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ZIMBABWE INSTITUTE OF MANAGEMENT

CERTIFICATE IN ENVIRONMENTAL
HEALTH AND SAFETY MANAGEMENT

ENIVORNMENTAL ECONOMICS
NATIONAL OFFICE
DZIDZO HOUSE
ENTERPRISE RD SOUTH
LONDONDERRY AVENUE
EASTLEA,
HARARE

P.O. BOX 3733, HARARE


TELEPHONE: 263-04-705291/2
707434 / 796509/
731478/0779775844/0715007331
EMAIL-ehsm@zim.ac.zw

Est. 1957

Bridging the Gap between Theory & Practice

DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


WRITTEN BY:

ISSAC KWESU

CONTENT REVIEWER:

NELSON CHANZA

Publisher:

ZIMBABWE INSTITUTE OF MANAGEMENT

Coordinator:

Dr. S. Karambwe

Editor:

E. Muzanenhamo

Layout and Design:

E. Muzanenhamo

All rights reserved: No part of this module may be reproduced or distributed in any form without the
prior written permission of the Zimbabwe Institute of Management.
Copyright (c) 2013

DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT

Table of Contents
MODULE OVERVIEW
iii


OVERALL MODULE OBJECTIVES
iii

UNIT ONE
1
OCCUPATIONAL HYGIENE AS A SUBJECT
1
SUMMARY
4
BIBLIOGRAPHY
4

UNIT TWO
NOISE AND VIBRATION
SUMMARY
BIBLIOGRAPHY

5
5
10
11

UNIT THREE
OCCUPATIONAL HEALTH EXPOSURE LIMITS
SUMMARY
BIBLIOGRAPHY

UNIT FOUR
MEASUREMENT OF HAZARDOUS SUBSTANCES
SUMMARY
BIBLIOGRAPHY

12
12
15
15

UNIT FIVE
THERMAL ENVIRONMENT AND NON-IONISING RADIATION
SUMMARY
BIBLIOGRAPHY

24
24
30
31

UNIT SIX
ERGONOMICS
SUMMARY
BIBLIOGRAPHY

32
32
36
36

UNIT SEVEN
ASBESTOS AND OTHER FIBRES
SUMMARY
BIBLIOGRAPHY

37
37
41
42

(ii)

17
17
22
23

DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


MODULE OVERVIEW

OVERALL OBJECTIVES OF THE MODULE

(iii)

UNIT ONE

THE NATURE AND SCOPE


OF ECONOMICS
1.0 INTRODUCTION

UNIT CONTENTS
Learning Outcomes
Definition of Economics
Economic systems
Market Economy
Commmand Economy
Mixed Economy
Introduction to Environmemtal and Resource Economics
Summary
Bibliography
1.2 LEARNING OUTCOMES
By the end of this unit, you should be able to:



Define the term economics


List three principles of economics
Explain the concept of opportunity cost, and
Discuss different economic systems.

1.3 DEFINITION OF ECONOMICS


Economics is a social science which studies human behaviour as a relationship between ends and
scarce means which have alternative competing uses. It is easy to remember the definition of economics by reducing it into three principles ( principles of economics).

DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT



The first principle of economics is that we live in a world of scarcity.

The second principle of economics is that we have unlimited wants and needs

The third principle of economics is that given the first and the second principle, we have

to make choices.
The problem of limited resources and unlimited wants also applies to society as a whole.
Can you think of any societies in which all wants are satisfied? Most societies would prefer to have better health care, quality education, higher standard of living and a cleaner environment. Unfortunately, there are not enough resources available to satisfy all of these goals.
1.4 UNLIMITED WANTS
Human material wants arise for two main reasons. First, each of us has basic biological
needs: the need for food, shelter and clothing. But there is also a second reason. Clearly we
are prepared to work more than is required to meet our minimum needs. We want more than
the basic diet of vegetables and water needed to sustain life. We want more than the minimum clothing needed to protect us from the cold. In other words, we want not only the essentials that make life possible, but also some of the non essentials that make life pleasant.
1.5 FACTORS OF PRODUCTION
Resources are the basic inputs used in the production of goods and services. Therefore, they are
also frequently known as factors of production. Factors of production can be categorized under
four main headings: land, labour, capital and entrepreneurship.
1. Land includes all natural resources: These natural resources include the land itself, as well as
any minerals, oil deposits, timber, or water that exists on or below the ground. This category is
sometimes described as including only the free gifts of nature, those resources that exist independent of human action.
2. Labour refers to human resources: The physical and mental talents that people apply to the production of goods and services. The construction worker provides labour, and so does the college
professor or the physician. The professor provides educational services and the doctor provides
medical services.
3. Capital: Refers to the body of materials that has been produced by humankind at some point in
time. Examples of capital goods include buildings, equipment and inventory of materials. The use
of the term capital differs from the everyday use of this term. Stocks, bonds, and other financial
assets are not capital under definition of this term. The production and accumulation of capital is
called investment. Unlike consumer goods (such as food or shoes), capital or investment goods
are not produced to satisfy human wants directly. Rather, they are intended for use in the production of other goods. Capital can be distinguished from land. Land is given by nature, while capital
is made by humankind. Land is fixed in supply (you cannot create another sun or another planet
earth) while capital can be increased in quantity. Land has zero cost of production (it takes people
nothing to create land apart from the rental exchange charges).

DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


4.
Entrepreneurship is derived from the French word entrepreneur, which means someone
who undertakes. More specifically, it means someone who:

a)
organizes production, bringing together the factors of production: landlabour and

capital to make goods and services

b)
makes business decisions, taking the initiative and figuring out what goods to

produce and how to produce them

c)
takes risks, knowing that there is no guarantee that business decisions will turn to


be correct. If the business is correct the entrepreneur reaps all profit and, if wrong,

the entrepreneur bears all the risk or losses, and

d)
innovates, introducing new ideas, new products, and new ways of organising

business.
1.6 THE CONCEPT OF SCARCITY, CHOICE AND OPPORTUNITY COST
Economics is, generally, defined, as the study of how our limited resources are allocated to satisfy
our unlimited wants for goods and services. The combination of limited resources and unlimited
wants implies a shortage, or scarcity. Scarcity forces us to make choices. Whenever we make
choices, we give up something else that we also desire. Scarcity requires choice and implies costs.
A scarce resource used to satisfy one need means there is some other need that is foregone. The
use of scarce resources to produce a good is always costly. Costs may be hidden, or non-monetary,
or delayed, but there is always a cost. Economists use opportunity cost as a broad concept of
cost that involves monetary and non-monetary, implicit and explicit cost. Opportunity cost can
be defined as the next highest valued alternative that must be sacrificed as a result of choosing
an alternative option. It is the real as opposed to mere monetary cost of an economic choice.
Examples
All economic agents face the problem of scarce resources.
Take the following scenarios:
(a) A household family has many things to be satisfied by its limited monthly income e.g. it may want
to pay school fees for its children while at the same time it wants to paint its house. If the income
is not sufficient to meet both the demands then it has to choose amongst these two alternatives.
Assume for some reasons it opted for the school fees then it implies no painting of the old house.
In this case the real cost (opportunity cost) of the school fees is the painting of the house forgone.
(b) Simplest case is when we have to choose between A and B (work full-time or go to school
full-time, go to movie A or movie B, vacation at destination A or B, choose between friend A or
B, choose between job A or B. In all these cases, the opportunity cost of A is option B forgone.
1.7 ECONOMIC GOODS, FREE GOODS, AND ECONOMIC BADS
A good is said to be an economic good (also known as a scarce good) if the quantity of the good
demanded exceeds the quantity supplied at a zero price. In other words, a good is an economic

DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


good if people want more of it than would be available if the good were available for free. A
good is said to be a free good if the quantity of the good supplied exceeds the quantity demanded at a zero price. In other words, a good is a free good if there is more than enough
available for everyone even when the good is free. Economists argue that there are relatively few, if any, free goods. There is an opportunity cost associated with consumption of an economic good, but there is no opportunity cost with consumption of a free good.
For example, if you take a drink of water from the Zambezi River, you are not denying some other
use of that water. There is enough to go around. But the doctor you see to treat you for an illness
from drinking polluted water is not free because the doctors time is no longer available to satisfy
the needs of another sick person. An item is said to be an economic bad if people are willing to pay
to avoid the item. Examples of economic bads include things like garbage, pollution, and illness.
ACTIVITY
DEFINE THE TERM ECONOMICS.
LIST AND EXPLAIN THE CATEGORIES OF FACTORS OF
PRODUCTION.
DISCUSS THE CONCEPT OF OPPORTUNITY COST.

1.8 ECONOMIC SYSTEMS


An economic system is an institutional arrangement of a countrys production system. In simple
terms think of an economic system as the way in which a country production and distribution
systems are organized. An economic system answers the central economic problem manifested in
questions such as:

Who is to produce - i.e. who owns the scarce resources? Is it the state or the private

individuals? This is the ownership question.

How to produce - i.e. the determination of the mix of resources that are to be used to

produce output. This is the production question.

What to produce - i.e. what mix of goods and services will be produced? This is the

product question.

For whom to produce? - i.e. who gets what? This is the distribution question. In a market

economy, this is determined by the interaction of buyers and sellers in both output and re

source markets.
1.9 TYPES OF ECONOMIC SYSTEMS
There are three main types of economic systems. These are market economy, command economy
and mixed economy.

DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


(A) MARKET ECONOMY
A market economy is a production system whereby private individuals own the factors of production: the land and capital. The role of the government in this system is very minor. A pure
market economy (a concept that is idealist) is when there is complete absence of government or
central planning. In a market economy, production and distribution activities are decentralised to
private individuals. Production is regulated by price and distribution is coordinated by the market
mechanisms. The incentive of individual behaviour is self-interest. Firms will produce goods if
they can make profit, whilst households will only buy if they benefit or gain satisfaction (utility).
Because of its features, a market economy is also called capitalism, lasses-faire (do it yourself)
or freehold economy. Examples of economies that practice capitalism include the USA and Japan.
(B) COMMAND ECONOMY
In a command economy, the factors of production (land and capital) belongs to the State. Under
this system, all decisions pertaining to what, how and for whom to produce are centralised by the
government. The central planning authority will, at its discretion, determine the type and quantity
of goods a country can produce and consume at each point in time. The role of the consumer is
very minor. Rationing and waiting lists are used to try and solve the problem of scarcity and shortages. The command economy is also called communism, centralization or collectivism. Examples
of economies that practiced communism include China and Cuba and former communist states are
Poland, Bulgaria, East Germany, Hungary, Yugoslavia, Czechoslovakia and the USSR (now Russia).
(C) MIXED ECONOMY
In a real situation, there are no pure market economies. There is no economy that can exist in
isolation to the government. The government has a duty to regulate the economy and correct
market failures such as providing public and merit goods, regulating monopoly activities and unfair
competition, regulating externalities (spillovers) and equitable distribution and redistribution of
wealth. An economic system that has features of both market and command economies is called
a mixed economy. A good example is the United Kingdom. Therefore, a mixed economy combines
the market mechanisms with government directives to determine economic outcomes. There are
certain services that do not work well in the market system such as defense, police and fire protection. These are commonly referred to as market failures and become part of the public sector.
1.10 PITFALLS TO AVOID IN ECONOMIC THINKING
The fallacy of composition occurs when one incorrectly attempts to generalise from a relationship
that is true for each individual, but is not true for the whole group. As an example of this, note that
any person can get a better view at a concert by standing (regardless of the actions of those in front
of him or her). It is incorrect, though, to state that everyone can get a better view if everyone stands.

DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


Similarly, one would commit the fallacy of composition if one were to claim that, since anyone could
increase his or her wealth by stealing from his or her neighbours (assuming there is no detection),
that everyone can become wealthier if everyone steals from their neighbours. The association as
causation fallacy, also known less technically as the post hoc, ergo propter hoc fallacy, occurs if
one incorrectly assumes that one event is the cause of another simply because it precedes the
other event. For example, a situation where unemployment increases just after the government
announces an increase in its budget expenditure and people start to consider unemployment as
resulting from an increase in government expenditure.
1.11 INTRODUCTION TO ENVIRONMENTAL AND RESOURCE ECONOMICS
I.11.1 RESOURCE TAXONOMY
For pedagogical purposes, we can categorise natural endowment of resources into three types:
(i) Natural resources
a). Resources that can be subdivided into smaller units. Example: barrels of oil, pounds of
fish, and cubic feet of wood.
b). To utilise these resources, one needs to employ other inputs, like labour, capita and energy.
c). They belong to one of the two types:
Exhaustible resources
Exhaustible resources have fixed stocks available, and the regeneration of stock is negligible.
As they are extracted, their stock starts depleting, and the cost of extraction may increase with
depletion of stock. The complete physical or economic depletion of stock is certain if extraction
continues; economic depletion is the depletion of stock to a level where further extraction is not
economically feasible. Examples are oil, metals, and coal.

Renewable resources
The stock of a renewable resource has a regeneration capability, and the rate of regeneration could
be a function of the current stock size (example: fish) or the age or the time allowed for growth
(example: tree). A renewable resource may become extinct if the rate of extraction continuously
exceeds the rate of regeneration.
(ii) Environmental resources
a). These resources are indivisible. Examples are ecosystem, ozone layer, and ambient air or water.
b). They are examined at the margin qualitatively but not in terms of quantity.
c). These resources are not consumed directly but the services they provide.
(iii) Resource flows
a). These resources do not exist as a stock; they are available as never-ending flows. Ex.

DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


Solar energy, wind power
b). There is no issue of exhaustion or regeneration.
c). Human consumption or action has no effect on stock or flow available in the future
Some resources can be classified in more than one group. For example, individual trees are renewable natural resources in the form of the timber they provide, but collectively, they are a part of
the forest ecological system and hence, an environmental resource.
1.12 WHAT IS ENVIRONMENTAL ECONOMICS?
Environmental economics is the subset of economics that is concerned with the efficient allocation
of environmental resources. The environment provides both a direct value as well as raw material
intended for economic activity, thus making the environment and the economy interdependent. For
that reason, the way in which the economy is managed has an impact on the environment which,
in turn, affects both welfare and the performance of the economy. One of the best known critics
of traditional economic thinking about the environment is Herman Daly. In his first book, SteadyState Economics, Daly suggested that enough is best, arguing that economic growth leads to
environmental degradation and inequalities in wealth. He asserted that the economy is a subset of
our environment, which is finite. Therefore his notion of a steady-state economy is one in which
there is an optimal level of population and economic activity which leads to sustainability. Daly
calls for a qualitative improvement in peoples lives development without perpetual growth.
Today, many of his ideas are associated with the concept of sustainable development.
By the late 1970s, the late economist Julian Simon began countering arguments against economic growth. His keystone work was The Ultimate Resource, published in 1981 and updated
in 1996 as The Ultimate Resource 2, in which he concludes there is no reason why welfare
should not continue to improve and that increasing population contributes to that improvement in the long run. His theory was that population growth and increased income puts pressure on resource supplies; this increases prices, which provides both opportunity and incentive for innovation; eventually the innovations are so successful that prices end up below what
they were before the resource shortages occurred. In Simons view, a key factor in economic
growth is the human capacity for creating new ideas and contributing to the knowledge base.
Therefore, the more people who can be trained to help solve arising problems, the faster obstacles are removed, and the greater the economic condition for current and future generations.
Environmental economics takes into consideration issues such as the conservation and valuation of
natural resources, pollution control, waste management and recycling, and the efficient creation of
emission standards. Economics is an important tool for making decisions about the use, conservation, and protection of natural resources because it provides information and the likely outcome of
environmental and other policies. Since resources whether human, natural, or monetary are
not infinite, these public policies are most effective when they achieve the maximum possible

DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


benefit in the most efficient way. Therefore, one job of policymakers is to understand how resources can be utilized most efficiently in order to accomplish the desired goals by weighing the
costs of various alternatives to their potential benefits.
In competitive markets, information exists about how much consumers value a particular good because we know how much they are willing to pay. When natural resources are involved in the production of that particular good, there may be other factors scarcity issues, the generation of pollution that are not included in its production cost. In these instances, scarcity issues or pollution
become externalities, costs that are external to the market price of the product. If these full costs
were included, the cost of the good may be higher than the value placed on it by the consumer.
A classic example of an externality is discussed in Garrett Hardins Tragedy of the Commons, which
occurs in connection to public commons or resources areas that are open and accessible to all,
such as the seas or the atmosphere. Hardin observed that individuals will use the commons more
than if they had to pay to use them, leading to overuse and possibly to increased degradation.
There are three general schools of thought associated with reducing or eliminating environmental externalities. Most welfare economists believe that the existence of externalities is sufficient
justification for government intervention, typically involving taxes and often referred to as Pigovian taxes after economist Arthur Pigou (1877-1959) who developed the concept of economic
externalities. Market economists tend to advocate the use of incentives to reduce environmental
externalities, rather than command-and control approaches, because incentives allow flexibility
in responding to problems rather than forcing a singular approach on all individuals. Free market economists focus on eliminating obstacles that prevent the market from functioning freely,
which they believe would lead to an optimal level of environmental protection and resource use.
The key objective of environmental economics is to identify those particular tools or policy alternatives that will move the market toward the most efficient allocation of natural resources.

DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


1.13 WHY STUDY NATURAL RESOURCE ECONOMICS AS A SEPARATE FIELD?
Primarily for four reasons:
(i)Natural resources often involve dynamic decisions
Time is an element in the decision. Microeconomics mostly talks about static decisions (this periods decision has no effect on the next years decision). But, when it comes to the extraction of oil from a fixed
stock or reserve in oil wells, a decision of how much to extract this year affects how much stock remains for
extraction in future years. Therefore, decisions are not time independent in natural resource economics.
(ii)Current decisions may have irreversible consequences
Excess harvesting may lead to extinction of fish species. Denudation of forests can permanently
damage the ecosystem.
(iii)Market failure is common in natural resource economics
In microeconomics there is emphasis on learning behavior of perfectly competitive markets; market
failure is covered as an exception to the rule of economic efficiency of perfect competition. But, in the
utilization of natural/environmental resources, one more generally observes market failure, which, therefore, needs to be learned more deeply. Examples are leeching of acids during mining activities and the
absence of market price and/or public good nature of certain resources which may be ignored by a market.
(iv)Natural resource economics requires multi disciplinary knowledge
When one thinks of utilization of fishery or timber forestry, it becomes necessary to integrate the
biological growth process of fish or trees into the economic model, for making efficient harvesting
decisions.
1.14 BROAD ISSUES OF DISCUSSION IN NATURAL RESOURCE ECONOMICS
(i) Resources are scarce; there is no argument. The primary focus of the course would be on learning models and principles of determining efficient rate of utilization of resources and on exploring
public policy alternatives to correct any market failures, especially in the context of current issues
related to natural resources.
(ii) Are resources getting more scarce over time? What is the evidence presented by economics
literature? We will learn about economists perspective and recommendations about the issue of
sustainability.

1.15 ECONOMICS APPROACH


How do economists look at resources? Some of you may disagree with the economics approach;
many ecologists disagree. The economics approach looks at a natural resource as an input

DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


or amenity or life-support mechanism which needs to be used to maimize the collective welfare of
the society of human beings. Therefore, this approach estimates benefits and costs of a resource
to humans and any beneficial or detrimental effect on other beings or species is accounted with
values estimated by humans. Hence, economics approach is completely human centered, anthropocentric. Economists recommend utilizing a resource if its marginal benefit exceeds marginal cost
and keep utilizing until the marginal benefit becomes equal to marginal cost, for attaining maximum
net benefit for the use of resource. On the other hand, ecologists and environmentalists at times
argue for the principle of minimum interference with nature and for preservation of a resource,
regardless of the cost of preservation and regardless of the importance of resource to people.
1.15 IMPORTANCE OF PRIVATE PROPERTY RIGHTS
Efficient functioning of a competitive market assumes the existence of a system of private property rights. Most market failures in the utilization of natural resources arise from the lack of a
well-functioning private property right system. Only when an owner has a well-defined private
property right, (s)he would have the incentive to make the most efficient use of the resource.
There are four main characteristics of an efficient property right system:
(i)
Universality

Resources are privately owned, and entitlements are completely specified.
(ii) Exclusivity

All benefits and costs accrued from owning and using a resource should accrue to the

owner and only to the owner, either directly or indirectly by sale to others.
(iii) Transferability

Property right should be transferable from one owner to another in a voluntary exchange.
(iv) Enforceability

Property right should be secure from involuntary seizure or encroachment by others.
Common property resources and/or open access resources lack universality characteristics. The
ecological benefits of a forest are not only accrued to the forest owner, but also to others; thus,
forests lack exclusivity characteristics.

