Environmental Science (Economics Module) Lectures PDF

# Environmental Science (Economics Module) ## Course Code: HS 200/HS250 **Prof. Haripriya Gundimeda** Department of Economics Indian Institute of Technology Bombay ## Module 2: Why do Environment Problems Occur? ### Market Failure - Market - An Exchange institution that can organize economic a...

# Environmental Science (Economics Module) ## Course Code: HS 200/HS250 **Prof. Haripriya Gundimeda** Department of Economics Indian Institute of Technology Bombay ## Module 2: Why do Environment Problems Occur? ### Market Failure - Market - An Exchange institution that can organize economic activity - Prices as a means of Communication - Perfectly functioning markets bring co-ordinated economic decisions in the most efficient manner - Optimal private decisions will lead to optimal social outcomes. ### Market Failure: Market Success (violations lead to Market failures) - Complete set of markets with well-defined property rights exist so that assets can be freely traded - Consumers and producers behave competitively by maximizing benefits and minimizing costs - Market Prices are known to all consumers and firms - Transaction costs are zero i.e. charging prices does not consume resources ### Avoiding Market failure: - Complete markets - Enough markets exist to cover every possible transaction - Traders can costlessly create a well-defined property rights system - Well-assigned property rights - Comprehensively assigned (either privately or collectively owned and all entitlements enforced effectively) - Exclusive (benefits accrue to the owner) - Transferable - Secure ### Environment being a Public good - Pure public good (consumption is non-rival and non-excludable) - Non- Exclusion - Non-rival goods (marginal social cost of supply to an additional individual is zero, Markets fail because firms cannot profit, the incentive to free-ride, prisoner's dilemma) - Rival Goods (overexploitation, Tragedy of Commons e.g. fishing grounds) ### Prisoner's dilemma (Individual rationality diverges from group rationality) - Two suspects, who are guilty of a specific crime are taken into custody and placed in different cells. - However, there is no adequate evidence to convict them at a trial. - The district attorney points out to each prisoner that each has two alternatives: to confess to the crime the police are sure they have done, or not to confess. - If they both do not confess - they will get minor punishment; - If they both confess they will be prosecuted but will be given less than severe sentence - But if one confesses and the other does not, then the confessor will receive lenient treatment for turning state's evidence whereas the latter will get severe punishment ### Prisoner's dilemma (example) A table with the title "Prisoner's dilemma (example)", the header "B" and rows named "confess" and "don't confess" and the columns named "confess" and "don't confess" and the following table entries is: | | confess | don't confess | |-------|---------|----------------| | confess | (8,8) | (1, 10) | | don't confess | (10,1) | (1, 1) | - Both players would be better off if none confesses - However, confessing comes out as dominant strategy and they end up spending more time in Prison ### Other reasons why Markets Fail - Non-Convexities - Asymmetric Information - Moral Hazard (Incentive Problem) - Adverse Selection) (cannot identify the type or character) - Externalities ### WHAT IS EXTERNALITY? Externalities are unintended (and uncompensated) side effects of one person's or firm's activities on another. - Examples: - Health effect of smoke emissions from vehicles - Health effect of smoke emissions from Thermal power plant - Health effect of discharging untreated effluent factory ### WHY THESE SIDE EFFECTS? - Interdependence in production or consumption. - The utility of individual i depends not only on his consumption but also on the consumption of another individual: - U₁ = U₁(X₁, X₁) & P₁ = P₁(X₁, X₁) - NOTE - These damages are unintentional per *se*, as they are typically challenging to avoid. - This interdependence must also be a non-market dependence to qualify as an externality ### EXAMPLES - Congestion caused by a vehicle on other drivers - unintentional and difficult to avoid. - Air Pollution caused by power plants - unintentional and difficult to avoid - If many people are in queue to buy water or medicine, this may lead to ↑ in price. Can this be Called as EXTERNALITY? – No - Why? Because it is perpetuated through market mechanisms. Hence not an external effect. ### WHEN EXTERNALITY ARISES? **Two Types of COSTS:** - Private Costs - Social Costs - Ex. - w.r.t. Vehicular Air pollution in Delhi/Chennai - Private Costs - Cost of Owning a vehicle, Fuel (petrol/diesel/LPG), maintenance cost etc. - Social Costs - Effect of pollutant on other people, my vehicle causing congestion for others + Private costs. - When SOCIAL COSTS > Private Costs → Negative Externality ### OTHER EXAMPLES OF EXTERNALITY? - Examples of Negative Externality - Pollution of Ganges or Yamuna by upstream activities - Transboundary Pollution - Soil Erosion caused by excessive and type of agriculture - Floods caused by Deforestation - Garbage (NIMBY) - Use of pesticides in agriculture - affecting downstream water bodies ### POSITIVE EXTERNALITY **Positive Externalities:** - When Social Benefit > Private Benefit **Examples of Positive Externality** - R&D by a firm for Cancer / COVID vaccine] - New filters for cars to reduce emissions - Forestation in hilly regions affecting water supply in the plains. ### TYPES OF EXTERNALITY **Two Types:** - Positive and Negative - Depletable and Non-depletable - Manure from a cow is depletable. - Because if one person takes it, the other cannot. - Vehicular air pollution or Odour from Solid waste are non-depletable ### Thank You