Sustainable Development
Economics and the Environment
1
References
• World Bank (2004) “Beyond Economic Growth
An Introduction to Sustainable Development”,
[Link]
d/beyondco/beg_all.pdf
• Adams, W. M. (2006). “The Future of
Sustainability: Re-thinking Environment and
Development in the 21st Century”. Report of the
IUCN Renowned Thinkers Meeting, 29-31
January 2006
2
What is growth?
• Economic growth is the increase of a
nation’s real output (GDP).
• Results from:
– Greater quantities of natural resources, human
resources, and capital,
– Improvements in the quality of resources, and
– Technological advances that boost productivity.
• Limitations?
3
Development
• Economic development is the process by
which a nation enhances its standard of
living over time.
• The economic standard of living is often
defined as GDP per capita.
• Composition of GDP
• Rural-Urban Migration
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What do we mean by
sustainability?
• Sustainable development is generally
considered to be that which is:
– viable,
– has an equitable impact on society, and
– an acceptable impact on the environment
• Imperative to consider the three components
both individually and collectively to achieve
an acceptable balance
• Sustainability often illustrated as three pillars
or three interlocking circles:
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Sustainable
Development
Social
zone
impact
(“triple bottom
line” or
Bearable Equitable “win-win-win”)
Environmental Economic
impact Viable success
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• Sustainable development can be defined as
“meeting the needs of the present without
compromising the ability of future generations
to meet their own needs.”
• Sustainable development is the effective use of
resource for economic development while
preserving the environment and ecosystem so
that not only the needs of presents are fulfilled
but also for the future generations.
• Sustainable development also interlinks the
development and carrying capacity of
environment and ecosystem.
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Development: The Basic Issues
• Sustainability: a development path is sustainable
‘if and only if the stock of overall capital assets
remains constant or rises over time’
• Environmental accounting: the preservation or
loss of valuable environmental resources should
be factored into estimates of economic growth and
well-being
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• NNP* =GNP –Dm –Dn – R –A
• NNP*: sustainable net national product
• Dm: depreciation of manufactured capital assets
• Dn: depreciation of environmental capital:
monetary value of environmental decay over a
year
• R: expenditure required to restore environmental
capital (forests, fisheries etc.)
• A: expenditure required to avert destruction of
environmental capital
9
Population, Resources, and the
Environment
• Perception that there is a limited population size
which can be sustained with the earth’s finite
resources
• Potential for new technologies may alleviate the
strain on the resources
• Growing populations in the LDCs have led to land,
water, and wood shortages in rural areas, and
sanitation and water crisis in urban areas
• Increasing population contributes to accelerated
degradation of resources
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Poverty and the Environment
• There exists a relationship between environmental
destruction and high fertility which are both out
growths of absolute poverty
• Preventing environmental degradation is linked to
providing institutional support to the poor
• Insecure land rights, lack of credit and inputs and
absence of information often prevent poor from
marking resource augmenting investments which
would help preserve the environment
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Growth versus the Environment
• Question of whether or not it is possible to achieve
growth without environmental damage
• The worst environmental damage by the richest
billion and poorest billion
• Therefore idea that increasing incomes of the poor
would decrease environmental damage
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Rural Development and the
Environment
• Land in LDC are already being overworked
by the existing population
• Increased accessibility of agricultural inputs
and introduction of sustainable methods of
farming are need to decrease destructive
patterns of land use
13
Urban Development and the
Environment
• Rapid population increase and rural-urban migration
has led to increasing urban population growth
• Strain on existing urban water supplies and
sanitation facilities, high costs of urban crowding
• Resulting in health hazards as circumstances allow
for epidemics and health crises
• Research reveals that urban environment tends to
worsen at a faster rate than urban population size
increases so that the marginal environmental cost of
additional residents rises over time
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Economic Solutions
• Allow scarcity rent to be collected
• Tradable rights to pollute:
– Individuals incorporate externalities
• SMC=Private marginal cost+pollution=MR
– Requires a cap to constrain individual and
world wide totals
– Should all countries be required to participate?
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True sustainable development
• It aims at optimum use of natural resources with
high degree of sustained, minimum wastage, least
generation of toxic by products and maximum
productivity.
Inter generational equity
• We should minimize any adverse impacts on
resources and environment for future generation.
Intra generational equity
• Technological development of rich countries
should support economic growth of poor countries
and lead to sustainability.
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How to achieve sustainable development?
The following four rules can be defined as the key mantras of sustainability.
These four rules are
• Reduce our dependency on heavy metals and fossil
fuels such as coal, oil and natural gas.
