Fall AY2016
Part II
FE345: Environmental Economics Course Notes
Part II: Fossil Fuels
S(2): Energy, Technology, and the Environment (FE345 Section only)
I.
The Environmental Kuznets Curve

The Environmental Kuznets Curve (EKC) → Characterizes the (hypothesized) relationship
between per capita income in a country and environmental quality in a country over time
Tax Credit

How is “environmental quality” to be measured?
e.g. (domestic) pollution tends to fall at high levels of economic development, but emission of
carbon dioxide increases, and habitat / biodiversity levels tend to decrease (so far)

Why should this relationship hold, in theory?
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
Part II
Does the EKC relationship hold, in reality? → Evidence is mixed
(1) Fairly strong evidence that it does for local air / water pollution
(2) Lack of evidence that it holds for global air pollutants (CO2) or for biodiversity or natural
capital (conservation of forests, water sources, etc, which tend to continue to be exploited as
income rises)
*** Perhaps the developed world is just now reaching sufficiently high income levels so that
there is a demand for lower greenhouse gas emissions, forest conservation, and greater
biodiversity. That is, perhaps the exact EKC relationship varies by specific “pollutant” or
measure of environmental quality.
(3) May be that high income countries never actually reduce their pollution output, they just
outsource their pollution and environmental degradation to less-developed countries.
(G8) Deriving Energy from Fossil Fuels (Caton Lecture #2)
(G9) Fossil Fuels: The Economics of Non-Renewable Energy Resources (Swope Lecture #2)
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II.
Part II
The Population Question

Is the “laissez faire” rate of population growth likely to be efficient?

Assuming the decision to have children is a rational, economic decision, consider the economic
model of fertility (i.e. how many children to bear):
Tax Credit
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
Marginal (private) benefit of children (MPB) →

Marginal (private) cost of children (MPC) →

Shifters of MPB curve →

Shifters of MPC curve →
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
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Are there positive or negative externalities from child bearing?
 Positive externalities (why MSB > MPB)
 Negative externalities (why MSC > MPC)
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
The “Demographic Transition Model”

Compare China’s population policy to that of U.S.:
Part II
China → “One-child policy” (for urban couples)
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Traced to Marxist theories of pop. growth (which originated with Malthus)
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Started in 1979; estimated to have led to 300 million fewer births
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Criticized by human rights groups (forced sterilizations/abortions; selective gender-based
abortions)
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Problems → male/female imbalance in population; unregistered children (ineligible for state
benefits); “4-2-1” problem (four grandparents, two parents, being cared for by one child)
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Benefits → improved health care for women; increased savings rate (fueling economic
growth)
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U.S.→ no official policy (but effectively subsidize childbirth in many ways)
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Tax exemption for each dependent ($3700) plus child tax credit ($1000, if eligible) plus
standard deduction for each dependent ($950) or itemized deductions for dependent care
expenses (up to $6000), student loan interest, and some medical expenses.
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Military housing allowance based on number of dependents
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Welfare (food stamps, housing, cash assistance programs) all based on number of dependents
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Public schooling
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 The “Simon-Ehrlich Wager” (1980) → Neo-Malthusians vs. Cornucopians
Paul Ehrlich (the “Doomsayer”, 1932 - )
Julian Simon (the “Doomslayer”, 1932 – 1998)
 Biologist Paul Ehrlich (in The Population Bomb (1968)) argued that overpopulation, resource
scarcity, and mass starvations were rapidly approaching.
 Economist Julian Simon disagreed (in The Ultimate Resource (1981)), saying that population
growth was beneficial to human well being, and the source of the technological growth that
would ultimately make resources less scarce over time.
 In 1980, Simon challenged Ehrlich to a bet → Ehrlich could pick any non-governmentally
controlled commodities and any date at least one year in the future. Simon predicted their
prices would be lower in the future than today (in 1980).
 Ehrlich picked five metals (chromium, copper, nickel, tin, tungsten) and Sept. 29, 1990. He
bought $200 worth of each metal, for a total bet of $1000. If the combined price increased,
Simon would have to pay Ehrlich the amount of the increase. If their combined price fell,
Ehrlich would pay Simon the difference.
 So what happened?
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“More people, and increased income, cause resources to become more scarce in the short run.
Heightened scarcity causes prices to rise. The higher prices present opportunity, and prompt
inventors and entrepreneurs to search for solutions. Many fail in the search, at cost to themselves.
But in a free society, solutions are eventually found. And in the long run the new developments
leave us better off than if the problems had not arisen. That is, prices eventually become lower
than before the increased scarcity occurred.”
-
Julian Simon
“The bet doesn't mean anything. Julian Simon is like the guy who jumps off the Empire State
Building and says how great things are going so far as he passes the 10th floor. I still think the
price of those metals will go up eventually, but that's a minor point. The resource that worries me
the most is the declining capacity of our planet to buffer itself against human impacts. Look at the
new problems that have come up: the ozone hole, acid rain, global warming. It's true that we've
kept up food production -- I underestimated how badly we'd keep on depleting our topsoil and
ground water -- but I have no doubt that sometime in the next century food will be scarce enough
that prices are really going to be high even in the United States.”
-
Paul Ehrlich
“As soon as one predicted disaster doesn’t occur, the doomsayers skip to another…why don’t
[they] see that, in the aggregate, things are getting better? Why do they always think we are at a
turning point – or at the end of the road?”
-
Julian Simon1
1
Simon challenged Ehrlich to a second bet based on measures of human welfare rather than commodity prices, but
the two could not agree on the terms of the bet before Simon’s death in 1998.
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
Part II
Is there an appropriate government policy toward population growth? What role, if any,
should the government play? Government’s role will likely vary by country, but…
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III.
Part II
Agriculture and the Environment

