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Environmental Economics
Volume 1: The Essentials
Inside the guide:
• Easy-to-understand explanations
of common economic terms
• Recommended Websites,
Articles, & Case Studies
• Classroom Resources
Scientists. Educators. Economists. 2
The Environmental Literacy Council
For more than a decade, the Environmental Literacy Council has been
dedicated to helping teachers, students, policymakers, and the general public Roger A. Sedjo, President
find cross-disciplinary resources on the environment. Environmental issues Resources for the Future
involve many dimensions — scientific, economic, aesthetic, and ethical.
Through our websites, science-based textbook reviews, and professional Kathleen Berry
development materials, we strive to provide information and resources that Canon-McMillan High School
convey the importance of environmental science and the deep complexity of Gail Charnley
environmental decision-making. Made up of scientists, economists, education HealthRisk Strategies
policy experts, and veteran teachers, our Council is drawn from the ranks of
prestigious organizations such as Resources for the Future, AAAS, The Nicholas N. Eberstadt
University of Virginia, GE Energy, and the National Center for Atmospheric American Enterprise Institute
Research. The multi-disciplinary guidance keeps our materials balanced,
current, and scientifically accurate. Michael H. Glantz
National Center for Atmospheric Research
Eric P. Loewen
GE Energy
Dawn M. Anderson, Executive Director
Dr. Roger Sedjo, Economics Project Advisor Thomas G. Moore
Nicole Barone Callahan, Project & Web Content Manager Hoover Institution
John Opie
For more information about environmental economics or other topics The University of Chicago
in environmental science, please see our website: enviroliteracy.org
F. James Rutherford
American Association for the Advancement of Science
Frederick Seitz
Rockefeller University
Leonard Shabman
Resources for the Future
Acknowledgements
Herman H. (Hank) Shugart, Jr.
University of Virginia, Charlottesville
The Council would like to thank the following people for their contribution to
the research and production of this guide: Robert L. Sproull
University of Rochester
Erica Brehmer Dana Hyland
Charles Fritschner Megan Wertz M. Jane Teta
Exponent, Inc.
Alvin W. Trivelpiece
Copyright © 2007 Henderson, Nevada
All rights reserved. No part of this document may be reproduced or transmitted in any form Anne K. Vidaver
without permission from the Environmental Literacy Council. University of Nebraska, Lincoln
3 4
Table of Contents Chapter 1: Introduction to Environmental
& Resource Economics
Chapter 1: Introduction to Environmental & Resource Economics.....................6
Chapter 2: The Law of Diminishing Returns....................................................... 9 Environmental economics is the subset of economics that is concerned with the
Chapter 3: Carrying Capacity ............................................................................ 12 efficient allocation of environmental resources. The environment provides both
Chapter 4: Sustainable Development................................................................. 15 a direct value as well as raw material intended for economic activity, thus
Chapter 5: How Markets Work – Supply and Demand .....................................18 making the environment and the economy interdependent. For that reason, the
Chapter 6: Externalities...................................................................................... 21 way in which the economy is managed has an impact on the environment which,
Chapter 7: Net Present Value............................................................................. 24 in turn, affects both welfare and the performance of the economy.
Chapter 8: Ecosystem Valuation........................................................................ 28
Chapter 9: Trade-offs......................................................................................... 31
Chapter 10: Marginal Costs and Benefits .......................................................... 34 One of the best known critics of traditional economic thinking about the
Chapter 11: Cost Benefit Analysis..................................................................... 37 environment is Herman Daly. In his first book, Steady-State Economics, Daly
Chapter 12: Environmental Impact Analysis..................................................... 40 suggested that “enough is best,” arguing that economic growth leads to
Chapter 13: Regulatory Policy vs. Economic Incentives...................................42 environmental degradation and inequalities in wealth. He asserted that the
Appendix: Resources for the Classroom............................................................ 46 economy is a subset of our environment, which is finite. Therefore his notion of
Basic Economics...................................................................................... 46 a steady-state economy is one in which there is an optimal level of population
Environmental & Resource Economics.................................................... 47 and economic activity which leads to sustainability. Daly calls for a qualitative
Diminishing Returns................................................................................. 48 improvement in people's lives – development – without perpetual growth.
Carrying Capacity..................................................................................... 48 Today, many of his ideas are associated with the concept of sustainable
Sustainable Development......................................................................... 49 development.
