Chapter 1

Introduction to Environmental Economics

The basic subject matter of Economics is the study how
people(individuals, house holds, firms & nations ) maximize their
gains from their limited resources and opportunities.
Economics is the study of how people allocate their resources to their
alternative uses for deriving maximum possible gains from scarce
resources.
Economics also studies the working mechanism of the market system
and the behavior of the market forces like demand, supply, prices and
competition; and how these forces determine the price of the product.
Economics the study of choice under conditions of scarcity.
Scarcity is a situation in which the amount of something available is
insufficient to satisfy the desire for it.
Land, capital and labor are scarce resources that are used to produce
goods and services to satisfy human needs.
 Environmental Economics
Why do we study Economics?
We do study Economics for the following reasons
1. To understand the world better
2. To become an economist
3. To gain self-confidence in the field of economics
4. To achieve social changes
5. To help prepare for other careers
6. To know how to economize & optimize resource

Why do people economize?

The need for economizing arises because of the following basic facts
of economic life of the human beings:
Human wants, desires & aspirations are endless
Resources are scarce & some are even non-renewable
People are of optimizing by nature
 Environmental Economics
What is development Economics?
Development Economics is the study of how economies are
transformed from stagnation to growth and from low-income to high-
income level.
Development economics is a branch of economics which deals with
economic aspects of the development process in low-income countries.
What is Environmental Economics?
Environment literally means surrounding and everything that affect an
organism during its lifetime is collectively known as its environment.
Environment is sum total of water, air and land interrelationships
among themselves and also with the human being, and other living
organisms
It includes all the physical and biological surrounding and their
interactions.
 Environmental Economics
Environmental studies provide an approach towards understanding the
environment of our planet and the impact of human life upon the
environment.
Environment means “all the conditions, circumstances, and influences
surrounding and affecting the development of an organism or group of
organisms”.
It also means that the complex of physical, chemical and biotic factors
that act upon an organism or an ecological community and determine its
form and survival.
What is Environmental Economics?
Environmental Economics is a field of study concerned with the flow
of residuals from economic activity back to nature.
Natural Resource Economics is a field of study concerned with the
flow of resources from nature to economic activity.
 Environmental Economics
What is a residual?
Residual is the amount of a pollutant remaining in the environment
after a natural or technological process has occurred.
The relationship between economic activity and the natural
environment is best explained by Materials Balance Model.
The Materials Balance Model shows the circular flow with in a larger
schematic to show the connections between economic decision-making
and the natural environment.
The circular flow model illustrates the real & monetary flows of
economic activity through the factor market and the product/output
market.
Environmental economics is concerned with the impact of economic
activities on the environment, the significance of ecosystem to the
economy, and suggests the appropriate ways of regulating economic
activity, so that cosmic balance is achieved in the society.
 Environmental Economics
An ecosystem consists of the biological community (biotic) and the
physical and chemical factors (abiotic) that exist in the environment.
The study of the ecosystem consists of the study of certain processes
that link the living or biotic components to non-living or abiotic
components.
Energy transformations and bio-geochemical cycling are the main
processes that comprise the field of ecosystem in Ecology.
Fundamentals of the Economics of Environmental resources
Most environmental problems are traceable to the common property
nature of environmental resources.
Common property ownership of resources such as the atmosphere has
traditionally meant no ownership at all and free access to all users.
Environmental degradation of such resources has occurred when the
demand has risen to overwhelm their limited capacity to absorb wastes.
Individual maximizing behavior becomes perversely inefficient when
property rights to resources are held in common and government
assertion of public property rights is required to assure efficient
resource allocation.
Although it may be objectionable to some, the conventional wisdom in
environmental and resource economics is to view the natural
environment as a commodity or an asset with a multitude of qualitative
attributes.
Contd.
Let us consider a river flowing along a wooded area as an example.
To desirous, this river is a valuable asset because it serves as a
constant source of fish.
To a group of nature lovers, the value of this river may be primarily
spiritual.
Moreover, for these individuals, the river may not be viewed in
isolation from its surroundings.
To yet another group, the river may serve as a dumping ground for
industrial waste.
This example shows that the environment is a multifaceted asset or
commodity.
It can be used as a spiritual object, aesthetic consumption goods, a
source of renewable resources such as fish, and/or a dumping ground
for waste.
Contd.
The primary focus will be on the economic management of the natural
environment (in the form of either water, air or landmass) in terms of its
potential service to degrade or store waste.
A proper management of the environment to this end requires the
following two considerations.
First, there should be a good understanding of the nature of the waste-
absorptive capacity of the environment under consideration.
