Environmental Economics & Management:
Theory, Policy, and Applications 5e
Scott J. Callan and Janet M. Thomas
MODULE 1
Modeling Environmental Problems
Chapter 1
The Role of Economics in
Environmental Management
“We can lead the world, secure our nation, and
leave our children a planet that is safer and
cleaner and healthier than the one we inherited.”
Barack Obama (1961- )
p. 2, our textbook
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1. Economics and the Environment
• Economic theory _______ what we observe in
reality, including environmental problems
• Recognize the link between economic activity
and the environment using ________
– Circular Flow Model
– Materials Balance Model
A model is an abstract representation of reality; built with
words, diagrams, and mathematical statements; should be
as simple as possible to accomplish its purpose
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Circular Flow Model
• Shows the real and monetary _______ of
economic activity through the _______ and
________ markets
– Forms the basis for modeling the relationship
between economic activity and the environment
– But does not explicitly show the linkage between
economic activity and the environment
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Circular Flow Model
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Outer arrows:
Firms supply goods/services to households
Households demand goods/services
Households supply resources to firms
Firms demand resources
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Inner arrows:
Households pay for goods/services
Firms receive revenue
Firms make factor payments to households
Households receive income
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Materials Balance Model
• Places the circular flow within a larger schematic to
show links between economic activity and the
natural environment via two sets of flows
– Flow of ___________________ from the environment to
the economy
• The focus of Natural Resource Economics
– Flow of ________ from the economy to the environment
• The focus of Environmental Economics
• Residuals are pollution remaining in the
environment after some process has occurred
– Residuals can be delayed, but not prevented, through
recovery, recycling, and reuse
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Materials Balance Model
The Interdependence of Economic Activity and Nature
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Source: Adapted from Kneese, Ayres, and D'Arge (1970).
Science and the Materials Balance Model
• The flow of resources and residuals are
balanced according to laws of science
• _____________________________
– Matter and energy can neither be created nor
destroyed
• _____________________________
– Nature’s capacity to convert matter and energy is
not without bound
Thermodynamics: physics that deals with the
mechanical action or relations of heat
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2. Fundamental Concepts in Environmental
Economics
Terms and Definitions
Environmental damage, or pollution—the
presence of matter or energy whose nature,
location, or quantity has undesired effects on the
environment.
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Causes of Environmental Damage
• Natural Pollutants arise from ____________
processes in nature
• e.g., ocean salt spray, pollen
• Anthropogenic Pollutants are _____________
and include all residuals associated with
consumption and production
• e.g., chemical wastes, gases from combustion
• Of greater concern to environmental
economists
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Sources of Pollution
• Sources grouped by mobility
– ____________ Source: fixed-site
– _________ Source: any nonstationary source
• Sources grouped by identifiability
– _______ source: single identifiable source
Point sources are discrete conveyances such
as pipes or man-made ditches.
– _________ Source: a source that cannot be
accurately identified, degrading in a diffuse way
Agricultural runoff from farmland: a nonpoint
polluting source if rainwater transports chemical
pesticides and fertilizers to nearby lakes and
streams.
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Scope of Environmental Damage
• ________Pollution
– Damage not far from the source
• e.g., urban smog
• __________ Pollution
– Damage extends well beyond the source
• e.g., acidic deposition
• ________ Pollution
– Involving widespread environmental effects with
global implications
• e.g., global warming, ozone depletion
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3. Identifying Environmental Objectives
• _______________________ – reduction in
anthropogenic contamination to socially
acceptable levels
• ______________________ – management of
resources to ensure long-term quality and
abundance
• __________ – assuring the variety of distinct
species, genetic variability, and variety of
inhabitable ecosystems
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4. Environmental Policy Planning: An Overview
• Environmental planning involves many
segments of society
• In the U.S., the Environmental Protection
Agency (EPA) acts as liaison to numerous
constituents within each sector
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Environmental Policy Planning
Source: Adapted from Vaupel (1978), Figure 5-3, p. 75.
EPA headquarters are in Washington, D.C., and there are 10 regional offices across
the nation.
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National Environmental Policy Act (NEPA)
of 1969
• Directs the integration of effort across
agencies, executive departments, and
branches of government in the U.S.
• Guides U.S. federal environmental policy
• Requires that environmental impact of public
policy proposals be addressed
– Calls for an Environmental Impact Statement (EIS)
on proposals or major federal actions
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Risk Analysis
--Chief Tool Guiding Policy Planning
• Two decision-making procedures
– _______________– qualitative and quantitative
evaluation of risk posed by an environmental
hazard
– ________________– decision process of
choosing from alternative responses to
environmental risk
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Risk Management
a. Policy Evaluation Criteria
• Economic Criteria
– Allocative Efficiency – requires resources be
appropriated such that benefits are equal to
costs
– Cost-effectiveness – requires the least amount
of resources be used to achieve an objective
• Equity Criterion
– Environmental Justice – concerned with the
fairness of the environmental risk burden across
segments of society or geographic region
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b. Government Policy Approach
• ___________________________– regulates
polluters through the use of rules
• ________________– incentive-based policy
that encourages conservation or pollution
reduction
– Can follow the “polluter-pays principle”
whereby the polluter pays for the damage
caused
see page 19
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• In theory, the price assigned to pollution is
set to cover any damages to health or the
ecology caused by pollution. The polluter is
made to pay this price for every unit of
pollution released to nature. The full costs of
production are captured. The profitmaximizing producer has an incentive to
reduce residuals.
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c. Setting the Time Horizon
• Management Strategies – a short-term
strategy intended to manage an existing
problem
• Pollution Prevention (P2) – a long-term
strategy aimed at reducing the amount of
toxicity of residuals released to nature
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