• Reduce our dependency on synthetic chemicals.
• Reduce our destruction of nature - includes clearing
of forest and natural habitats for human needs.
• Ensure that we don’t stop people from meeting their
needs in order to achieve environmental
sustainability. We must maintain a balance between
environmental and economic sustainability.
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• Place more emphasis on pollution prevention and waste
reduction.
• Recycle and reuse as many waste products and resources
possible.
• Make more goods that last longer and easy to use, recycle
and repair.
• Depend on renewable source of energy, sun wind, biomass,
flowing water, geo thermal and tidal.
• Sustain Earths Biodiversity with emphasis on protecting
vital habitats of the wild species.
• Use potentially renewable resources such as wastes soil,
plants, animals no faster than they are renewed.
• Increase the usage of non renewable resources to minimize
the resource depletion at a faster rate.
• Earth Degrading activities should be discouraged
• Reduce poverty and rate of population growth
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In this look for the answers to these
questions:
• What is an externality?
• Why do externalities make market outcomes inefficient?
• What public policies aim to solve the problem of
externalities?
• How can people sometimes solve the problem of
externalities on their own? Why do such private
solutions not always work?
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Introduction
• Markets are usually a good way
to organize economy activity.
In absence of market failures, the competitive
market outcome is efficient, maximizes total
surplus.
• One type of market failure:
externality, the uncompensated impact of one
person’s actions on the well-being of a
bystander.
• Externalities can be negative or positive,
depending on whether 20impact on bystander is
Introduction
• Self-interested buyers and sellers neglect the
external costs or benefits of their actions,
so the market outcome is not efficient.
• Another principle :
Governments can sometimes
improve market outcomes.
In presence of externalities, public policy can
improve efficiency.
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Examples of Negative
Externalities
• Air pollution from a factory
• The neighbor’s barking dog
• Late-night stereo blasting from
the dorm room next to yours
• Noise pollution from
construction projects
• Health risk to others from
second-hand smoke
• Talking on cell phone while driving makes the roads
less safe for others
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Recap of Welfare Economics
P The market for gasoline
$5 The market eq’m
maximizes consumer
+ producer surplus.
4
Supply curve shows private
3 cost, the costs directly
$2.50 incurred by sellers.
2
Demand curve shows
private value, the value to
1
buyers (the prices they are
willing to pay).
0
0 10 20 25 30 Q
(gallons)
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Analysis of a Negative Externality
P The market for gasoline
$5 Social cost
= private + external cost
4 external
Supply (private cost)
cost
3 External cost
= value of the negative
2 impact
on bystanders
1 = $1 per gallon
(value of harm
0 from smog,
0 10 20 30 Q
greenhouse gases)
(gallons)
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Analysis of a Negative Externality
P The market for gasoline
The
The socially
socially
$5
Social optimal
optimal quantity
quantity
cost is
is 20
20 gallons.
gallons.
4
S
3 At
At any
any Q
Q << 20,
20,
value
value of
of additional
additional gas
gas
exceeds
exceeds social cost.
2 At any Q > 20, cost.
At any Q social
> 20,
D social
social cost
cost ofof the
the
1 last
last gallon
gallon is
is
greater
greater than
than its
its value
value
0 to
to society.
society.
0 10 20 25 30 Q
(gallons)
25
Analysis of a Negative Externality
P The market for gasoline
$5
Social Market eq’m
cost (Q = 25)
4
S is greater than
social optimum
3
(Q = 20).
2 One solution:
D tax sellers
1 $1/gallon,
would shift
0 S curve up $1.
0 10 20 25 30 Q
(gallons)
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“Internalizing the Externality”
• Internalizing the externality: altering incentives
so that people take account of the external effects of
their actions
• In our example, the $1/gallon tax on sellers makes
sellers’ costs = social costs.
• When market participants must pay social costs,
market eq’m = social optimum.
(Imposing the tax on buyers would achieve the same
outcome; market Q would equal optimal Q.)
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Examples of Positive
•
Externalities
Being vaccinated against
contagious diseases protects
not only you, but people who
visit the salad bar or produce
section after you.
• R&D creates knowledge
others can use.
• People going to college raise the
population’s education level, Thank you for
which reduces crime and not contaminating
improves government. the fruit supply!
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Positive Externalities
• In the presence of a positive externality,
the social value of a good includes
– private value – the direct value to buyers
– external 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. 29
ACTIVE LEARNING 1
Analysis of a positive externality
P The market for flu shots
External benefit
$ 50 = $10/shot
40 Draw the social
value curve.
