassionate development and testing of theories about how

the world works. This method of inquiry is as applicable to studying a nation's

economy as it is to studying the earth's gravity or a species' evolution.

As Albert Einstein once put it, "the whole of science is nothing more than the refinement of everyday thinking

The scientific method observation, theory, and more observation

How does the interplay between the theory and observation work?

Does the challenge that experiments are often difficult in economics make economics not scientific?

The role of Assumption Should an assumption be real? Or what does it have to do with

the art of scientific thinking? What is the role of different assumptions to answer different

questions?Positive vs. Normative Analysis

Natural resource economics

Natural resource economics deals with the supply, demand, and allocation of the Earth's natural resources. One main objective of natural resource economics is to better understand the role of natural resources in the economy in order to develop more sustainable methods of managing those resources to ensure their availability to future generations. One main objective of natural resource economics is to better understand the role of natural resources in the economy in order to develop more sustainable methods of managing those resources to ensure their availability to future generations.The economics and policy area focuses on the human aspects of environmental problems. Traditional areas of environmental and natural resource economics include welfare theory, pollution control, resource extraction, and non-market valuation, and also resource exhaustibility,] sustainability, environmental management, and environmental policy. Research topics could include the environmental impacts of agriculture, transportation and urbanization, land use in poor and industrialized countries, international trade and the environment, climate change, and methodological advances in non-market valuation, to name just

a few. welfare theory, pollution control, resource extraction, and non-market valuation,

and also resource exhaustibility, sustainability, environmental management, and environmental policy.

Natural resource economics also relates to energy, and is a broad scientific subject area which includes topics related to supply and use of energy in societies.

Source: http://en.wikipedia.org/wiki/Natural_resource_economics

Environmental economics

Environmental economics is a subfield of economics concerned with environmental issues. Quoting from the National Bureau of Economic Research Environmental Economics program: “ [...] Environmental Economics [...] undertakes theoretical or empirical studies of the

economic effects of national or local environmental policies around the world [...]. Particular issues include the costs and benefits of alternative environmental policies to deal with air pollution, water quality, toxic substances, solid waste, and global warming.”

Environmental economics is distinguished from Ecological economics that emphasizes the economy as a subsystem of the ecosystem with its focus upon preserving natural capital. One survey of German economists found that ecological and environmental economics are different schools of economic thought, with ecological economists emphasizing "strong" sustainability and rejecting the proposition that natural capital can be substituted by human-made capital. For an overview of international policy relating to environmental economics, see Runnals (2011).

Central to environmental economics is the concept of market failure. Market failure means that markets fail to allocate resources efficiently. As stated by Hanley, Shogren, and White (2007) in their textbook Environmental Economics.

Source: http://en.wikipedia.org/wiki/Environmental_Economics

The Market for Aluminum (Efficiency)

What is an externality?

Why do externalities make market outcomes inefficient?

How can people sometimes solve the problem of externalities on their own? Why do such private solutions not always work?

What public policies aim to solve the problem of externalities?

Introduction

One type of market failure: externalities.Externality: the uncompensated impact of

one person’s actions on the well-being of a bystander Negative externality:

the effect on bystanders is adversePositive externality:

the effect on bystanders is beneficial

Self-interested buyers and sellers neglect the external effects of their actions, so the market outcome is not efficient.

Pollution: A Negative Externality

Example of negative externality: Air pollution from a factory. The firm does not bear the

full cost of its production, and so will produce more than the socially efficient quantity.

How govt may improve the market outcome:Impose a tax on the firm equal to the

external cost of the pollution it generates

Other Examples of Negative Externalitiesthe neighbor’s barking doglate-night stereo blasting from the dorm room next to yoursnoise pollution from construction projectstalking on cell phone while driving makes the roads less safe for othershealth risk to others from second-hand smoke

Positive Externalities from EducationA more educated population benefits society: lower crime rates: educated

people have more opportunities, so less likely to rob and steal

better government: educated people make better-informed voters

People do not consider these external benefits when deciding how much education to “purchase”Result: market eq’m quantity of education too lowHow govt may improve the market outcome: subsidize cost of education

Other Examples of Positive Externalities

Being vaccinated against contagious diseases protects not only you, but people who visit the salad bar or produce sectionafter you. R&D creates knowledge others can useRenovating your house increases neighboring property values

Thank you for not

contaminating the fruit supply!