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DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


1.15 SUMMARY

ACTIVITY
COMPARE AND CONTRAST MARKET ECONOMY AND
COMMAND ECONOMY.
GIVEN THE ANALYSIS PRESENTED IN THIS MODULE,
WHICH ECONOMIC SYSTEM WOULD YOU RECOMMEND FOR ZIMBABWE AND WHY?

1.16 BIBLIOGRAPHY

11

UNIT TWO

MARKET AND PRICE


MECHANISMS
2.0 INTRODUCTION

UNIT CONTENTS
Learning Outcomes

2.2 LEARNING OUTCOMES


By the end of this Unit, you should be able to:







Explain the functions of price,


Define demand,
Explain the law of demand,
Define and explain the law of supply,
Explain the conditions of demand and supply,
Explain how price is determined on a market,
Determine the impact of changes in conditions of the market on price, and
Discuss the effects of price controls.

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DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


2.3 MARKETS AND PRICES
All market participants attempt to satisfy specific goals. Every rational consumer tries to maximise
satisfaction. She cant afford everything, so choices (tradeoffs) must be made about how to spend
his scarce dollars. Every market transaction involves an exchange and thus some elements of both
supply and demand.
In a factor market, a factor of production is exchanged. Participants buy or sell land, labour, capital, or entrepreneurial skill that can be used in the production process.

Consumers are sellers in the factor market.

Businesses (and government) are buyers in the factor market.

Goods are produced from the product market.

Consumers are buyers in the product market.

Businesses (and government) are sellers in the product market.
2.4

ROLE OF PRICES IN THE MARKET

The scope of a market is the area over which a single price prevails. Price serves the following
functions, namely transmission of information, correctly influence incentives, and coordinating
economic activity between buyers and sellers
(a) Transmit Information - Information content of prices
An individuals dollar expenditure transmits very valuable information about his preferences. We
tell producers/suppliers what we like by what we spend money on and how much we spend. If we
want to see whether people like Lee or Levis jeans, we look at how much they spend. Spending
money transmits very valuable information to producers about what we like. Suppliers are able to
extract our desires through the price system. Prices are a measure of relative scarcity, they transmit very valuable information about the relative scarcity of a good.
(b) Prices correctly influence incentives
Market prices create an atmosphere of incentives that motivate people. Prices are the foundation
of the profit/loss system that creates a reward/penalty system of organisations. Market prices
for our labour service motivate us to study and prepare for years through education and training
to develop our human capital. If prices change, incentives change automatically and behaviour
changes are always correct. At a higher price, suppliers are willing to supply more of a good.
(c)
Prices coordinate economic activity between buyers and suppliers
Prices and profits guide the invisible hand of self-interest and maximise consumer satisfaction,
optimise production and maximise our standard of living. Prices are the basis of the self-correcting
mechanism of the free market by transmitting valuable, accurate information as part of the feedback loop of the market.

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DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


2.5 THE CONCEPT OF DEMAND
Demand can be defined as the willingness and ability to possess a good at given prices over
a given period of time, ceteris paribus (holding all other factors constant). Demand is not a
mere wish. Effective demand is demand backed by money (ability to pay a price). When economists talk of demand, they will be referring to planned demand and not realised demand.
Planned demand is what you are prepared to buy and realised demand is what you actually buy.
(a)Effective demand
Only when the consumers desire to buy something is backed up by willingness and an ability to pay for it do we speak of demand. To emphasize this point economists use the term effective demand. There are an unlimited number of human wants and needs - but in the
market-place these can only be bought / purchased if there is sufficient purchasing power.
(b)Latent demand
Latent demand exists when there is willingness to purchase a good or service, but where the consumer
lacks the real purchasing power to be able to afford the product. Latent demand is affected by persuasive advertising - where the producer is seeking to influence consumer tastes and preferences.
2.5.1 THE LAW OF DEMAND
The Law of Demand simply proposes that as the price of a good declines, the quantity you
would be willing and able to purchase during some period of time increases, given that everything else remains unchanged. Conversely, less of a good would be demanded as its price rises.
When we described the Law of Demand, we made a statement: given that everything else remains unchanged. This is referred to as the ceteris paribus assumption. This is not an assumption we make for convenience, but is a necessary condition for each law to hold. When we draw
a demand curve, we hold constant the many other variables that can affect it such as income.
2.5.2 DEMAND SCHEDULE
We can represent a single persons decision about how many kilograms of beef to purchase over a
month in a table called a demand schedule:

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DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


Table 2.1: Single Consumer Demand Schedule
Average Price
of Beef

Quantity
Demanded (kg) per month

$5
$4
$3
$2
$1

0
2
4
5
8

The demand schedule we presented above is for one individual consumer. But what we are really
interested in is the total demand for a particular good or service for all the consumers in an economy. This is called the market demand curve. To derive a market demand schedule we add up all the
individual demand schedules. If the demand schedule for each consumer conforms to the Law of
Demand, then the market demand schedule will also conform to the Law of Demand. For example,
lets assume we have a market that has only three consumers: Susan, Melissa, and Prince. We create
a market demand schedule by adding up the quantities demanded at each price by each consumer:

Table 2.2: Market Demand Schedule


Average
price
of beef
per kg

Quantity purchased by
Susan

Mellissa

Prince

Total (market
demabd)
per month

$5

$4

$3

$2

13

$1

17

The market demand schedule applies to a specific population and to a specific time period.

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DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


2.5.3 DEMAND CURVE
A demand curve is a graphic representation of the market demand schedule or the Law of Demand. The
demand curve represents the quantities of a good or service that consumers are willing and able to
purchase at various prices. By tradition, the demand curve is drawn with prices on the vertical or y-axis
and quantities demanded on the horizontal or x-axis. The demand curve slopes down to right based
on the Law of Demand. Using our market demand schedule for beef above, we can draw a demand
curve with price on the vertical axis (y-axis) and quantity demanded on the horizontal axis (x-axis).
Figure 2.1

Figure 2.1 above shows that when price decreases from $4 to $3 per kg quantity demanded will increase from 5kg to 9kg per month.
The Law of Demand implies the following with respect to a demand curve (all of these say exactly
the same thing):

The demand curve is downward sloping.

The demand curve has a negative slope.

The demand curve shows an inverse relationship between price and quantity demanded.
2.5.4 WHY A DEMAND CURVE SLOPES DOWNWARDS
There are two reasons why a demand curve is downward sloping:
The Income Effect: There is an income effect when the price of a good falls because the consumer
can maintain current consumption for less expenditure. Provided that the good is normal, some
of the resulting increase in real income is used by consumers to buy more of this product.
The Substitution Effect: There is also a substitution effect when the price of a good falls because

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DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


the product is now relatively cheaper than an alternative item and so some consumers switch their
spending from the good in competitive demand to this product.
Tutorial note: The demand curve is normally drawn in textbooks as a straight line suggesting a linear relationship between price and demand but in reality, the demand curve will be non-linear! No
business has a perfect idea of what the demand curve for a particular product looks like, they use
real-time evidence from markets to estimate the demand conditions and they accumulated experience of market conditions gives them an advantage in constructing demand-price relationships.
2.5.5 CHANGE IN DEMAND VERSUS CHANGE IN QUANTITY DEMANDED
A change in price will lead to a movement along a stable demand curve and result in a change in the
quantity demanded. For example, more of a good would be purchased, but only at a lower price.
The only thing that can change the quantity demanded is a change in the market price. If one of the
ceteris paribus assumptions is relaxed (e.g., a change in income) there will be a change in demand.
Economists use the term demand to refer to the entire demand curve. A change in demand is a
shift of the demand curve in response to a change in one of the variables assumed to be held constant under the ceteris paribus assumption (e.g., income), holding the goods price constant. Consequently, when we say there has been an increase in demand, we mean that the entire demand
curve has shifted to the right. A decrease in demand is explained by the leftward shift of the demand
curve. The figure 2.2 below shows how demand increases or decreases when income changes. As
income increases (holding the price of beef at $3 per kg) demand curve will shift to the right from
the original curve D0 to the new curve D2 the demand for beef increases to from the original 9 kg
to 13kg per month. Alternatively, a decline in income without changing the price of beef will result
in the demand curve to shift to the left (D1) and demand for beef will decline to 5kg per month.
Figure 2.2: Shift of Demand Curve

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2.5.6 CONDITIONS OF DEMAND
Apart from price, there are other factors of demand. Apart from the price, there are other factors
of demand. Conditions of demand include size of the market and consumer tastes, income, prices
of other related goods, weather and climatic conditions, government policy, international effects,
expectations, and availability of credit facilities.
1. Size of the Market and Consumer Tastes
If the number of consumers in the market increases, such as from population growth, there
should be a greater number of willing and able buyers at some given price. This implies that
market demand will increase and the market demand curve shifts to the right. A similar outcome results if there is a change in consumer tastes or desire for a particular product. If a
product like low-cut jeans becomes the latest fashion fad, demand at any given price will increase and the demand curve shifts to the right. On the other hand, if there is a decline in the
size of the market or a product becomes unfashionable or obsolete, then the demand curve
shifts to the left. Consumer tastes can be influenced by advertisement or consumer interdependence (social effect). For example, some consumers always want to conform to group behaviour (band wagon effect), which means their fashion and tastes are influenced by what majority will be consuming. The second group is those who always refrain from consuming what
the majority demands (snob effect). These people seek dignity and respect by being different.
2. Income: Normal Versus Inferior Goods
For normal goods, an increase in income means a consumer will purchase more of the good
at a particular price, which would cause the demand curve to shift to the right. But there are
inferior goods for which an increase in income leads to a decrease in demand. We may compare the effect of an increase in the quantity purchased for a premium brand ice cream with a
generic store-branded ice cream. As your income increases, you may begin to purchase more
premium ice cream and less of the lower quality generic store-branded ice cream. The premium ice cream is a normal good while the generic store-branded ice cream is an inferior good.
3. Prices of Related Goods: Complements versus Substitutes in Demand
The demand for one good can be affected by the price of another related good. For example,
consider demand for petrol. The demand for petrol not only depends on the price of petrol but
also on the demand for or price of cars that use petrol. As the price of cars increases quantity
less card will be demanded and less petrol will a be demanded as well. This is an example of
complements in demand (joint demand). Of course, not all products complement each other.
Some products may compete with each other like butter and margarine. As the price of butter
increases, some people will reduce their purchases of butter and switch to margarine instead. As
the price of butter increases, the demand for margarine will increase and the demand curve for
margarine will shift to the right. This is an example of substitutes in demand (competing demand).