Second, there should be a mechanism by which to identify the costs
(degradation of environmental quality) and the benefits resulting from
the use of the natural environment to an economic end (the production
of more goods and services).
In other words, the trade-off between economic goods and
environmental quality or degradation needs to be carefully assessed,
taking into consideration the opportunity costs for all alternative uses of
the environmental asset in question.
 The concept of resources
In broad terms, a resource can be defined as anything that is directly or
indirectly capable of satisfying human wants.
 Traditionally, economists classify resources into three broad
categories: labor, capital and natural resources.
Labor encompasses the productive capacity of human physical and/or
mental efforts measured in terms of ability to do work or produce goods
and services.
Examples are a worker on an auto assembly line, a high-school teacher
and a commercial truck driver.
Capital refers to a class of resources that is produced for the purpose
of creating a more efficient production process.
In other words, it is the stock of produced items available not for direct
consumption, but for further production purposes.
Examples include machines, buildings, computers and education
(acquired skill).
 The concept of resources
Natural resources are the stock of living and nonliving materials found
in the physical environment, and which have an identifiable potential
use to human beings.
 Agricultural land, deposits of ferrous and nonferrous minerals, water,
fisheries, and wilderness and its multiple products are examples of
natural resources.
At this point, four key issues need to be clarified regarding this
economic notion of resources.
First, it is rare that basic resources (labor, capital and natural
resources) are used for direct consumption without some modification.
Resources are often used as factors of production or as means to
produce final goods and services that are capable of directly satisfying
human needs.
In other words, basic resources are often viewed as a means to an end,
rather than ends in themselves.
 The concept of resources
The second and somewhat related issue is that, the economic notion of
resources is strictly anthropocentric.
That is, the economic value of any resource is defined by human needs
and nothing else which implies that resources have no intrinsic value
The worthiness of a watershed service (water purification process by
root systems and soil microorganisms) is identified solely by its
commercial value.
The fact that the watershed under consideration may have other,
noneconomic value is not considered.
The third issue that needs to be understood is that each of the above
resource categories is of economic concern to the extent that they are
scarce found in limited quantities and/or qualities.
 The concept of resources
The fourth issue deals with the fact that as factors of production,
resources are used in combinations.
Furthermore, resources are generally considered to be fungible.
That is, one kind of resource (such as a machine) can be freely
replaced by another (such as labor) in the production process; or one
type of energy resource (such as petroleum) can be replaced by another
form of energy (such as natural gas).
Fungibility implies that no particular resource is considered to be
absolutely essential for production of goods and services.
 Fungibility does not in any way suggest an escape from the general
problem of resource scarcity
 The concept of resources
The environment's services are, without a doubt, valuable. The air
we breathe, the water we drink and the food we eat are all available
only because of services provided by the environment.
How can we transform these values into income while conserving
resources?
Scarcity and its economic implications
At the root of any economic study is the issue of resource scarcity.
In fact, as a discipline, economics is defined as the branch of social
science that deals with the allocation of scarce resources among
competing ends.
What exactly do economists mean by resource scarcity? What are
the broader implications of scarcity?
 The concept of resources
For economists, scarcity is the universal economic problem.
Every human society, whether a tribal society or an economically
and technologically advanced society, is confronted with the basic
problem of scarcity.
That is, at any point in time, given societal resource endowments and
technological know-how, the total sum of what people want to have
(in terms of goods and services) is far greater than what they can
have.
Considering that human wants for goods and services are immense
and, worse yet, insatiable in a world of scarcity, what can be done to
maximize the set of goods and services that people of a given society
can have at a point in time?
This question clearly suggests that the significant economic problem
involves rationing limited resources to satisfy human wants and,
accordingly, has the following four general implications:
 The concept of resources
1 Choice The most obvious implication of scarcity is the need to
choose.
That is, in a world of scarcity, we cannot attain the satisfaction of all
our material needs completely.
 Hence, we need to make choices and set priorities.
2 Opportunity cost Every choice we make has a cost associated with
it; one cannot get more of something without giving up something
else. In other words, an economic choice always entails sacrifice or
opportunity cost the highest-valued alternative that must be sacrificed
to attain something or satisfy a want.
In a world of scarcity, there is no such thing as a free lunch.
3 Efficiency In the presence of scarcity, no individual or society can
afford to be wasteful or inefficient.
The objective is, therefore, to maximize the desired goods and
services that can be obtained from a given set of resources.
 The concept of resources
This state of affairs is attained when resources are fully utilized (full
employment) and used for what they are best suited in terms of
production (i.e., there is no misallocation of resources).
Furthermore, efficiency implies that the best available technology is
being used
4 Social institutions As noted earlier, the essence of scarcity lies in the
fact that people's desire for goods and services exceeds society's
ability to produce them at a point in time.