Recap of Welfare Economics

0

1

2

3

4

5

0 10 20 30Q

(gallons)

P

$

The market for gasoline

Demand curve shows private value, the value to buyers (the prices they are willing to pay)

Supply curve shows private cost, the costs directly incurred by sellers

The market eq’m maximizes consumer + producer surplus.

$2.50

25

Analysis of a Negative Externality

0

1

2

3

4

5

0 10 20 30 Q (gallons

)

P $


Supply (private cost)

External cost = value of the negative

impact on bystanders

= $1 per gallon(value of harm from smog, greenhouse gases)

Social cost = private + external cost

external cost


0

1

2

3

4

5

0 10 20 30 Q (gallons

)

P $


D

S

Social

cost

The socially optimal quantity is 20 gallons.

The socially optimal quantity is 20 gallons.

At any Q < 20, value of additional gas exceeds social cost

At any Q < 20, value of additional gas exceeds social cost

At any Q > 20, social cost of the last gallon isgreater than its value

At any Q > 20, social cost of the last gallon isgreater than its value

25


0

1

2

3

4

5

0 10 20 30 Q (gallons

)

P $


D

S

Social cost

Market eq’m (Q = 25)is greater than social optimum (Q = 20)

25

One solution: tax sellers $1/gallon,would shift supply curve up $1.

“Internalizing the Externality”Internalizing the externality: altering incentives so that people take account of the external effects of their actionsIn the previous example, the $1/gallon tax on sellers makes sellers’ costs equal to social costs.When market participants must pay social costs, the market eq’m matches the social optimum. (Imposing the tax on buyers would achieve the same outcome; market Q would equal optimal Q.)

Positive Externalities

In the presence of a positive externality, the social value of a good includesprivate value – the direct value to buyersexternal benefit – the value of the

positive impact on bystanders

The socially optimal Q maximizes welfare:At any lower Q, the social value of

additional units exceeds their cost.At any higher Q, the cost of the last unit exceeds its

social value.

AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : Analysis of a positive externalityAnalysis of a positive externality

External benefit = $10/shotDraw the social value curve.Find the socially optimal Q. What policy would internalize this externality?

21

The market for flu shots

D

S

0

10

20

30

40

50

0 10 20 30

P

Q

$

AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : AnswersAnswers

Socially optimal Q

= 25 shotsTo internalize the externality, use subsidy = $10/shot.

22

The market for flu shots

D

S

Social value = private value + external benefit

0

10

20

30

40

50

0 10 20 30

P

Q

$externa

l benefit

25

Effects of Externalities: Summary

If negative externality market produces a larger quantity

than is socially desirable

If positive externality market produces a smaller quantity


To remedy the problem, “internalize the externality” tax goods with negative externalities subsidize goods with positive externalities

If negative externality market produces a larger quantity


If positive externality market produces a smaller quantity


To remedy the problem, “internalize the externality” tax goods with negative externalities subsidize goods with positive externalities