S
30 Find the socially
optimal Q.
20 What policy would
internalize this
10 externality?
D
0 Q 30
0 10 20 30 30
ACTIVE LEARNING 1
Answers
Socially optimal Q
P The market for flu shots
= 25 shots.
$ 50
external To internalize the
40 benefit externality, use
subsidy = $10/shot.
S
30
Social value
20 = private value
+ $10 external benefit
10
D
0 Q 31
0 10 20 25 30 31
Effects of Externalities: Summary
IfIf negative
negative externality
externality
–– market
market quantity
quantity larger
larger than
than socially
socially desirable
desirable
IfIf positive
positive externality
externality
–– market
market quantity
quantity smaller
smaller than
than socially
socially desirable
desirable
To
To remedy
remedy the
the problem,
problem,
“internalize
“internalize the
the externality”
externality”
–– tax
tax goods
goods with
with negative
negative externalities
externalities
–– subsidize
subsidize goods
goods with
with positive
positive externalities
externalities
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Public Policies Toward
Externalities
Two approaches:
• Command-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. Examples:
– corrective taxes and subsidies
– tradable pollution permits
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Corrective Taxes & Subsidies
• 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
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Corrective Taxes & Subsidies
• Other taxes and subsidies distort incentives and
move economy away from the social optimum.
• Corrective taxes & subsidies
– align private incentives with society’s interests
– make private decision-makers take into account the
external costs and benefits of their actions
– move economy toward a more efficient allocation
of resources.
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Corrective Taxes vs. Regulations
• Different firms have different costs of pollution
abatement.
• Efficient outcome: Firms with the lowest abatement
costs reduce pollution the most.
• A pollution tax is efficient:
– Firms with low abatement costs will reduce
pollution to reduce their tax burden.
– Firms with high abatement costs have greater
willingness to pay tax.
• In contrast, a regulation requiring all firms to reduce
pollution by a specific amount
36 not efficient.
Corrective Taxes vs. Regulations
Corrective taxes are better for the environment:
• The corrective tax gives firms incentive to
continue reducing pollution 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.
• In contrast, firms have no incentive for further
reduction beyond the level specified in a
regulation.
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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.
– Accidents
Larger vehicles cause more damage in an accident.
– Pollution
Burning fossil fuels produces greenhouse gases.
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A. Regulating lower SO2 emissions
• Firm ‘F1 and F2’ run coal-burning power plants. Each
emits 40 tons of sulfur dioxide per month,
total emissions = 80 tons/month.
• Goal: Reduce SO2 emissions 25%, to 60 tons/month
• Cost of reducing emissions:
$100/ton for F1, $200/ton for F2
Policy option 1: Regulation
Every firm must cut its emissions 25% (10 tons).
Your task: Compute the cost to each firm and
total cost of achieving goal using this policy.
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A. Answers
• Each firm must reduce emissions by 10 tons.
• Cost of reducing emissions:
$100/ton F1, $200/ton for F2.
• Compute cost of achieving goal with this policy:
Cost to F1: (10 tons) x ($100/ton) = $1000
Cost to F2: (10 tons) x ($200/ton) = $2000
Total cost of achieving goal = $3000
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40
Tradable Pollution Permits
• A tradable pollution permits system reduces
pollution at lower cost than regulation.
– Firms with low cost of reducing pollution
do so and sell their unused permits.
– Firms with high cost of reducing pollution
buy permits.
• Result: Pollution reduction is concentrated
among those firms with lowest costs.
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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.
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Corrective Taxes vs.
Tradable Pollution Permits
• Like most demand curves, firms’ demand for the ability
to pollute is a downward-sloping function of the
“price” of polluting.
– A corrective tax raises this price and thus reduces
the quantity of pollution firms demand.
– A tradable permits system restricts the supply of
pollution rights, has the same effect as the tax.
• When policymakers do not know the position of this
demand curve, the permits system achieves pollution
reduction targets more precisely.
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B. Tradable pollution permits
• Initially, F1 and F2 each emit 40 tons SO2/month.
• Goal: reduce SO2 emissions to 60 tons/month total.
Policy option 2: Tradable pollution permits
• Issue 60 permits, each allows one ton SO2 emissions. Give
30 permits to each firm.
Establish market for trading permits.
• Each firm may use all its permits to emit 30 tons,
may emit < 30 tons and sell leftover permits,
or may purchase extra permits to emit > 30 tons.
Your task: Compute cost of achieving goal if F1
uses 20 permits and sells 10 to F2 for $150 each. 44
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B. Answers
• Goal: reduce emissions from 80 to 60 tons
• Cost of reducing emissions:
$100/ton for F1, $200/ton for F2.