Supply and Demand: How Markets Work ...............................................50
Externalities.............................................................................................. 50 By the late 1970s, the late economist Julian Simon began countering arguments
Net Present Value..................................................................................... 51 against economic growth. His keystone work was The Ultimate Resource,
Ecosystem Valuation................................................................................ 51 published in 1981 and updated in 1996 as The Ultimate Resource 2, in which he
Trade-offs................................................................................................. 51 concludes there is no reason why welfare should not continue to improve and
Marginal Costs and Benefits .................................................................... 52 that increasing population contributes to that improvement in the long run. His
Cost Benefit Analysis............................................................................... 52 theory was that population growth and increased income puts pressure on
Environmental Impact Analysis............................................................... 53 resource supplies; this increases prices, which provides both opportunity and
Regulatory Policy vs. Economic Incentives............................................. 53 incentive for innovation; eventually the innovations are so successful that prices
Endnotes ............................................................................................................ 54 end up below what they were before the resource shortages occurred. In Simon's
view, a key factor in economic growth is the human capacity for creating new
ideas and contributing to the knowledge base. Therefore, the more people who
can be trained to help solve arising problems, the faster obstacles are removed,
and the greater the economic condition for current and future generations.
Environmental economics takes into consideration issues such as the
conservation and valuation of natural resources, pollution control, waste
management and recycling, and the efficient creation of emission standards.
Economics is an important tool for making decisions about the use,
conservation, and protection of natural resources because it provides information
5 6
about choices people make, the costs and benefits of various proposed measures, economics is to identify those particular tools or policy alternatives that will
and the likely outcome of environmental and other policies. Since resources – move the market toward the most efficient allocation of natural resources.
whether human, natural, or monetary – are not infinite, these public policies are
most effective when they achieve the maximum possible benefit in the most
efficient way. Therefore, one job of policymakers is to understand how
resources can be utilized most efficiently in order to accomplish the desired Recommended Resources
goals by weighing the costs of various
alternatives to their potential benefits.
In competitive markets, information exists Center for the Advancement of the Steady State Economy
about how much consumers value a www.steadystate.org
particular good because we know how much The Center for the Advancement of the Steady State Economy is a nonprofit
they are willing to pay. When natural organization that educates citizens and policy makers on the fundamental
resources are involved in the production of conflict between economic growth and environmental protection, economic
that particular good, there may be other sustainability, national security, and international stability through its promotion
factors – scarcity issues, the generation of of a steady state economy as a sustainable alternative to economic growth.
pollution – that are not included in its
production cost. In these instances, scarcity Political Economy Research Center
issues or pollution become externalities, www.perc.org
costs that are external to the market price of The Political Economy Research Center is dedicated to original research that
the product. If these full costs were brings market principles to resolving environmental problems. The site has an
included, the cost of the good may be higher extensive publications list and an environmental education section that touches
than the value placed on it by the consumer. on a variety of subject areas that relate to both economics and the environment.
A classic example of an externality is © NOAA Coastal Services Center Protecting Ecosystem Services: Science, Economics, and Law
discussed in Garrett Hardin's Tragedy of eprints.law.duke.edu/archive/00001071/01/20_Stan._Envtl._L._J._309_(2001).p
the Commons, which occurs in connection to public commons or resources – df
areas that are open and accessible to all, such as the seas or the atmosphere. This paper is the result of a workshop that took place in December 2000 when a
Hardin observed that individuals will use the commons more than if they had to group of 30 scientists, conservationists, economists, lawyers, and policymakers
pay to use them, leading to overuse and possibly to increased degradation. came together at Stanford University to discuss ways to market ecosystem
services.
There are three general schools of thought associated with reducing or
eliminating environmental externalities. Most welfare economists believe that
the existence of externalities is sufficient justification for government
intervention, typically involving taxes and often referred to as Pigovian taxes
after economist Arthur Pigou (1877-1959) who developed the concept of
economic externalities. Market economists tend to advocate the use of
incentives to reduce environmental externalities, rather than command-and-
control approaches, because incentives allow flexibility in responding to
problems rather than forcing a singular approach on all individuals. Free-
market economists focus on eliminating obstacles that prevent the market from
functioning freely, which they believe would lead to an optimal level of
environmental protection and resource use. The key objective of environmental
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