Market FailureExternality: the basic idea is that an externality exists when a person makes a choice that affects other people that are not accounted for in the market price. For instance, a firm emitting pollution will typically not take into account the costs that its pollution imposes on others. As a result, pollution in excess of the 'socially efficient' level may occur. A classic definition influenced by Kenneth Arrow and James Meade is provided by Heller and Starrett (1976), who define an externality as “a situation in which the private economy lacks sufficient incentives to create a potential market in some good and the nonexistence of this market results in losses of Pareto efficiency.” In economic terminology, externalities are examples of market failures, in which the unfettered market does not lead to an efficient outcome.Common property and non-exclusion: When it is too costly to exclude people from access to an environmental resource for which there is rivalry, market allocation is likely to be inefficient. The challenges related with common property and non-exclusion have long been recognized. Hardin's (1968) concept of the tragedy of the commons popularized the challenges involved in non-exclusion and common property. "commons" refers to the environmental asset itself, "common property resource" or "common pool resource" refers to a property right regime that allows for some collective body to devise schemes to exclude others, thereby allowing the capture of future benefit streams; and "open-access" implies no ownership in the sense that property everyone owns nobody owns. The basic problem is that if people ignore the scarcity value of the commons, they can end up expending too much effort, over harvesting a resource (e.g., a fishery). Hardin theorizes that in the absence of restrictions, users of an open-access resource will use it more than if they had to pay for it and had exclusive rights, leading to environmental degradation. See, however, Ostrom's (1990) work on how people using real common property resources have worked to establish self-governing rules to reduce the risk of the tragedy of the commons.Public goods and non-rivalry: Public goods are another type of market failure, in which the market price does not capture the social benefits of its provision. For example, protection from the risks of climate change is a public good since its provision is both non-rival and non-excludable. Non-rival means climate protection provided to one country does not reduce the level of protection to another country; non-excludable means it is too costly to exclude any one from receiving climate protection. A country's incentive to invest in carbon abatement is reduced because it can "free ride" off the efforts of other countries. Over a century ago, Swedish economist Knut Wicksell (1896) first discussed how public goods can be under-provided by the market because people might conceal their preferences for the good, but still enjoy the benefits without paying for them.

Four Types of Goods/Bads

Garbage: Excludable bad, so long as there are laws and enforcement that help control its management and disposal

Garbage

Garbage without enforcement & Law

Indoor air pollution

Air, Noise pollution

Market Efficiency and Market Failure

Maximizing the Surplus

$

MWPT MC

a

bc

Pe

qe

$

MWPT MC

a

bc

Pe

qe

MEC(Marginal External Cost)

$

MWPT MC

a

bc

Pe

qe

$

MWPT MC

a

bc

Pe

qe

MEC +MC

Maximization of Social Welfare- Check the difference between

private optimum and social optimum

Public Good and Market Failure

Pollution

(ppm)

MWTP1

(Household 1)

MWTP2

(Household 1)

MWTP3

(Household 1)

Total

MWTP

MC of Pollution

Reduction

4 110 60 30 200 50

3 85 35 20 140 65

270

(55)

10

(0)

15

(10)

95

(65)95

1 55 0 10 65 150

0 45 0 5 50 240

125

100

75

50

25

4 3 2 1 0

125

100

75

50

25

4 3 2 1 0

125

100

75

50

25

4 3 2 1 0

250

200

150

100

50

4 3 2 1 0

가구 1

MC

가구 3

가구 2

MWTP1

MWTP2

MWTP3

MWTPT

125

100

75

50

25

4 3 2 1 0

125

100

75

50

25

4 3 2 1 0

125

100

75

50

25

4 3 2 1 0

250

200

150

100

50

4 3 2 1 0

가구 1

MC

가구 3

가구 2

MWTP1

MWTP2

MWTP3

MWTPT

Incentive to Under-report=> Market Failure

Environmental Good and Its Characteristics

• Three Lakeside Households• Current pollution of Lake, 5ppm could be improved by the installation of a purification unit.•Each household has following WTP.

Household 1

Household 2

Household 3

Public Policies Toward Externalities

Property Rights and Coase Theorem

Two approachesCommand-and-control policies regulate behavior directly. Examples: limits on quantity of pollution emitted requirements that firms adopt a particular technology to

reduce emissions

Market-based policies provide incentives so that private decision-makers will choose to solve the problem on their own.

Solutions (Market Failure and Gov’t Intervention)

Environmental Regulations Pay-As-You-Throw

Taxes and tariffs on pollution/Removal of "dirty subsidiesTREC (tradeable emissions reduction permits)

RFID (radio frequency identification) for Waste Management

Source: B.T.Kim, 2011. 11. 25

Solutions (Taxes and tariffs on pollution)

Corrective tax: a tax designed to induce private decision-makers to take account of the social costs that arise from a negative externality Also called Pigouvian taxes after Arthur Pigou (1877-1959). The ideal corrective tax = external cost For activities with positive externalities,

ideal corrective subsidy = external benefit

Taxes and tariffs on pollution/Removal of "dirty subsidies." Increasing the costs of polluting will discourage polluting, and

will provide a "dynamic incentive," that is, the disincentive continues to operate even as pollution levels fall.