Compute cost of achieving goal:
F1
– sells 10 permits to F2 for $150 each, gets $1500
– uses 20 permits, emits 20 tons SO2
– spends $2000 to reduce emissions by 20 tons
– net cost to F1: $2000 - $1500 = $500
continued…
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B. Answers, continued
• Goal: reduce emissions from 80 to 60 tons
• Cost of reducing emissions:
$100/ton for F1, $200/ton for F2.
F2
– buys 10 permits from F1, spends $1500
– uses these 10 plus original 30 permits, emits 40 tons
– spends nothing on abatement
– net cost to F2 = $1500
Total cost of achieving goal = $500 + $1500 = $2000
Using tradable permits, goal is achieved at lower total cost
and lower cost to each firm than using regulation.
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Objections to the
Economic Analysis of Pollution
• 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.
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Private Solutions to Externalities
Types of private solutions:
• Moral codes and social sanctions,
e.g., the “Golden Rule”
• Charities, e.g., the Sierra Club
• Contracts between market participants and
the affected bystanders
48
Private Solutions to Externalities
• The Coase theorem:
If private parties can costlessly bargain over
the allocation of resources, they can solve
the externalities problem on their own.
49
The Coase Theorem: An Example
A owns a dog named Spot.
Negative externality:
Spot’s barking disturbs B,
A’s neighbor.
The socially efficient outcome
maximizes A’s + B’s well-being.
– If A values having Spot more
See Spot bark.
than Jane values peace & quiet,
the dog should stay.
Coase theorem: The private market will reach the
efficient outcome on its own…
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The Coase Theorem: An Example
• CASE 1:
A has the right to keep Spot.
Benefit to A of having Spot = $500
Cost to B of Spot’s barking = $800
• Socially efficient outcome:
Spot goes bye-bye.
• Private outcome:
B pays A $600 to get rid of Spot,
both B and A are better off.
• Private outcome = efficient outcome.
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The Coase Theorem: An Example
• CASE 2:
A has the right to keep Spot.
Benefit to A of having Spot = $1000
Cost to A of Spot’s barking = $800
• Socially efficient outcome:
See Spot stay.
• Private outcome:
B not willing to pay more than $800,
A not willing to accept less than $1000,
so Spot stays.
• Private outcome = efficient outcome.
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The Coase Theorem: An Example
• CASE 3:
B has the legal right to peace & quiet.
Benefit to A of having Spot = $800
Cost to A of Spot’s barking = $500
• Socially efficient outcome: A keeps Spot.
• Private outcome: A pays Be $600 to put up with Spot’s
barking.
• Private outcome = efficient outcome.
The
The private
private market
market achieves
achieves thethe efficient
efficient outcome
outcome
regardless
regardless of
of the
the initial
initial distribution
distribution of
of rights.
rights.
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Applying Coase
Collectively, the 1000 residents of Green Valley
value swimming in Blue Lake at $100,000.
A nearby factory pollutes the lake water, and
would have to pay $50,000 for non-polluting
equipment.
A. Describe a Coase-like private solution.
B. Can you think of any reasons why this solution
might not work in the real world?
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Coasian Solution
• .A good Coasian solution would be for each
of the 1000 residents to chip in $75, so the
town can offer $75,000 to the factory to
stop polluting.
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Why Private Solutions Do Not Always Work
1. Transaction costs:
The costs parties incur in the process of
agreeing to and following through on a bargain.
These costs may make it impossible to reach a
mutually beneficial agreement.
2. Stubbornness:
Even if a beneficial agreement is possible,
each party may hold out for a better deal.
3. Coordination problems:
If parties are very large, coordinating them may be
costly, difficult, or impossible.
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SUMMARY
• An externality occurs when a market
transaction affects a third party. If the
transaction yields negative externalities (e.g.,
pollution), the market quantity exceeds the
socially optimal quantity.
If the externality is positive (e.g., technology
spillovers), the market quantity falls short of
the social optimum.
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SUMMARY
• Sometimes, people can solve externalities on
their own. The Coase theorem states that the
private market can reach the socially optimal
allocation of resources as long as people can
bargain without cost. In practice, bargaining is
often costly or difficult, and the Coase theorem
does not apply.
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SUMMARY
• The government can attempt to remedy the
problem. It can internalize the externality
using corrective taxes. It can issue permits to
polluters and establish a market where permits
can be traded. Such policies often protect the
environment at a lower cost to society than
direct regulation.
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