1.Environmental economics and general economics


27 Οκτ 2013 (πριν από 5 χρόνια και 2 μήνες)

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Handout environmental economics

Spring 20

Finn R. Førsund


Environmental economics and general economics

Pigou (1920)
, private and social costs, tax to include sosial costs in private costs

Classical externalities models:


circuit the
environment, direct representation of externality
generating activities in
production and/or utility functions.

The materials balance, 1. Law of thermodynamics; mass cannot disappear

Ayeres and Kneese (1969)

economics, welfare theory as building blo
cks, applied, external effects, public goods,
efficiency of prices of a competitive market system, first and second welfare theorems

Development of new methods for estimating demand for environmental services

Policy instruments and theory of regulation

logical economics: more concerned about sustainability


The formal structure of environmental economics

Basic stages:

(1) Extracting/harvesting resources

(2) Transformation of resources into products

Residuals as by
products (Primary/secondary residuals if

on purification is an

(3) Environmental impacts of absorption of residuals

(4) Evaluation of changes in environmental indicators

Evaluation through utility functions, environment as public good, or damage functions.

Products are also evaluat
ed either through utility functions or benefit functions.

types of relations that need specification


Production of man
made goods


Generation of pollutants and interference economic activity and the environment


production of environmental services



valuation of man
made and environmental goods

Range of models from very aggregate

pedagogical models to detailed micro models for
concrete economic instrument applications,

Different textbook and journal paper traditions, styles, getting familiar with dif
ferent ways of
representing the four building blocks.

The micro economic building blocks:

Production theory, multiple output production

Public good/bad

Pareto efficiency

Consumer choice, social choice

Demand functions


benefit analysis


Catalogue of

environmental economics models


The aggregate pedagogical model


The environment
resource model


The general equilibrium model, Pareto efficiency


The external effect model


The microeconomic policy oriented model


Purification possibilities as cost functions.

Most aggregate pedagogical model of benefit from pollution and costs of pollution:


function based on aggregating block (i)
and (ii),

damage function based on aggregating block (ii) and (iv)

This is the

course model.

Social choice: how to choose P, no other restrictions explicitly shown

Social choice criterion: Maximisation of net benefits on the aggregate level:



Necessary first order condition:


The fundamental pedagogical marginal rule:

Optimal pollution where marginal benefit from pollution equals marginal damage of

Second order su
fficient condition:


Towards policy instruments:

What is behind benefit of pollution?

What is behind damage of pollution?

Must d
isaggregate to formulate prescriptions for policy instruments.




Multiple output production theory

Pollution is generically a problem with joint outputs in economic activities of production and
consumption. The first law of thermodynamics tells us

that matter cannot disappear. If we
weigh the inputs into an activity, including non
paid factors like oxygen from the air, and
weigh the products that are the conscious purpose of activities, the difference is the residuals
that may turn out to be pollut
ing the natural environment. Thus, the general feature of
residuals is that they arise from use of inputs in a wide sense. Ayres and Kneese (1969)
coined the phrase
materials balance
to underline the inevitability of residuals generation
when employing mat
erial resources.

Although multiple outputs is the rule rather than exception at the micro level of production,
economists usually specify single output only. This may be interpreted as a reflection of
economics being concerned about principles of resource

allocation, revealing economic
mechanisms and devising policy instruments, etc. Operating with a representative firm and an
output aggregate at the micro level will usually suffice. But as pointed out above the latter is
a difficult position to maintain
when dealing with pollution. Therefore, some form of multiple
outputs involving «ordinary» or intended outputs, and unintended residuals or pollutants, or
generically «bads», have been used at least indirectly in the old externalities literature, and
icitly in the more recent environmental economics literature (see Mishan (1971) for a
review of the externalities literature, and Fisher and Peterson (1976), Cropper and Oates
(1992) for reviews of the literature covering the 70
ies and 80
ies decades). Ho
wever, the
choice in the literature of specifications of relationships between ordinary outputs and bads
vary and is often not based on any explicit consideration of the most suitable model to pick
from the field of multiple output production function theo
ry. Since policy conclusions that
can be drawn on results from environmental economics are basically concerned with choice
among instruments for control of externalities, a firm grasp on the modelling of the multi
output nature is essential.

At the micro
level of a firm multiple outputs are the rule rather than the exception. The
preoccupation with single output production in textbooks may be due to the technical


complexities involved, or that economic issues often can be dealt with aggregating outputs t
a single output index. When we want to model multiple outputs we should be aware of some
main forms of multiple outputs (see e.g. Frisch (1965), Chapter 1d. for a brief introduction).
Inputs may be employed alternatively to produce different outputs, e.g
. a piece of agricultural
land may be used to produce potatoes or wheat, a wood cutting tool may be used to produce
different types of furniture. There is freedom of choice in what outputs to produce. At the
other end of the scale we may have multiple outp
uts due to jointness in production; sheep
yield mutton as well as wool, cattle yield beef and hide, we get both wheat and straw, and
coal can be converted to coke and gas, to use classical examples from Edgeworth and
Marshall. As an extreme form of jointne
ss we have that outputs are produced in fixed
proportions, as the distillates of crude oil in a refinery. We will regard a firm as the unit, and
not discuss issues concerning internal organisation such as parallel production of
commodities or process chain
s of intermediate products, etc.