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Table 2.3: Changes in the Price of Related Goods
Nature of goods

Change in Price
of Good B

Change in Demand
for Good A

Example

Complements

Increase

Decrease (shift
left)

beef and rice

Increase (shift
right)

Beef and chicken

Substitutes

Increase

4. Weather and Climatic Conditions


Demand for certain products can be influenced by weather. For example, demand for products
such as ice creams is high in summer, whilst demand for items such as jackets or jerseys will be
high during the winter season.
5. Government Policy
Government legislature can promote or penalize the demand for a product. This is called forced demand. For example, the demand for certain drugs decreases as soon the government announces
their consumption illegal.
6. Expectations
If individuals expect an increase in price, they are likely to buy more of a product today. The
opposite is true if price is expected to decline in the near future.
7. Availability of credit facilities
Demand for most durable goods increases with attractive terms of credit and low interest rates.
2.5.7 EXCEPTIONS TO THE LAW OF DEMAND
The demand for a product does not always vary inversely with the price. There are two possible
reasons why more might be demanded even when the price of a good or service is increasing.
We consider these briefly ostentatious consumption and the effects of speculative demand.
(a) Ostentatious consumption
Some goods are luxurious items where satisfaction comes from knowing both the price of the good
and being able to flaunt consumption of it to other people! The demand for the product is a direct
function of its price. A higher price may also be regarded as a reflection of product quality

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and some consumers are prepared to pay this for the snob value effect. Examples
might include perfumes, designer clothes, and top of the range cars. Consider the case
of VI which is considered to be the most exclusive perfume in the world. Goods of ostentatious consumption are known as Veblen Goods and they have a high-income elasticity of demand. That is, demand rises more than proportionately to an increase in income.
(b) Speculative Demand
The demand for a product can also be affected by speculative demand. Here, potential buyers are interested not just in the satisfaction they may get from consuming the product, but
also the potential rise in market price leading to a capital gain or profit. When prices are rising, speculative demand may grow, adding to the upward pressure on prices. The speculative
demand for housing and for shares might come into this category and we have also seen, in
the last few years, strong speculative demand for many of the worlds essential commodities.

ACTIVITY
LIST AND EXPLAIN THE FUNCTION OF PRICE IN A
MARKET ECONOMY.
EXPLAIN THE DIFFERENCE BETWEEN A CHANGE IN
QUANTITY DEMANDED AND A CHANGE IN DEMAND.

2.6 THE CONCEPT OF SUPPLY


Supply can be defined as the willingness and ability of firms to sell a product at given prices over
a given period of time, ceteris paribus.
2.7 THE LAW OF SUPPLY
Just as consumers are influenced by prices, so are firms, but in the opposite direction. Consumers like low product prices, firms like high product prices. When product prices rise, firms have an
incentive to employ additional scarce resources to increase production. The Law of Supply states
that firms will produce and offer for sale greater quantities of a good or service, the higher the
market price, given that everything else remains unchanged. The theory behind the Law of Supply
rests on the principle of increasing opportunity costs. When we produce something, we use the
most efficient resources first. As we increase production, we must draw on less-efficient resources,
which lead to increasing opportunity costs. We will not increase production and incur those higher
opportunity costs unless we can sell our product at a higher price.

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2.7.1 SUPPLY SCHEDULE
We can create individual firm supply schedules and a market supply schedule just as we did for demand. The market supply schedules for beef may look something like the scenario in Table 2.4 below.
Table 2.4: Market Supply Schedule for Beef
Qantity supplied
(kg per month)

Average Price
of beef
$5

16

$4

13

$3

$2

$1

2.7.2 SUPPLY CURVE


The supply curve is a graphic representation of the market supply schedule and the Law of Supply.
The supply curve represents the quantities of a good or service that firms are willing to produce
and sell at various prices. The supply curve slopes upwards to right based on the Law of Supply. As
the price of a good increase relative to price of all other goods, firms switch resources and production from other goods, increasing the quantity supplied. This is illustrated by in figure 2.3 below.
Figure 2.3

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The Law of Supply ceteris paribus (everything else unchanged) assumption means the following
do not change:

Prices of inputs to the production process (labour, raw materials, cost of capital).

Technology.

The prices of other products from the same resources or production process.
This does not mean these factors cannot change. The importance of a change in each of these
variables will hopefully become clearer later.
2.7.3 CHANGE IN SUPPLY VERSUS CHANGE IN QUANTITY SUPPLIED
Just like on the demand side, we have introduced two different ways that the production quantity
of a good can change. Again, we must highlight the specific language we have used to distinguish
between the two:







First, we said that according to the Law of Supply that a change in price will lead to a
movement along a stable supply curve and result in a change in the quantity supplied. For
example, more will be produced for sale, but only at a higher price.
Second, we said that if one of the ceteris paribus assumptions is violated or relaxed
(e.g., a change in technology) there will be a change in supply. Economists use the term
supply to refer to the entire supply curve. Consequently, when we say there has been
an increase in supply, we mean that the entire supply curve has shifted to the right. More
will now be produced at the same price.

Figure 2.4 Shifts of the Supply Curve

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2.7.4 CONDITIONS OF SUPPLY
Conditions of supply are non-price factors of supply. Conditions of supply include cost of production and changes in technology and prices of other products from the same production process.
1. Cost of production and changes in technology
Costs of production relate to the costs of the human and non-human inputs to the production process. An increase in the costs of inputs,, such as raw materials, energy, or labour, will shift the supply curve to the left. For example, as the price of fertilizer goes up,
some farmers will find it no longer economical and viable to grow wheat. At some given price
less wheat will be produced. Costs of production can also decline, such as from the benefits of technological innovation. With improvements in technology and lower production
costs, the supply curve will shift to the right. At some given price, more will be produced.
2. Prices of Other Products from the Same Production Process
Many production processes yield more than one product from the same inputs. For example, crude
oil is refined into propane, petrol, diesel, heating oil, and other related products. These are by products of the same production process and are referred to as complements in production. If the price
of just one of the by products changes this affects the profitability of the entire production process
and the economics of producing all of the byproducts is affected. When the price of petrol increases,
oil refiners have an incentive to increase their crude oil refinery processing rates to produce more.
This also yields increases in the output of all the other by products. An increase in the market price
of petrol leads to an increase in supply (shift of the supply curve to the right) of the propane, diesel
fuel, and heating oil products. Substitutes in production, on the other hand, are goods that are produced as alternatives to each other using the same inputs to the production process. For example,
wheat and rye grains are substitutes in production where either is grown on the same field. If the
price of rye grain increases, farmers have incentive to switch from growing wheat to growing rye. As
the price of rye increases, the supply curve for its substitute in production, wheat, shifts to the left.
Table 2.5: Changes in the Price of Related Goods
Nature of the goods

Change in price of
Good B

Complements

Increase

Increase
(shift right)

Beeef and leather

Substitutes

Increase

Decrease
(shift left)

Rye and
wheat grains

23

Change in supply of
Good A

Example

DIPLOMA IN ENVIRONMENTAL HEALTH, SAFETY AND MANAGEMENT


ACTIVITY
DEFINE THE TERM SUPPLY.
EXPLAIN THE DIFFERENCE BETWEEN A CHANGE IN
QUANTITY SUPPLIED AND A CHANGE IN SUPPLIED

2.8 MARKET PRICE DETERMINATION AND DEMAND-SUPPLY EQUILIBRIUM


When we combine a demand curve and supply curve on the same graph we create a model of demand
and supply equilibrium. The model helps explain how prices and quantities are determined in a market.
2.8.1 MARKET EQUILIBRIUM
A market is in equilibrium when the quantity demanded is equal to quantity supplied at the market price. When a market is in equilibrium, there is no tendency for price or quantity to change.
The market equilibrium for beef can be identified in our market demand and supply schedules.

Table 2.6 Market Demand and Supply Schedules for beef


Average price of
beef

Quantity
demanded

Quantity
supplied

Explanation

$5

17

Excess supply

$4

13

Excess supply

$3

Equilibrium

$2

13

Excess demand

$1

17

Excess demand

A more convenient depiction of market equilibrium is where the demand and supply
curves intersect. When a market price is below or above the equilibrium level, there will be
an imbalance (disequilibria) between the quantity demanded and the quantity supplied.

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2.8.2 EQUILIBRIUM PRICE


Equilibrium price is the price at which the quantity demanded is equal to the quantity supplied. Other
things being unchanged, there is no tendency for this price to change. How can you tell if the market is not in equilibrium? The easiest way for the firm to tell is by monitoring its inventory. When the
quantity supplied is not equal to the quantity demanded at the current market price there is either
undesired inventory build or undesired inventory decline. Store shelves start overflowing because
the firm is producing more than is being sold or the store shelves go bare because people are buying the product faster than the firm can supply. What process occurs to bring the market back into
equilibrium? Simple, the market price adjusts. When the quantity supplied by firms is greater than
the quantity demanded by consumers there is more being produced than is being consumed. Unsold production starts to accumulate. Firms respond by cutting prices to stimulate demand. Lower
prices also mean that firms will begin to produce less. The quantity demanded increases and the
quantity supplied declines until the desired level of inventory is attained and equilibrium is restored.
When the quantity supplied is less than the quantity demanded, the opposite happens. Inventories decline below the desired level. This is a sign for firms to raise prices. With higher prices,
the quantity demanded declines and firms are motivated by the higher prices to produce more,
which returns the market to equilibrium. The market attains equilibrium as if led by an invisible
hand. It requires no leadership or direction from a central planner (such as a government) or a
dominant firm. But markets are not always free to function efficiently. We assume the market is
perfectly competitive in that there is not a single firm (monopolist) or very small number of firms
(oligopolists) that have the power to set market prices. Similarly, we assume there is not a single
consumer (monopsonist) with market-setting power. And finally, we assume there is no government intervention.