A pollution tax that reduces pollution to the socially "optimal" level would be set at such a level that pollution occurs only if the benefits to society (for example, in form of greater production) exceeds the costs.

Some advocate a major shift from taxation from income and sales taxes to tax on pollution - the so-called "green tax shift."

Corrective Taxes & Subsidies

Example: Acme, US Electric run coal-burning power plants. Each emits 40 tons of sulfur dioxide per month. SO2 causes acid rain & other health issues.Policy goal: reducing SO2 emissions 25%

Policy options regulation:

require each plant to cut emissions by 25% corrective tax:

Make each plant pay a tax on each ton of SO2 emissions. Set tax at level that achieves goal.

Corrective Taxes & Subsidies

Suppose cost of reducing emissions is lower for Acme than for US Electric. Socially efficient outcome: Acme reduces emissions more than US Electric. The corrective tax is a price on the right to pollute. Like other prices, the tax allocates this “good” to the firms

who value it most highly (US Electric). Under regulation, firms have no incentive to reduce emissions

beyond the 25% target. A tax on emissions gives firms incentive to continue reducing

emissions as long as the cost of doing so is less than the tax. If a cleaner technology becomes available, the tax gives firms

an incentive to adopt it.Other taxes distort incentives and move economy away from the social optimum.But corrective taxes enhance efficiency by aligning private with social incentives.

Example of a Corrective Tax: The Gas Tax

The gas tax targets three negative externalities: congestion

the more you drive, the more you contribute to congestion

accidentslarger vehicles cause more damage in an accident

pollutionburning fossil fuels produces greenhouse gases

Solutions (Environmental Regulations)

Congestion charges or road usage charges

Source: Jonathan Leape, The London Congestion Charge, Journal of Economic Perspectives—Volume 20, Number 4—Fall 2006—Pages 157–176

Solutions (Environmental Regulations)

Pay-As-You-ThrowEPA supports this new approach to solid waste management because it encompasses three interrelated components that are key to successful community programs: Environmental Sustainability - Communities with programs in place have reported

significant increases in recycling and reductions in waste, due primarily to the waste reduction incentive created by PAYT. Less waste and more recycling mean that fewer natural resources need to be extracted. In addition, greenhouse gas emissions associated with the manufacture, distribution, use, and subsequent disposal of products are reduced as a result of the increased recycling and waste reduction PAYT encourages. In this way, PAYT helps slow the buildup of greenhouse gases in the Earth's atmosphere which leads to global climate change. For more information on the link between solid waste and global climate change, go to EPA's Climate Change Web site.

Economic Sustainability - PAYT is an effective tool for communities struggling to cope with soaring municipal solid waste management expenses. Well-designed programs generate the revenues communities need to cover their solid waste costs, including the costs of such complementary programs as recycling and composting. Residents benefit, too, because they have the opportunity to take control of their trash bills.

Equity - One of the most important advantages of a variable-rate program may be its inherent fairness. When the cost of managing trash is hidden in taxes or charged at a flat rate, residents who recycle and prevent waste subsidize their neighbors' wastefulness. Under PAYT, residents pay only for what they throw away.

Tradable Pollution Permits in the Real World

SO2 permits traded in the U.S. since 1995.

Nitrogen oxide permits traded in the northeastern U.S. since 1999.Carbon emissions permits traded in Europe since January 1, 2005. Examples:

CCX(Chicago Climate Exchange), CFE(Chicago Climate Future Exchange) ECX(European Climate Exchange)

Types of Emission Credit AAUs (Assigned Amount Units) EUAs (EU Allowance Units) CERs (Certified Emission Reductions) ERUs (Emission Reduction Units) RMUs (Removal Units)

Let’s Check! – Introduction of Market Mechanism under Kyoto Protocole

CDM (Clean Development Mechanism)JI (Joint Implementation) ET (Emission Trading)

Solutions (Quotas on pollution)

tradeable emissions permits, which if freely traded may ensure that reductions in pollution are achieved at least cost. In theory, if such tradeable quotas

are allowed, then a firm would reduce its own pollution load only if doing so would cost less than paying someone else to make the same reduction.