In the presence of scarcity, therefore, the allocation and distribution
of resources always cause conflicts.
To resolve these conflicts in a systematic fashion, some kind of
institutional mechanism(s) needs to be established.
For example, in many parts of the contemporary world, the market
system is used as the primary means of rationing scarce resources.
 Principle of market economics
 a market economy is an economic system where two
forces, known as supply and demand , direct the production
of goods and services.
Market economics are not controlled by a central authority
(like government) and are instead based on voluntary
exchange.
Where the free flow of goods and services facilities and
protects both producers and consumers.
First, there is no governmental control, and exchange of
goods and services is determined by the market mechanisms
of demand and supply.
a market economy functions under the laws of supply and
demand .
 Principle of market economics
it is characterized by private ownership, freedom of
choice, self-interest, buying and selling platforms,
competition, and limited government intervention.
Competition drives the market economy as it encourages
efficiency and innovations.
A market economy is one in which goods are brought and
sold and prices are determined by the free market, with a
minimum of external government control.
The principle of market economy dictates that producers
and sellers of goods and services will offer them at the
highest price that consumer are willing to pay for goods or
services.
when the level of supply meets the level of demand , a
natural economic equilibrium is achieved.
Environmental Economics and natural resource economics
What is natural resource economics ?is a combination of
natural resources and economics.
Natural resource is specific of the environment that are
valued to humans.
Aspects of nature that can be used by humans to satisfy
human wants.
Economics the study of the production, processing,
distribution and consumption of goods/services in an
exchange system.
Natural resource economics application of economics to
manage naturally occurring resources for human
needs/wants with efficiency as the primary goal.
 Environmental Economics and natural resource economics
Importance of natural resource economics to minimize
Global warming
Ozone depletion
Acid deposition
 And Conservation of biological diversity
Classification of natural resources
Production resources
Natural resources provide economics with raw materials
that are turned into goods via process of production.
Environment also provides a direct service to the
consumer.
Eg. Fuel, fishery, forest, water
 Environmental Economics and natural resource economics
Non production resource
 these are the resources which do not have a direct
relationship with the production of goods and services.
 Development & Environmental Linkages
A balanced growth in all economic sectors lead to development,
where Industrialization plays a key role in modern socio-economic
development.
Man cannot exist in isolation from the environment.
Man’s life is interconnected with various other living and non-living
things.
His life also depends on social, political, economic, ethical,
philosophical and other aspects of social system.
Economic development can affect the environment in both way
(positive & negative).
The life of human beings is shaped by his living environment.
Environment means all the conditions, circumstances, and influences
surrounding and affecting the development of an organism or group
of organisms.
 Development & Environmental Linkages
It also means that the complex of physical, chemical and biotic
factors that act upon an organism or an ecological community and
ultimately determine its form and survival, including the lives of
human being.
 Economy and the Environment -Inter linkages
The relationship between the economy and the environment is
generally explained in the form of a “Material Balance Models”
developed by Alen Kneese and R.V. Ayres.
Materials and energy are drawn from the environment, which are
used for production and consumption activities that returned to the
environment as wastes.
If this balance is maintained, there are no environmental issues.
The environment is the supplier of all forms of resources like
renewable and non-renewable, and it is also acting as a sink for
cleaning up of wastes.
Households and firms are connected to the environment, and they
are interconnected too.
Households and firms depend on nature for resources to produce
goods and services.
Both households and firms send out residuals of consumption and
production respectively to nature.
 Economy and the Environment -Inter linkages
The environment discharges the following economic functions:
1. The environment is the supplier of all forms of resources.
2. The wastes are cleaned up by the environment.
3. The environment maintains genetic diversity and stabilizes the
ecosystem.
Circular Flow Diagram
 Economy and the Environment -Inter linkages
In the name of economic activity the environmental resources are
transformed into economic goods [converting low entropy resources
into high entropy ones].
In this process of transformation, wastes are created.
Resources are also getting depleted due to the over use by human
beings.
When environment is disturbed by the overuse and the huge amount
of wastes, it cannot discharge the third function i.e., maintaining
genetic diversity and stabilization of ecosystems.
It further affects the life and existence of flora and fauna.
Circular flow & the environment
 Economy and the Environment -Inter linkages
•Environmental economics is concerned with the impact of economic
activities on the environment, the significance of ecosystem to the
economy, and suggests the appropriate ways of regulating economic
activity, so that cosmic balance is achieved in the society.
•Therefore an integrated approach to the study of economy, ecology,
and environment is essential, as all these are closely interlinked with
each other.