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2.9 MARKET FAILURES
Markets do not always perform in a desired manner. Market failure means that the best attainable
outcome has not been achieved. In this unit, we look at those areas in which a free market may give
rise to various types of inefficiency. When markets do not provide us with the best outcome in terms
of efficiency and fairness, then we say that there exists market failure. This unit introduces you to
some of the main causes of market failure; we will explore them in more detail in succeeding units.
What is market failure?
Market failure occurs whenever freely-functioning markets operating without government intervention, fail to deliver an efficient allocation of resources and the result is a loss of economic and social
welfare. Market failure exists when the competitive outcome of markets is not satisfactory from
the point of view of society. This is usually because the benefits that the free-market confers on
individuals or businesses carrying out an activity diverge from the benefits to society as a whole.
Market failure and economic efficiency
When markets function well we experience an efficient and fair (equitable) allocation of resources.
Market failure results in:
Productive inefficiency: Businesses are not maximising output from given factor inputs.

This is a problem because the lost output from inefficient production could have been

used to satisfy more wants and needs. Costs are higher and productivity is lower than it

might have been.
Allocative inefficiency: Resources are misallocated and the economy is producing

goods and services that are not wanted or not valued by consumers. This is a problem

because resources might be put to a better use making products that we value more

highly.
A.1 ECONOMIC AND TECHNICAL EFFICIENCY
Technical efficiency is said to occur when an economy operates on the production possibilities
curve. In this case, there are no unemployed and no underemployed resources. Economic efficiency is a more general concept that occurs when any change that benefits someone results in loss for
someone else. Note that technical efficiency is a necessary condition for economic efficiency since
a movement toward the production possibilities curve benefits one or more individuals.
A.2 IMPERFECT INFORMATION
The effect of imperfect information on economic efficiency cannot be underestimated. Buyers or
sellers may not gain from voluntary trade if they do not know the quality of the product being
bought or sold. Everyone has made at least one purchase that they regretted later. Government
may correct this type of market failure by:

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requiring that product labels list ingredients,


requiring guarantees for some products (such as the lemon law for used cars),
banning fraudulent claims and requiring truth in advertising,
licensing workers in certain professions, and
By providing public information about products.

ACTIVITY
GIVE A CONCRETE EXAMPLE OF EACH OF THE LISTED
CORRECTIVE MEASURES TAKEN BY THE ZIMBABWEAN
GOVERNMENT TO REMEDY MARKET FAILURE.

2.10 PUBLIC GOODS


A public good is a good that is non-rival in consumption. This means that one persons consumption does not reduce the quantity or quality of the good available to other consumers. Examples
of public goods include national defense and television and radio signals broadcast through the
airwaves. Some public goods have some congestion costs in which the benefits do decline a
bit as the number of people consuming them rises. Town parks, highways, police and fire protection, and other similar commodities and services fit this definition. The problem with public
goods is that no individual has an incentive to pay for the good. Since it is inefficient, and not
always feasible, to exclude people from consuming a public good, people can consume it even
if they do not pay for it at all. In such a situation, each person has an incentive to be a free
rider and to let others pay for the good. The problem, of course, is that the good will be either
under produced or not produced at all if the provision of such goods were left to the market.
A government attempts to correct this type of market failure by either providing or subsidizing the
production of public goods.
2.11 THE ABSENCE OF PROPERTY RIGHTS
A related problem occurs when no one has private property rights to a good. This problem occurs in the case of common property resources in which no individual has private property rights.
When everyone shares ownership of some resource, each individual receives all of the benefits
from using the resource, but the costs are shared by everyone. Consider, for example, the case
of buffalo, fisheries, and similar resources. In each case, the hunter, or fisherman receives property rights only after catching and killing the animal. Each person gets the full benefit from their
activity, but the cost of a reduced breeding stock is shared by everyone. If you are an individual
fishing in an endangered fishery, you have no incentive to reduce your individual harvest of fish

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because you know that if you do not catch an additional fish, someone else might. In such a situation,
the resource is over utilised. Governments deal with this problem by setting restrictions on consumption or by introducing property rights when feasible. This tragedy of the commons (as it is also known)
explains why public parks and highways often have more litter than most individuals back yards, why
bathrooms and common rooms in dormitories are messier than those in private houses and apartments, and why many species of animals have been hunted to extinction or threatened with extinction.
2.12 MONOPOLY
When monopolies are present, prices will tend to be higher and output lower than would occur
under competitive market conditions. Government may respond to this problem through antitrust enforcement, by regulating the monopoly, or by public production of the good or service.
2.14 MACROECONOMIC INSTABILITY
The business cycle results in periodic stages of recession in which unemployment rates rise. This
results in a state of economic inefficiency that the government may attempt to remedy by implementing policies designed to ameliorate the business cycle. (This is a topic discussed in much more
detail in macroeconomics units that follow).
2.15 PUBLIC CHOICE THEORY OF GOVERNMENT
The public choice theory of government suggests that self-interested individuals, who are likely to
work for their own interests, rather than public interest, make government policy. Advocates of
the public choice theory argue that special interest groups will engage in rent-seeking behaviour
that is designed to increase their wealth at the expense of society as a whole. Many expenditures
on lobbyists and political contributions do not result in increases in output and may result in economic inefficiency if the lobbyists are successful in redistributing income to the groups that they
represent.
2.16 MICROECONOMIC AND MACROECONOMIC POLICY
The government engages in both microeconomic and macroeconomic policy to achieve its set
objectives. Microeconomic policy involves policies designed to correct for imperfect information,
externalities, public goods, the absence of property rights, and monopolies. Macroeconomic policy
is policy designed to enhance macroeconomic stability and encourage economic growth. Macroeconomic policy involves the use of fiscal and monetary policies. Fiscal policy involves changing government spending, taxes, and transfer payments. (Transfer payments are payments
made to individuals for which no good or service is provided in return. This category of spending includes unemployment compensation, social security payments, and welfare spending.)

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2.17 SUMMARY

ACTIVITY
IN EACH CASE, IDENTIFY THE NATURE OF THE MARKET FAILURE
- WHY ARE THESE PROBLEMS ARISING?
IDENTIFY POTENTIAL MEASURES THE GOVERNMENT MIGHT USE
TO INTERVENE IN THE MARKET TO CORRECT THE PERCEIVED
FAILURE. THERE MAY NEED TO BE A VARIETY OF SOLUTIONS
USED, EACH OF WHICH CONTRIBUTES IN SOME WAY TO THE SOLUTION.
REFER TO THE INFORMATION ON RENT SEEKING AND LOGROLLING IN THE PRESENTATION. WHAT RELEVANCE HAVE
THESE CONCEPTS GOT TO THE PROBLEMS IDENTIFIED? WHO
MIGHT THE SPECIAL INTEREST GROUPS BE WHO MIGHT SEEK
TO GAIN BENEFITS AT THE EXPENSE OF OTHERS?
HOW MIGHT THE GOVERNMENT MEASURE THE EFFECT OF THE
INTERVENTION STRATEGIES YOU HAVE IDENTIFIED IN QUESTION 2 ABOVE? WHAT PROBLEMS MIGHT THEY FACE IN GAINING AN ACCURATE MEASURE OF SUCH EFFECTS?
CHOOSE ONE OF THE PROBLEMS YOU HAVE INVESTIGATED AND
PRODUCE A 750-WORD REPORT SUMMARISING THE PROBLEM,
THE SOLUTIONS AND THE LIKELY OUTCOMES OF THE SOLUTIONS ON CORRECTING THE MARKET FAILURE.

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2.18 BIBLIOGRAPHY

30

UNIT THREE

EXTERNALITIES
3.0 INTRODUCTION

UNIT CONTENTS
Learning Outcomes

3.2 LEARNING OUTCOMES


By the end of this Unit, you should be able to:

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3.3 DEFINITION
Externalities are unintentional side effects of an activity affecting people other than those directly involved in the activity. A negative externality is one that creates side effects that could
be harmful to either the general public directly or through the environment. An example would
be a factory that pollutes as a result of its production process. This pollution may pose health
risks for nearby residents or degrade the quality of the air or water. Either way, the owner of
the factory does not directly pay the additional cost to address any health issues or to help
maintain the cleanliness of the air or water. In some cases, however, the harmed parties can
use legal measures to receive compensation for damages. A positive externality, on the other
hand, is an unpaid benefit that extends beyond those directly initiating the activity. One example would be a neighborhood resident who creates a private garden, the aesthetic beauty
of which benefits other people in the community. Also, when a group voluntarily chooses to
create a benefit, such as a community park, others may benefit without contributing to the project. Any individuals or groups that gain additional benefits without contributing are known as
free riders. Traditionally, both negative and positive externalities are considered to be forms
of market failure - when a free market does not allocate resources efficiently. Arthur Pigou, a
British economist best known for his work in welfare economics, argued that the existence of
externalities justified government intervention through legislation or regulation. Pigou supported
taxes to discourage activities that created harmful effects and subsidies for those creating benefits to further encourage those activities. These are now known as Pigovian taxes and subsidies.
Many economists believe that placing Pigovian taxes on pollution is a much more efficient way
of dealing with pollution as an externality than government imposed regulatory standards. Taxes
leave the decision of how to deal with pollution to individual sources by assessing a fee or tax on
the amount of pollution that is generated. Therefore, in theory, a source that is looking to maximize its profit will reduce, or control, their pollution emissions whenever it is cheaper to do so.
Other economists believe that the most efficient solution to externalities is to include them in
the cost for those engaged in the activity. Thus, the externality is internalized. Under this
framework externalities are not necessarily market failures, which weaken the case for government intervention. Many externalities (pollution, free rider benefits) can be internalized through the creation of well defined property rights. Through much of his work, economist Ronald Coase showed that taxes and subsidies were typically not necessary as long as
the parties involved could strike a voluntary bargain. According to Coases theorem, it does
not matter who has ownership, so long as property rights exist and free trade is possible.
Two methods of controlling negative externalities loosely related to property rights include cap
and trade and individual transferable quotas (ITQs). The cap and trade approach sets a maximum
amount of emissions for a group of sources over a specific time period. The various sources are
then given emissions allowances which can be traded, bought or sold, or banked for future use,
but - over the course of the specified period of time - overall emissions will not exceed the