In practice, tradeable permits approaches have had some success, such as the U.S.'s sulphur dioxide trading program or the EU Emissions Trading Scheme, and interest in its application is spreading to other environmental problems.

Point Carbon Secondary CER OTC

자료 : http://www.pointcarbon.com

Tradable Pollution Permits

Recall: Acme, US Electric each emit 40 tons SO2, total of 80 tons. Goal: reduce emissions 25% (to 60 tons/month)Suppose cost of reducing emissions is $100/ton for Acme, $200/ton for US Electric.If regulation requires each firm to reduce 10 tons,

cost to Acme: (10 tons) x ($100/ton) = $1,000

cost to USE: (10 tons) x ($200/ton) = $2,000

total cost of achieving goal = $3,000

Alternative: issue 60 permits, each allows its bearer one ton

of SO2 emissions (so total emissions = 60 tons)give 30 permits to each firm establish market for trading permits

Each firm can choose among these options:1.emit 30 tons of SO2, using all its permits

2.Trade the permit emit < 30 tons, sell unused permits buy additional permits so it can emit > 30

tons


Suppose market price of permit = $150 One possible equilibrium:

Acme spends $2,000 to cut emissions by 20

tons has 10 unused permits, sells them for

$1,500 net cost to Acme: $500

US Electric emissions remain at 40 tons buys 10 permits from Acme for $1,500 net cost to USE: $1,500

Total cost of achieving goal: $2,000



A system of tradable pollution permits achieves goal at lower cost than regulation. Firms with low cost of reducing pollution - sell whatever permits they can. Firms with high cost of reducing pollution - buy permits.

Result: Pollution reduction is concentrated among those firms with lowest costs. When policymakers do not know the position of this demand curve, the permits system achieves pollution reduction targets more precisely.

Some politicians, many environmentalists argue that no one should be able to “buy” the right to pollute, cannot put a price on the environment.However, people face tradeoffs.The value of clean air & water must be compared to their cost. The market-based approach reduces the cost of environmental protection, so it should increase the public’s demand for a clean environment.

EC (External Cost)

Pollution

Price

The Equivalence of Pigovian Taxes and Pollution Permits

Pollution Permit

Private Solutions to Externalities

Types of private solutions:moral codes and social sanctions, e.g., the “Golden Rule”charities, e.g., the Sierra Clubcontracts between market participants and the affected bystandersThe Coase theorem: If private parties can bargain without cost over the allocation of resources, they can solve the externalities problem on their own.

The Coase Theorem: An Example

Dick owns a dog named Spot.

Negative externality: Spot’s barking disturbs Jane, Dick’s neighbor.

The socially efficient outcome maximizes Dick’s + Jane’s well-being.

If Dick values having Spot more than Jane values peace & quiet, the dog should stay.

Coase theorem: The private market will reach the efficient outcome on its own…

See Spot bark.


CASE 1: Dick has the right to keep Spot. Benefit to Dick of having Spot = $500Cost to Jane of Spot’s barking = $800

Socially efficient outcome: Spot goes bye-bye.

Private outcome: Jane pays Dick $600 to get rid of Spot, both Jane and Dick are better off.

Private outcome = efficient outcome.


CASE 2: Dick has the right to keep Spot. Benefit to Dick of having Spot = $1000Cost to Jane of Spot’s barking = $800

Socially efficient outcome: See Spot stay.

Private outcome: Jane not willing to pay more than $800, Dick not willing to accept less than $1000, so Spot stays.



CASE 3: Benefit to Dick of having Spot = $500Cost to Jane of Spot’s barking = $800But Jane has the legal right to peace & quiet.

Socially efficient outcome: Dick keeps Spot.

Private outcome: Dick pays Jane $600 to put up with Spot’s barking.


The private market achieves the efficient The private market achieves the efficient outcome regardless of the initial outcome regardless of the initial

distribution of rights.distribution of rights.

The private market achieves the efficient The private market achieves the efficient outcome regardless of the initial outcome regardless of the initial

distribution of rights.distribution of rights.

Why Private Solutions Do Not Always Work

Transaction costs: the costs that parties incur in the process of agreeing to and following through on a bargainSometimes when a beneficial agreement is possible, each party may hold out for a better deal.Coordination problems & costs when the number of parties is very large.

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