Internationally (and in the U.S.) hunger and malnutrition are important and serious problems. Are
they getting worse, or better? Were Malthus / Ehrlich right about population growth and the food
supply, or was Simon right?

World food production per capita has been steadily _______________________________
 % of human population that is malnourished has been steadily __________________
 % of human population that is obese has been steadily _____________________ (both in
wealthy developed countries and in less developed countries)

Dramatic increases in agricultural productivity (yield per acre) achieved by

Trends in U.S. agriculture
 Less employment on farms → Figure 1
 Fewer, larger farms → Figure 3
 Specialization of output → Figure 4
 Increased productivity → Figure 5
 Increased exports → Figure 6
 Increased share of off-farm household income
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
Part II
Brief history of U.S. farm policy
 1930’s → Traditional price supports and supply controls [set-asides] (some continued
into 1980’s → Reagan-era “government cheese”, which now seems to refer to any kind
of government handout)
In response to hardship during Great Depression
Many school lunch programs have their origins in attempts to dispose of surplus ag.
commodities
Tariff controls to prevent imports
 1960’s – 1970’s → Introduce “target prices” accompanied by “deficiency payments”
In response to large surpluses resulting from productivity increases after WWII
Increases reliance on markets (rather than government buying surpluses); encouragement
of export growth
Served to depress world crop prices, negatively impacting farmers overseas, particularly
in developing countries
 Increased use of “direct payments” to farmers based on historical output and less on
current production
Has probably reduced inefficiencies from “unnecessary” government intervention; rural
“welfare”?
 2007 → Biofuel mandates part of the Energy Security and Independence Act
According to experts, the mandates have made us no more “secure” or “independent”;
have other negative social and environmental impacts (higher food prices; increased
water / fertilizer / pesticide / land use and associated negative environmental impacts)
 Agricultural subsidies also continue to take the form of subsidized crop insurance and
subsidized water use
Note: By law, U.S. international food aid (distributed by USDA and U.S. Agency for
International Development (USAID) must come from U.S. farmers.
U.S. Food Stamp Program (now called “Supplemental Nutrition Assistance Program”
(SNAP)), administered by USDA, prohibits purchase of imported food with food stamps.
High tariffs on ethanol imports (from Brazilian sugar-cane ethanol, in particular)

