Economics can be defined as "the study of the allocation of scarce resources among alternative uses."  The operative words here are allocation, implying human decision, scarce, implying constraints, and alternative, implying choice.  Notice that this definition does not refer to money, although monetary wealth may be viewed as a resource.  And it doesn't refer to prices, although these are useful indices of scarcity for most market goods.  The point is that economics is a general decision science with far broader scope than conventional market analyses.

This definition begs the question of what motivates the economic behaviors of people and institutions.  The usual answer, as Adam Smith argued so eloquently, is self-interest.  People respond to economic incentives by attempting to maximize their own well-being in their individual actions, and through institutions that provide mutual advantage through cooperation.  The rational self-interested behavior of people makes their economic activities fairly predictable.  This is the foundation of social order.

By definition, economic goods are scarce. Markets allocate conventional economic goods to their highest-valued uses, using prices to signal scarcity and ration goods to those willing to pay the most for them.  But economic goods include many things that are not market goods such as clean air and water, biodiversity, public safety, etc.  We value these things and commit resources to providing them, even though our market system doesn't reveal explicit prices for them.  (In contrast, economic "bads" such as pollution and crime are over-supplied and "provided" to you for free.)  This course will cover several methods by which economists can estimate economic values for non-market environmental amenities.

A market is really just one type of collective decision-making process: buyers and sellers converge to negotiate a price that matches the quantity firms are willing to sell with the quantity consumers are willing to buy.  Everyone acts in his or her own self-interest according to established rules (e.g., we acknowledge and respect each others' property rights, we use an agreed-on currency, etc.).  And as long as people pursue their own self-interest in other non-market decision-making processes, then economic theory can help us understand those collective decision processes as well.

Economics provides the tools to analyze competing objectives and define socially-optimal compromise solutions.  It is thus useful for understanding a wide range of environmental controversies and (hopefully) determining efficient environmental protection policies.  Pollution problems arise from conflicting economic incentives: polluters want the environment to provide low-cost disposal of waste by-products; citizens want the environment to provide clean air and water.  This pollution problem involves a social choice: which use of the environment yields greater aggregate benefits to society?  Environmental conflicts such as these tend to persist until society develops efficient institutional mechanisms for resolving them.

Society has various public choice institutions, including legislatures, courts, public referenda and markets.  Economics can provide valuable insights into the benefits and costs of alternative social choices to be decided in almost any institutional context, and it can gauge the relative efficiencies of alternative institutions in making appropriate choices.  Since environmental economics is so closely linked with public policy, this course will focus some attention on the public choice processes through which environmental policies are generated.  In fact, we can use economic theory to model political processes and explain why government regulation often fails to provide efficient protection of the environment.

Although economics has a great deal to contribute to environmental policy, most environmentalists and politicians lack training in economics and have been slow to embrace economic methods.  In fact, many environmentalists misunderstand and mistrust environmental economics. After all, our market economy, driven by greedy individualism, has caused today's environmental problems!  Why should we trust economics to solve them?   While it is popular to view our environmental problems as an automatic consequence of unbridled market capitalism, this does not justify a rejection of market capitalism in favor of more centralized control over society's natural resources.  In fact, many of the world's worst pollution problems (including Chernobyl) arose in the centrally-planned economies of Eastern Europe. The truth is that distorted economic incentives will cause excess pollution in any kind of economy.  The trick is to correct those incentives.

This course will extend tools of economic analysis to a broad set of environmental issues: air and water quality, biodiversity, waste managment, land use, etc.  As noted above, many environmental amenities or services are non-market goods with no revealed price to guide their allocation, although this does not imply that they have no economic value.  Environmental economists have developed a set of techniques for estimating economic values for non-market environmental goods, where the valuations include both use and non-use values.  These values are commonly expressed in money units so that the relative benefits and costs of policy decisions can be compared directly.  The use of a money metric does not imply that economists are only interested in the cash value of environmental amenities.

As in any class dealing with public choice issues, we distinguish positive from normative economics.  Positive economics addresses objective questions about "what is:" What are the economic benefits of a particular pollution control policy? What are the costs? Will the aggregate dollar benefits outweigh the aggregate dollar costs?  In contrast, normative economics addresses subjective issues about "what should be:"  How will the benefits and costs of a particular policy choice be allocated among different individuals or groups in society?  A policy that benefits one group at the expense of another may be seen as inequitable even if the benefits received by the winners outweigh the costs suffered by the losers.

There are basically two ways in which environmentalists can approach environmental issues.  The moral approach views pollution as a consequence of unethical or immoral human behaviors.  We need a moral reawakening, so that once people understand the environmental consequences of their activities, everyone will stop polluting.  Unfortunately, this sense of moral responsibility is far from universal.  While environmentalists are sincerely committed to protecting the environment, many polluters are just as sincerely committed to protecting jobs and incomes in their communities.  Moral posturing often polarizes environmental policy debates and frustrates rational negotiation and compromise.