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amount of the cap and may even decline. Therefore, individual sources, or facilities, can determine
their level of production and/or the application of pollution reduction technologies or the purchase
of additional allowances. Individual transferable quotas are a market-based solution that is often
used to manage fisheries. Regulators first determine a total annual catch that will preserve the
health of the ecosystem, and then it is divided into individual quotas to prevent over-fishing. Each
ITQ allows for a certain amount of fish to be caught in any given year. ITQs are transferable,
which allows fishing vessel owners to buy and sell their quotas depending on how much they
want to catch. The ITQ program also tries to create a commercial fishing industry that is more
stable and profitable. The options for dealing with externalities - positive or negative - are numerous, and often depend on the type of externality. The key is to identify the particular tool or
policy alternative that will best move the market toward the most efficient allocation of resources.

Whatever solution or combination of solutions are used to help reduce the problem of negative
externalities, the main aim is to try to internalise the externality - what we mean by this is that
the decision maker takes into consideration the impact of his or her decisions on a third party.

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ACTIVITY
EXPLAIN HOW THE REFERENCE TO REPEAT OFFENDERS
IN THE NEWS STORY HIGHLIGHTS THE ISSUE OF MARKET FAILURE.
(8 MARKS)
DISCUSS THE DEGREE OF SUCCESS EXPERIENCED BY
THE ENVIRONMENT AGENCY IN DEALING WITH CASES
OF ENVIRONMENTAL DAMAGE. CITE AT LEAST TWO CASE
STUDY EXAMPLES TO ILLUSTRATE THE POINTS YOU ARE
MAKING IN YOUR ANSWER. (12 MARKS)
3.4 THE LAW OF DIMINISHING RETURNS
The law of diminishing returns is one of the best-known principles outside the field of economics.
It was first developed in 1767 by the French economist Turgot in relation to agricultural production,
but it is most often associated with Thomas Malthus and David Ricardo. They believed that human
population would eventually outpace the production of food since land was an integral factor in limited supply. In order to increase production to feed the population, farmers would have to use less
fertile land and/or increase production intensity on land currently under production. In both cases,
there would be diminishing returns. The law of diminishing returns which is related to the concept
of marginal return or marginal benefit states that if one factor of production is increased while the
others remain constant, the marginal benefits will decline and, after a certain point, overall production will also decline. While initially there may be an increase in production as more of the variable
factor is used, eventually it will suffer diminishing returns as more and more of the variable factor is
applied to the same level of fixed factors, increasing the costs in order to get the same output. Diminishing returns reflect the point in which the marginal benefit begins to decline for a given production process. For example, the table below sets the following conditions on a farm producing corn:
Number of Workers Corn Produced Marginal Benefit

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It is with three workers that the farm production is most efficient because the marginal benefit
is at its highest. Beyond this point, the farm begins to experience diminishing returns and, at
the level of 6 workers, the farm actually begins to see decreasing returns as production levels decline, even though costs continue to increase. In this example, the number of workers
changed, while the land used, seeds planted, water consumed, and any other inputs remained
the same. If more than one input were to change, the production results would vary and the
law of diminishing returns may not apply if all of the inputs could be increased. If this case were
to lead to increased production at lower average costs, economies of scale would be realized.
The concept of diminishing returns is as important for individuals and society as it is for businesses
because it can have far-reaching effects on a wide variety of things, including the environment. This
principle although first thought to apply only to agriculture is now widely accepted as an economic law that underlies all productive endeavors, including resource use and the cleanup of pollution.
The theory was effectively applied by Garrett Hardin in his 1968 article on the tragedy of the
commons in which he looked at many common property resources, such as air, water, and forests, and described their use as being subject to diminishing returns. It is in this case that individuals acting in their own self-interest may overuse a resource because they do not take
into consideration the impact it will have on a larger, societal scale. It can also be expanded
to include limitations on our common resources. The services that fixed natural resources are
able to provide for example, in acting as natural filtration systems will begin to diminish as
contaminants and pollutants in the environment continue to increase. It is externalities such as
these that can lead to the depletion of our resources and/or create other environmental problems.
However, the point at which diminishing returns can be illustrated is often very difficult to pinpoint
because it varies with improved production techniques and other factors. In agriculture, for example, the debate about adequate supply remains unclear due to the uneven distribution of population
and agricultural production around the globe and improvement in agricultural technology over time.
The challenge whether it be local, regional, national, or global is how best to manage the problem of declining resource-to-people ratios that could lead to a reduced standard of living. Widely
used solutions for internalizing potential externalities include taxes, subsidies, and quotas. Often,
there are attempts to find bigger picture solutions that focus on what many see as the primary
causes, namely population growth and resource scarcity. Reducing population growth, along with
increased technological innovation, may slow the growth in resource use and possibly offset the
impact of diminishing returns. These potential benefits are a key reason why population growth and
technological innovation are most often used in analyzing sustainable development possibilities.
3.5 CARRYING CAPACITY
Changes in population can have a variety of economic, ecological, and social implications. One
population issue is that of carrying capacity the number of individuals an ecosystem can support

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without having any negative effects. It also includes a limit of resources and pollution levels that
can be maintained without experiencing high levels of change. If carrying capacity is exceeded,
living organisms must adapt to new levels of consumption or find alternative resources. Carrying capacity can be affected by the size of the human population, consumption of resources, and
the level of pollution and environmental degradation that results. Carrying capacity, however,
need not be fixed and can be expanded through good management and the development of new
resource-saving technologies. The relationship between carrying capacity and population growth
has long been controversial. One of the original arguments appeared in 1798 by English economist
Thomas Malthus who stated that continued population growth would cause over-consumption of
resources. Malthus further argued that population was likely to grow at an exponential rate while
food supplies would increase at an arithmetic rate, not keeping up with the exponential population
growth. Malthus believed that an ever increasing population would continually strain societys ability to provide for itself and, as a result, mankind would be doomed to forever live in poverty.
Over a century later, American economist Julian Simon countered Malthus arguments, asserting
that an increase in population would improve the environment rather than degrade it. He believed
human intellect to be the most valuable renewable natural resource that would continue to find
innovative solutions to any problems that might arise environmental, economical, or otherwise.
Simon was also one of the founders of free market environmentalism, finding that a free market,
together with appropriate property rights, was the best tool in order to preserve both the health
and sustainability of the environment.
Throughout the late 1960s and 1970s, the controversy over the effect that an increasing population has on the Earths limited resources reemerged. Garrett Hardin and Paul Ehrlich, both
authors on overpopulation, believed that human population had already exceeded the carrying capacity. Hardin is best known for his paper The Tragedy of the Commons, in which he
argues that overpopulation of any species will deplete shared natural resources. Ehrlich, who
wrote The Population Bomb in 1968, predicted a population explosion accompanied by increasing famine and starvation. Although his prediction did not come true in fact, in 1970
there was a slight decline in the population growth rate he was correct in pointing out that,
with the exception of solar energy, the Earth is a closed system with limited natural resources.
The standard of living in a region can help to alter an areas carrying capacity. Areas with a higher
standard of living tend to have a reduced carrying capacity compared to areas with a lower standard of living due to the access to and demand for more resources. Nevertheless, the environmental Kuznets Curve an observed phenomenon suggests that beyond some point, increased
income and environmental improvement often goes hand-in-hand. While population growth rates
have stabilized and, in fact, are declining in many developed nations, consumption of resources
and the generation of pollution and waste continue to grow. The effect this has on an ecosystem
is called an ecological footprint, which can be used to measure and manage the use of resources
throughout an economy. It is also widely used as an indicator of environmental sustainability.

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Carrying capacity often serves as the basis for sustainable development policies that attempt to
balance the needs of today against the resources that will be needed in the future. The 1995 World
Summit on Social Development defined sustainability as the framework to achieve a higher quality
of life for all people in which economic development, social development, and environmental protection are interdependent and mutually beneficial components. The 2002 World Summit furthered
the process by identifying three key objectives of sustainable development: eradicating poverty,
protecting natural resources, and changing unsustainable production and consumption patterns.
While the exact value of the human carrying capacity is uncertain and continues to be under debate,
there has been evidence of the strain that both overpopulation and over-consumption has placed on
some societies and the environment. Economists, ecologists, and policy analysts continue to study global
consumption patterns to determine what the human carrying capacity is and what steps can be taken
to ensure it is not exceeded. In the meantime, actions to reduce the strain and ensure natural resource
recovery for the future will depend on an increase of sustainable development policies worldwide.
3.6 SUMAARY

ACTIVITY
CONSIDER THE SOLUTIONS TO THE PROBLEM OF
MARKET FAILURE IN THIS CONTEXT AND EXAMINE THE
CASE FOR AND AGAINST EACH MEASURE. SUPPORT YOUR
ANSWER WITH APPROPRIATE EXAMPLES. (30 MARKS)

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3.7 BIBLIOGRAPHY

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UNIT FOUR
SUSTAINABLE DEVELOPMENT
4.0 INTRODUCTION

UNIT CONTENTS
Learning Outcomes

4.2 LEARNING OUTCOMES


By the end of this Unit, you should be able to:

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4.3 DEFINITION OF SUSTAINABLE DEVELOPMENT
Over the past few decades, many definitions of sustainable development have been suggested
and debated, resulting in a concept that has become broad and somewhat vague. In recognition
of the need for a clearer understanding of sustainable development, the United Nations World
Commission on Environment and Development commissioned a study on the subject by what is
now known as the Brundtland Commission. The resulting report, Our Common Future (1987),
defined sustainable development as development that meets the needs of the present without
compromising the ability of future generations to meet their own needs, which has become the
accepted standard definition. The report also identified three components to sustainable development: economic growth, environmental protection, and social equity, and suggested that all
three can be achieved by gradually changing the ways in which we develop and use technologies.
Although sustainable development is a widely accepted goal by many governmental and non-governmental agencies, concerns about what it means in practice have often been raised. One point of contention is over the role of economic development in fostering sustainable development. Some argue
that economic growth is the best way to help developing countries conserve their natural resources,
while others argue that any economic growth is unsustainable because we already consume too much.
The United Nations attempted to reconcile these views in 1992 by convening the first Earth Summit in
Rio de Janeiro. It was here that the international community first agreed on a comprehensive strategy to address development and environmental challenges through a global partnership. The framework for this partnership was Agenda 21, which covered the key aspects of sustainability economic
development, environmental protection, social justice, and democratic and effective governance.
The second Earth Summit, held in Johannesburg in 2002, was an attempt by the UN to review the
progress of the expectations raised in Rio and to reaffirm the commitment of world leaders in continuing to pursue actions towards sustainable development. The Report of the World Summit on Sustainable Development outlined the challenges to, and commitments of, the international community in
attaining these goals. The summit leaders also developed a plan of implementation, which included
means of eradicating poverty, changing unsustainable patterns of consumption, and protecting biodiversity and natural resources. Since sustainable development goes well beyond economic issues,
linking the economy, environment, and society, no comprehensive economic theory related to sustainable development exists. However, progress toward sustainable development is often measured
by a variety of indicators, which can be used at the local, regional, national or international level.
The primary components are economic performance, social equity, environmental measures, and
institutional capacity. Examples of indicators within each component are located in the box to the
left. Within the economic performance component, the indicators selected under economic structure are well-known and commonly used measures at the national and international levels. They
reflect important issues of economic performance, trade, and financial status. Consumption and
production patterns are also represented within the economic performance component, providing

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additional coverage of material consumption, energy use, waste generation and management, and transportation. For many nations, the ability of the economy to meet basic needs
allows them to focus more on environmental issues. Historically, the general public is not willing to place a high priority on protecting the environment when there is concern about achieving a certain level of welfare or economic goals. For example, when the economy was doing
well in the United States in the late 1980s, there was an increased awareness about the environment. However, as the economic conditions began to decline in the early 1990s, people
became more concerned about their own well-being and less concerned with the environment
The study of economics has always emphasized the relative scarcity of resources, whether they
are natural, capital, or human, thereby placing constraints on what we can have and affecting
the choices and decisions made by individuals or by society. Sustainable development encompasses the view that a healthy environment is essential to support a thriving economy. Therefore,
decisions should be made taking into account both the present and future value of our resources in order to achieve continued economic development without a decline of the environment.

4.4 NET PRESENT VALUE


Economists focus much of their analyses on a marketplace where supply and demand are based
on the perceptions of present value and scarcity. However, when going beyond the simplicity of the
short-term, particularly when costs and benefits occur at different points in time, it is important to
utilize discounting to undertake longer-term analyses. Discounting adjusts costs and benefits to
a common point in time. This approach can be useful in helping to determine how best to utilize
many of our non-renewable natural resources. Net present value (NPV) is a calculation used to
estimate the value or net benefit over the lifetime of a particular project, often longer-term

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investments, such as building a new town hall or installing energy efficient appliances. NPV allows
decision makers to compare various alternatives on a similar time scale by converting all options
to current dollar figures. A project is deemed acceptable if the net present value is positive over
the expected lifetime of the project.
The formula for NPV requires knowing the likely amount of time (t, usually in years) that cash will
be invested in the project, the total length of time of the project (N, in the same unit of time as
t), the interest rate (i), and the cash flow at that specific point in time (cash inflow cash outflow,
C).

For example, take a business that is considering changing their lighting from traditional incandescent bulbs to fluorescents. The initial investment to change the lights themselves would be
$40,000. After the initial investment, it is expected to cost $2,000 to operate the lighting system
but will also yield $15,000 in savings each year; thus, there is a yearly cash flow of $13,000 every
year after the initial investment. For simplicity, assume a discount rate of 10% and an assumption
that the lighting system will be utilized over a 5 year time period. This scenario would have the
following NPV calculations:
t = 0 NPV = (-40,000)/(1 + .10) 0 = -40,000.00
t = 1 NPV = (13,000)/(1.10) 1 = 11,818.18
t = 2 NPV = (13,000)/(1.10) 2 = 10,743.80
t = 3 NPV = (13,000)/(1.10) 3 = 9,767.09
t = 4 NPV = (13,000)/(1.10) 4 = 8,879.17
t = 5 NPV = (13,000)/(1.10) 5 = 8,071.98
Based on the information above, the total net present value over the lifetime of the project would
be $9,280.22.
Once the net present value is calculated, various alternatives can be compared and/or choices can
be made. Any proposal with a NPV < 0 should be dismissed because it means that a project will
likely lose money or not create enough benefit. The clear choice is a project whose NPV > 0 or,
if there are several alternatives with positive NPVs, the choice would be the alternative with the
higher NPV. With most societal choices, the opportunity costs are also considered when making
decisions. Net present value provides one way to minimize foregone opportunities and identify the
best possible options.
This particular example assumes that the interest rate does not change over time. Longer periods of time will often require separate calculations for each year in order to adjust for anticipated
changes in the interest rate. When discounting is used it takes into account the fact that benefits
in the future are not expected to be worth as much as in the present time. For example, $10 today
may only be worth $9, $5, or even $1 in 2025. The rationale behind using a discount rate is twofold: all things being equal, (1) individuals prefer to benefit now rather than later and (2) they tend
to be risk averse, uncertain of what will occur in the future.

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Net present value calculations can also help account for depreciation. Over time most assets depreciate, or lose value. Companies or individuals must be able to calculate a rate that includes depreciation for account balancing and tax purposes, as well to help predict replacement times for the asset
in question. NPV and depreciation calculations are extremely valuable in the world of economics;
they tell us what projects and businesses are better investments and what outcomes we may expect
in the future. However, while depreciation rates can be reliably estimated for most physical items,
such as computer equipment or buildings, their application to natural resources and other environmental issues is more uncertain. Natural resources do not necessarily lose value over time. Thus, in
most cases natural resources should not be depreciated when calculating resource NPVs. Also, since
there is uncertainty about the future and external effects exist, it is much easier to predict what a
company can do and what the reaction will be in the structured world of business than to accurately
assess, say, the value of a forest to a local economy in future years. Despite how helpful calculating
NPV can be, using it to assess projects related to the environment will continue to be controversial.
Ecosystem valuation is a complex process that does not always result in the assignment of accurate
values to natural resources. And, while the use of discounting may make sense for money being
not as valuable in the future as it is today it may be more difficult to use in assessing natural resources. Since many natural resources often increase in value, this type of evaluation method would
need to recognize increased future resource values and/or that of other environmental services.
4.5 ECOSYSTEM VALUATION
Valuation can be a useful tool that aids in evaluating different options that a natural resource manager might face. Because our ecological resources and services are so varied in their composition,
it is often difficult to examine them on the same level. However, after they are assigned a value, an
environmental resource or service can then be compared to any other item with a respective value.
Ecosystem valuation is the process by which policymakers assign a value monetary or otherwise
to environmental resources or to the outputs and/or services provided by those resources. For
example, a mountain forest may provide environmental services by preventing downstream flooding. Environmental resources and/or services are particularly hard to quantify due to their intangible
benefits and multiple value options. It is almost impossible to attach a specific value to some of the
experiences we have in nature, such as viewing a beautiful sunset. Problems also exist when a resource can be used for multiple purposes, such as a tree the wood is valued differently if it is used
for flood control versus if it is used for building a house. The quantity of a resource must also be
taken into consideration because value can change depending how much of a resource is available.
An example of this might be in preventing the first unit of pollution if we have a pristine air environment. Preventing the first unit of pollution is not valued very highly because the environment can
easily recover. However, if the pollution continues until the air is becoming toxic to its surroundings;
the value of preserving clean air by preventing additional pollution is going to be increasingly valued.
Within economics, value is generally defined as the amount of alternate goods a person is willing to
give up in order to get one additional unit of the good in question. An individuals preference for

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certain goods may either be stated or revealed. In the case of stated preferences, the amount
of money a person is willing to pay for a good determines the value because that money could
otherwise be used to purchase other goods. However, value may also be determined by simply
ranking the alternatives according to the amount of benefit each will produce. Revealed preferences can be measured by examining a persons behavior when it is not possible to use market
pricing. There are typically two ways to assign value to environmental resources and services
use and non-use and there are approaches to measuring environmental benefits based on these
defined values. When environmental resources or services are being used, it is easier to observe
the price consumers are willing to pay for the conservation or preservation of those resources.
Market or opportunity cost pricing can be used when there are tangible products to measure, such
as the amount of fish caught in a lake. Replacement cost can also be used, calculated based on
any expenses incurred to reverse environmental damage. Hedonic pricing will measure the effect
that negative environmental qualities have on the price of related market goods. When evaluating non-use value, contingent valuation is employed through the use of surveys that attempt to
assess an individuals willingness to pay for a resource that they do not consume. A cost-benefit
analysis requires the quantification of possible impacts of a proposed project. The impacts could
be physical or monetary, but both must be calculated and included since a financial analysis that
requires assigning dollar values to every resource evaluated is also performed. The process of
environmental resource or service valuation provides a way to compare alternative proposals, but
it is not without problems. All valuation techniques encompass a great deal of uncertainty: flaws
can exist in the methods of assigning value accurately due to a wide number of variables and it is
difficult to compartmentalize and measure environmental and natural resources and/or services
within an ecosystem that functions as an interconnected web.
In summary, ecosystem valuation is a complex process by which economists attempt to assign a
value to natural resources or to the ecological outputs and/or services provided by those resources. Although challenging, it allows policymakers to make decisions based on specific comparisons,
typically monetary, rather than some other arbitrary basis. In recent years, the government has
placed increasing emphasis on cost-effective laws and projects. Therefore, establishing a common
measure by which to evaluate alternatives is essential.
4.6 TRADE-OFFS
As we make everyday choices how much time to spend working or studying, what to spend our
money on we are experiencing what in economics are called trade-offs and opportunity costs. A
trade-off is when we choose one option in favor of another and the opportunity cost is what is sacrificed in order to get something. Whether we realize it or not, we are constantly evaluating the costs
and benefits of each decision we make; therefore, it can also be said that we are performing our
own cost-benefit analysis each time we make a choice. As decisions are made either individually or
as a society we constantly make trade-offs in order to get more of one thing by giving up another.
The saying time is money illustrates this point. If we consume more free time, we are left with

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less money due to the fact that we are not earning money from using the time to work. The opposite is
true as well; if we want more money, we must put in more work hours to get it; therefore there is less
free time available. When we consider time and money, and graph the combinations for where one
has no preference of one over the other, we come up with an indifference curve, such as the one below.