Result is that 1/3 to ½ of farm income in U.S. comes from government subsidies (farmers in
Japan typically receive twice as much from government as from farming itself).
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
Part II
Primary impacts of U.S. farm policy (and typical policies of other developed countries) on
developing countries:
1. Restricting imports of commodities in which developing countries have a comparative
advantage depresses their domestic prices.
2. Encouraging overproduction and export of U.S. commodities depresses world crop prices
3. Provision of in-kind food aid (produced by U.S. farmers) to developing countries may further
distort their markets and depress prices
Commodity
Percent Price Depressed
Rice***
33 – 50%
Sugar
20 – 40%
Dairy
20 – 40%
Cotton
10 – 20%
Peanuts
10 – 20%
Source: World Bank
*** From 1995 – 2009 nearly $13 billion in rice subsidies paid to U.S. farmers. Since 2000,
$1.3 billion paid to people who don’t even farm (and most have household income well in
excess of the national average). One Houston surgeon has collected $490,000 (owns property
on which rice was grown in the past and qualifies for rice subsidies).
Cuts under recent debt reduction legislation call for reductions or elimination of many
subsidies.

Agricultural policies in developing countries may cause or exacerbate food problems:
 Price controls often used to make food affordable to the poor (but this lowers the return to
farmers)
 Governments often tempted to purchase cheap imported food or accept food aid to alleviate
food shortages in short-run (but this doesn’t help develop domestic food supply)
 Property rights protections are often weak (or violated by governments themselves (e.g.
confiscating property to address social goals or during periods of political unrest, etc).
People may simply flee land during civil wars.
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
Part II
Agricultural production involves many externalities:
 Negative externalities
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Fertilizer, sediment, pesticide / herbicide runoff → damage to insect populations (e.g.
bees, etc) and other wildlife (e.g. oysters, blue crabs)
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Greenhouse gas emissions
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Excessive (common-property) water use for irrigation (if farmers do not bear full
marginal social cost of water used)
 Positive externalities

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Farm land provides open space / scenic views
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Historical or heritage values
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Some benefit of farm land to for wildlife (relative to suburban development); e.g. hawk on
alfalfa farm in California
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Excess domestic agricultural production may also be justified on food security grounds
Predominance of negative externalities suggests government should possibly be taxing farm
output (or taxing polluting inputs and water use). Little justification for continued subsidizing of
agriculture on efficiency grounds (given the environmental impacts and consequences for
international relations).
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IV.
Part II
Regional and Global Air Pollution Challenges
1. Atmospheric deposition of acid substances (a.k.a. Acid Rain!)
Acid rain damage to trees in Great Smoky Mountains
Cause: SO2 emissions from coal-fired power plants
Solution: SO2 “cap and trade” programs in Europe and U.S. (leading to use of lowsulfur coal, “scrubbers”2, lower electricity use, alternative electricity generation sources
→ nuclear power, some wind / solar)
2
E.g. “wet” scrubbers, “dry” scrubbers, or “absorbers”. If you are interested in purchasing a “scrubber”, see
http://www.hanseneng.com/scrubber.html.
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Acid rain deposition in the USA from 1983 through 1997. From: Driscoll (2001).
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2. Ozone Depletion
False-color view of total ozone over the Antarctic pole. The purple and blue colors are where there is the least ozone, and the yellows and reds are
where there is more ozone.
Image Source: NASA’s Ozone Hole Watch (updated daily, image from 8/5/14)
Cause: Chloroflourocarbons (CFC’s) from aerosols, refrigeration units
Solution: Montreal Protocol (1988) and subsequent agreements → called for gradual
phase-outs of CFC’s (replacing them with hydrochloroflourocarbons (HCFC’s));
included delayed phase-outs for developing countries and assistance to help with costs;
considered a model for international cooperation on global pollution problems.
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3. Global Climate Change
Cause (of anthropegenic portion): “Greenhouse gas” emissions (CO2, methane, NO2,
HCFC’s, ozone); land-use changes (more cities, highways), desertification
Solution:

For each of the following questions, circle “yes” or “no”:
(1) Is the temperature of the earth rising?
Yes → There is scientific consensus that global temperatures are rising.
No → Warming trends have been overly emphasized. Many areas have had no significant change,
and some are even getting colder.
(2) If the temperature of the earth is rising, is human activity a significant contributing factor? Which
activities are contributing to climate change?
Yes → Human activities have caused global temperatures to rise beyond any natural background
warming that may be occurring.
No → Although there has been an upward trend in temperatures, the relationship between this
trend and the human activities above is insignificant or non-existent.
(3) Would it be technically or scientifically possible for humans to mitigate or reverse global
warming?
Yes → If the theoretical relationship between climate change and human activities is correct, then
a significant amount of climate change could be mitigated.
No → Climate change is already well underway, and all potential changes in human activity can
have little or no impact on future climatic changes.
(4) Globally, would the benefits of mitigating climate change exceed the costs?
Yes → The economic damage costs from global warming are likely to be so high, and the
mitigation costs sufficiently low, such that the overall benefits of a global mitigation plan will
exceed the costs of such a plan.
No → Climate change is not a “crisis”; adaptation will be less costly and more pragmatic that
costly initiatives to try to prevent or mitigate climate change; costs of mitigating climate change
will be immediate, while the “benefits” will only be realized in the distant future.
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(5) If mitigation benefits exceed the costs, is an effective, enforceable, and sustainable international
agreement to mitigate climate change obtainable?
Yes → the international community has already proven that it can successfully come together to
tackle other environmental problems (e.g. addressing the “ozone hole” problem through the
Montreal Protocol and the phasing out of CFC’s)
No → Costs and benefits are distributed very unevenly internationally, and the organizational
costs of establishing an agreement are too high; it will be difficult or impossible to monitor and
enforce international agreements; future generations cannot vote now (even if they would get
large benefits from mitigating climate change), therefore, political action today is unlikely to be
obtained; large revenues from “carbon taxes” or “cap and trade” programs would simply result in
larger governments and more corruption.
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V.
Part II
Climate Change and Cost/Benefit Analysis

Questions of science: Is the earth’s climate changing? Is human activity (e.g. greenhouse gas
emissions) a significant contributing factor? The first three questions above are science
questions.

Questions of economics (and/or ethics): Should we take action now to mitigate climate
change? Question 4 above is an economics question. Question 5 is a question of both politics
and economics.

If we take an economic approach to this last question, we face a difficult cost/benefit analysis
problem for two reasons:
1. What are the costs and benefits of actions to mitigate climate change? How do we
measure them?
2. How do we properly discount costs and benefits that may occur in the distant future?
(That is, what should we choose as our discount factor?)
A. Time-Value of Money

If i is the discount factor3 and t is the number of years, the present discounted value of
receiving $C (or other monetary units) at time t is
PV 
C
(1  i )t
B. Annuities and Perpetuities

If you are to receive $C once every year for the next n years (called an annuity), the present
discounted value of the annuity would be
PV  C

1  (1  i )  n
i
If you are to receive $C once every year indefinitely (called a perpetuity), the present
discounted value of the perpetuity would be
PV 
C
i
3
The discount rate is often the simple, real, market rate of interest one would expect to receive over the time
period in consideration (e.g. 5% or 0.05). The discount rate may or may not be assumed constant over the entire
time period. The choice of discount rate for public projects is often the source of controversy. Higher discount
rates lower the present value of projects with benefits that occur in the future.
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Some practice problems:
1. A project will have net benefits of $1 million. Complete the following table showing the
present discounted value of the benefits occurring at different points in the future and for
different discount factors:
Discount rate
50 years
100 years
2%
3%
5%
10%
2. You have to replace your hot water heater. You have the two options below. Which one is
preferred?
Option A: Whirlpool 80-Gallon (6-Year Tank Warranty) Tall Electric Water Heater at Lowes
$539
Option B: Marathon 85-gallon (Lifetime Warranty) water heater at Home Depot $1,002
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