The economic approach views pollution as a consequence of market and/or institutional failures, and looks for ways to alter incentives to reduce pollution levels.  As noted above, the basic assumptions here are that people and firms are rational and self-interested.  In fact, these assumptions are typically validated by observed market behaviors.  Consumer responses to price and income changes are generally consistent with utility maximization.  Firms' responses to changes in input costs and output prices are generally consistent with profit maximization.  Since pollution is generated by predictable behaviors, we can achieve improvements in environmental quality by altering the incentives that motivate those behaviors.
 

Pollution often generates externality costs, since the firm generating the pollution does not account for the damage costs its pollution imposes on other people.  These third-party costs are external to the firm's profit-and-loss accounting.  Economic incentives can be used to correct such externalities, however.  For example, if the government imposes a tax on pollution emissions equivalent to the marginal externality costs it imposes on others, the profit-maximizing firm will reduce its emissions to the point where the marginal cost of emission control equals the emissions tax.

Consider the external costs of highway driving, e.g. accidents, congesion, air pollution, noise and land use.  US Drivers pay maybe 60 percent of the total social cost of the US highway system through highway tolls and federal and state gasoline taxes.  Much of the remaining cost is externalities.  Each additional car on a crowded highway increases congestion for all drivers on that stretch of highway.  Some states, including Delaware, are implementing EZ-Pass to speed toll collection.  Once all cars switch to EZ-Pass, the state would be able to vary tolls by time of day, rationing highway access during rush hours by increasing toll rates.  This kind of "congestion pricing" will provide incentives for drivers to carpool, alter work schedules so they can comute at other times, use public transportation, etc.

Some policies can create perverse incentives.  A few years back Mexico City attempted to improve its air quality with a rotating ban on cars (e.g., cars with license plates ending in 1 or 2 can't be driven on Mondays, plates ending in 3 or 4 can't be driven on Tuesdays, etc.).  Sounds like a good policy, right?  Actually this is a good illustration of the law of unintended consequences:  many people simply got extra cars to circumvent the rule, and Mexico City's air quality got worse!  (And it turned out the primary source of smog was actually cooking fires anyway.)

Some macroeconomic context

Business interests often oppose environmental regulations by arguing that these will slow economic growth and increase unemployment.  The empirical evidence suggests the opposite: environmental protection actually creates jobs and generates economic growth.

Pollution control costs in the US and various western European countries mostly range between 1 and 1.5 percent of GDP, with the US spending a slightly higher percent of its GDP than other countries on pollution control. There is no apparent correlation between percent of GDP spent on pollution control and unemployment or GDP growth.  Furthermore, GDP is a poor proxy for overall quality of life, since it obviously excludes non-market goods such as environmental quality, health and longevity, etc.

Economic growth doesn't necessarily harm the environment either.  Pollution tends to increase during intermediate stages of development, then diminishes as countries generate the economic resources to control pollution.  Thus environmental quality is a luxury good, which just means that as national income rises, demand for environmental quality increases more than proportionately.  This implies that the US ought to be spending higher percents of GDP on environmental protection as its real GDP rises.  It also implies that global agreements on greenhouse gas emissions should account for signatory nations' different levels of economic: the most developed nations should bear most of the emission reduction burden because they can achieve these reductions at lower cost.

Criteria for evaluating environmental policies

The basic decision-making framework for this course is benefit-cost analysis, which involves direct comparisons of the costs versus benefits of alternative policies.  Benefit-cost analysis thus identifies the policy that yields the largest B-C difference, or largest B/C ratio.  In the case of pollution control, a complete B-C analysis includes non-market benefits, e.g., economic value of scenic quality preserved, lives saved or illnesses prevented.  Although President Reagan's Executive Order 12291 (1982) requires Federal regulatory agencies to justify their regulations using B-C criteria, in practice such analyses can be complicated and controversial.  And in some cases, Congress has explicitly prohibited agencies from considering costs when developing regulations.  So while most economists clearly prefer B-C analysis as a policy criterion, its use is far from universal.

Cost-effectiveness analysis simply compares the relative costs of alternative pollution control strategies in order to identify the least-cost strategy for achieving a specified pollution reduction.  It does not address the question of whether the benefits of that pollution reduction are worth the costs.  Examples include portions of the Clean Air Act (where the EPA is required to minimize health risks from pollutants for the most susceptible members of the population without regard to cost), Federal Corporate Average Fuel Economy (CAFE) standards, and regulations on energy-saving household appliances.

In some cases, regulatory agencies use impact analysis to simply catalog the likely consequences of a pollution policy, with little or no attempt made to translate either the costs or the benefits of the policy to any common metric.  Impact analyses are the least useful for guiding rational public policy.