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Environmental Economics

Environmental economics is a branch of economics that studies how the relationship between men and nature affects the economy. It tries to help countries grow economically with least damage to the environment. Environmental economics looks at how people use the things that nature has to offer. Some of the effects that come from the relation between men and nature are externalities, depletion and the free rider problem, among others.. Environmental economics also gives solutions to these questions.

Market Failure

Market failure takes place when an economy cannot distribute goods and services in the best way possible. This means there are better outcomes than the current one. There are different types of market failure, such as positive and negative externalities, public goods, and common goods.

Oil spills are cases of negative externalities

Externality

An externality is the cost or benefit of something that people do that is not part of the price people pay in the market. These costs and benefits affect other people that are not part of the market. Externalities can be positive or negative. Environmental economics usually talks about negative externalities.

The most common case of a negative externality is pollution. Companies, for example, can damage the environment when they make goods if they produce chemicals like carbon dioxide and sulphur dioxide, or cause sewage and oil spills.

Another case of a negative externality is when a company gives waste that has dangerous substances to somebody else so that he or she can recycle. The person that receives waste can recycle it to make money, but risks his health and the environment when he handles these substances .

Public goods and the free-rider problem

Air pollution as an example of the free-rider problem

A public good is something that will still exist after many uses without disappearing (i.e. non-rival) and everybody will be able to use it after it is given (i.e. non-excludable).

The free-rider problem says that because everybody can use public goods and they are free to use, people will not pay even if there is a cost. In environmental economics, the free-rider problem takes place when air is polluted. Air is a public good (everybody can use air, and it will not go away even if many people use it) but because air is free, people will pollute and damage it.

Common goods

A common good is something that everybody can use (i.e. non-excludable) but there is less of it after each person uses it (i.e. rival). The fish in the ocean are an example of common goods: there is a certain number of fish in the ocean. Because it would cost too much to control all the fishing, everybody can do it. But people want to fish more because they can make more money. If people fish too much, they will be a point when there will be no more fish in the ocean.

Tragedy of the Commons

The Tragedy of the Commons happens when too many people use a common good for their individual reasons. Even if people want to take care of the good, they have their own personal reasons to use it. Because there is a limited amount of the common good and too many people using it, the good can disappear. For instance, fishers know that if they fish a lot, there will be a point when fish will disappear. But each fisher wants to make more money, so he will try to get as many as he can. This can lead to overfishing and depletion.

Solutions

Cap and Trade

Cap and Trade is a system in which the government sells a number of permits. These permits let companies produce chemicals or gases like carbon dioxide. Companies buy and sell these permits in a market. Those who need to pollute more will pay more money for the permits.

Taxes on pollution

Taxes on pollution are made so people do not pollute too much. Companies pay a tax every time they produce bad chemicals. Carbon taxes are an example of taxes on pollution. Companies that produce carbon dioxide will have to pay a tax. Taxes serve as a way to stop companies from polluting too much. Carbon taxes add the cost of the externality to the market price.

Environmental regulations

Environmental regulations are rules for individuals, companies, governments and other institutions. These regulations limit and/or stop people from doing things that damage the environment or their health. The United States Environmental Protection Agency (EPA) has many environmental regulations. The Clean Air Act, for example, controls air emissions. It looks at the danger that comes from air pollutants and sets guidelines for them.

The Coase Theorem

The Coase Theorem is a rule to address the problems with common goods and public goods. The Theorem says that the best way to solve a case of common or public goods is the one that has the least transaction costs. These can be the costs of the effect, payments to lawyers and other people involved, transportation costs, etc.

Privatization

Privatization is when private companies buy public goods or services. Privatization means that property rights are better defined because they now have an owner. For example, if common goods like forests become private, people that want to cut trees will have to pay the owners of the forest. Privatization can be difficult with things like the ocean and air.

Type of Market Failure	Description	Possible Solution
Externality	Cost or benefit of something that people do that is not part of the market price. Example: water pollution (negative externality)	Cap and Trade Taxes on pollution Environmental Regulations
Public Goods / Free-rider problem	Goods that are non-rival and non-excludable. Free-rider problem: people will not pay for public goods Example: air pollution	Coase Theorem Privatization
Common Goods	Goods that are rival and non-excludable Example: fish in the ocean	Coase Theorem Privatization
Tragedy of the Commons	People finish up a common good because they think about themselves first Example: overfishing/depletion of fish in the ocean	Coase Theorem Privatization