On the graph, X is the point where we have an even balance of time and money; yet an indifference curve is such that one is equally satisfied at any point along the curve. Therefore, we
could move to point A, where we would have a lot more time but less money, or we could move
to point B, with a lot more money but less time, and we would be equally satisfied. The slope of
the indifference curve is based on the marginal utility of each decision; each successive move towards an axis comes at a higher price. For example, at point B we require more money for each
unit of time than we do at point X because our time is more valuable since we have less of it.
Therefore, we will begin to experience diminishing marginal utility. The economy and the environment are inextricably linked. Whether one is looking at daily life or natural resources and other
environmental issues, because resources are scarce, choices have to be made about how to use
them. The basic fact is that resources used to meet one choice or alternative cannot be used to
meet another. Just like how we value regular goods, the valuation of natural resources and the
environment is based on how we value their services and, for services that are consumed directly,
that value is based on our utility and willingness to pay for a certain amount of the services.
The decision about how to allocate resources relating to the environment has an impact on all
sectors of our economy, primarily because of the complex relationship between utilizing natural
resources and economic output. Many times, the cost of utilizing these resources and/or services
include direct costs as well as opportunity costs and external costs, which are not traded in markets or assessed directly in monetary terms. For example, when trees are cut for such uses as
housing and furniture, some of the direct costs will include the cost of machinery and labor during cutting, processing, and manufacturing. The opportunity costs relating to this use would be
the opportunities foregone by the machinery and labor that could not be used elsewhere, since it
was occupied cutting trees. The external costs are the loss of environmental benefits that are no
longer realized which may include a loss in watershed management services, species protection,
and CO2 reduction. Many agree that in most cases the market is the best way to determine the
allocation of resources. The demand for various products and the availability of natural resources
along with a number of other factors, including preferences, the number of buyers and sellers,

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pricing, alternative choices, etc is expected to lead to an efficient result of actual supply and demand. However, markets can fail to account for the full cost of a natural resource and/or services,
which will prevent it from achieving an efficient allocation of the resource, leading to externalities.
To reduce the potential for market failures and their resulting externalities, planners and
policymakers attempt to identify a course of action that generates the greatest societal benefits. Much of this is done by using a mix of policy and strategies, including regulation, taxes, permits, access restrictions, etc. It is finding the appropriate balance between
utilizing our natural resources and meeting the demands of society that will allow us to continue to expand our economy while sustaining our natural resources and the environment.
4.7 MARGINAL COSTS AND BENEFITS
Marginal costs and benefits are essential information for economists, businesses, and consumers. Even if we do not realize it, we all make decisions based on our marginal evaluations of the
alternatives. In other words, what does it cost to produce one more unit? or what will be the
benefit of acquiring one more unit? When necessary, individual and social marginal cost and benefit curves can be drawn separately in order to understand different effects that a given action or
policy might have. In the case of pollution, the social cost is generally higher than the individual
cost due to externalities. However, as a whole, an economic system is considered efficient at the
point where marginal benefit and marginal cost intersect, or are equal. Similar to the production
of goods and services, we can utilize the same information in order to analyze pollution abatement
in terms of the production or reduction of pollution within the market. In order to assess environmental improvement, we must take cost into consideration. The cost of these improvements
is often thought of as the direct cost of any action taken in order to improve the environment.
Marginal cost measures the change in cost over the change in quantity. For example, if a company
is producing 10 units at $100 total cost, and steps up production to 11 units at $120 total cost,
the marginal cost is $20 since only the last unit of production is measured in order to calculate
marginal cost. Mathematically speaking, it is the derivative of the total cost. Marginal cost is an
important measurement because it accounts for increasing or decreasing costs of production,
which allows a company to evaluate how much they actually pay to produce one more unit.
Marginal cost will normally initially decrease through a short range, but increase as more is produced. Therefore the marginal cost curve is typically thought of as upward sloping. The marginal cost curve can represent a wide range of activities that can reduce the effects of environmental externalities, like pollution. The key point is that most environmental improvements are
not free; resources must be expended in order for improvement to occur. For example, take
an environment that has been polluted while the initial unit of cleanup may be cheap, it becomes more and more expensive as additional cleanup is done. If cleanup is undertaken to point
Q, the total cost of the cleanup is P*Q the white and light gray areas on the graph below.

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Marginal benefit is similar to marginal cost in that it is a measurement of the change in benefits over the change in quantity. While marginal cost is measured on the producers end, marginal benefit is looked at from the consumers perspective in this sense it can be thought of as
the demand curve for environmental improvement. The marginal benefit curve represents the
tradeoff between environmental improvement and other things we could do with the resources
needed to gain the improvement. Again take an environment that has been polluted, the first
unit of this pollution that is cleaned up has a very high benefit value to consumers of the environment. Each additional unit that is cleaned up is valued at a somewhat lower level than
each previous one because the overall pollution level continues to decrease. Once the pollution is reduced below a certain point, the marginal benefit of additional pollution control measures will be negligible because the environment itself is able to absorb a low level of pollution.

Taking a look at the graph above, the total consumer benefit that is represented as the dark grey
area, the net benefit is greatest when the quantity Q reaches the marginal benefit curve. We
could increase total benefit by adding pollution controls beyond Q, but only with marginal costs
(MC) greater than marginal benefits (MB), so it is no longer efficient to further increase the benefits. Oftentimes, benefits are more difficult to measure because they are not always monetary.
In cases such as these the measurement may involve utilizing revealed preferences, through a
survey or another mechanism, in order to discover the maximum price consumers are willing to
pay for a particular quantity of a good. An average benefit is used when considering society as a
whole because each individuals willingness to pay is different. Marginal costs and benefits are a
vital part of economics because they help to provide the relevant measurement of costs and benefits at a certain level of production and consumption. If measured marginal costs and benefits are
provided, it is much easier to calculate the ideal price and quantity. It is where the two intersect
that will always be the most economically efficient point of production and consumption. When
considering environmental issues, the efficient point at which marginal costs and marginal benefits
are equal is an important economic concept because it captures the essence of tradeoffs. Often,
environmental improvement Concerns often revolve around whether we are above or below this
point whether any additional environmental improvement can provide more benefit than it will
cost; this becomes an essential component in cost-benefit analysis.

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4.8 COST BENEFIT ANALYSIS
Cost-benefit analysis (CBA) is an analytical way for society to make decisions about complicated
issues such as education, health care, transportation, or the environment. Like most personal
decisions, it involves a comparison of the costs of an action compared with considerations of
the benefits of that action. However, for public policy it is formalized and quantitative. For instance, a public policy can be evaluated by calculating and weighing the benefits against the
costs, once all factors have been given a common unit of measurement. When policymakers
have to choose among various alternatives, they require a tool that will allow them to distinguish between the options. Decision makers can then choose the policy with the largest surplus,
or overall net benefits. In recent years, for example, the U.S. government is increasingly seeking more cost-effective policies in order to balance the budgets. While the overall concept of
CBA is simple, the steps taken to evaluate each benefit and cost can become quite complicated.
The most important component of a CBA is the base situation or what would happen if no
changes were made. All other decisions are compared to this base situation. The first step is to
identify the relevant time period: when would the costs and benefits be realized? Once the base
and relevant time period are established, benefits and costs can be calculated in terms of human well being. In this case, a benefit is defined as anything that increases human well-being,
and a cost is anything that decreases it. These definitions and their respective calculations tend
to provoke controversy due to the use of valuation and discounting, which involves applying a
mathematical formula to determine the present value of future benefits and costs. For example,
a dollar today will not be worth the same amount in 50 years, its value will have decreased due
to inflation. Also, todays dollar could be put to other uses (foregone opportunities) which can decrease its net future value in the chosen use. Discounting takes the values of costs and benefits
in the future and discounts them by the value of the foregone opportunities, or makes them
smaller, to account for their inevitable change in value. Measuring the benefits of a policy can
involve anything from additional income, to an increased quality of life, or even to a cleaner environment; costs may consist of forgone opportunities, internal and external costs, and externalities.
However, in measuring costs, it is important not to confuse externalities with secondary effects:
externalities result in real output changes whereas secondary effects do not. An example of this
would be electricity generation the externality would be pollution while the secondary effect would
be the increased cost of doing business when the price of electricity rises. The pollution actually
generates new costs, such as the need to scrub sulfur dioxide from smokestacks. The increased
business costs are simply a reflection of the fluctuation in the price of electricity which is already
calculated as a cost. In order to avoid double-counting, only true externalities can be included
in a CBA. After all benefits and costs have been given a common unit of measurement, options
can be evaluated. The ideal situation will result in Pareto improvement: some are made better-off
while no one is made less well off. But, since the ideal outcome is rare, CBA is based on a potential Pareto improvement and economic efficiency. A potential Pareto improvement is where the

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possibility exists for compensation to those who are less well off, whether or not it actually happens.
A final result of a CBA should be where marginal benefits and marginal costs of a proposed
project are equal. In the graph below, this is at point Q. The surplus is illustrated by the shaded
area in the graph. At the equilibrium, the surplus is greatest, making it the best possible solution. If the quantity were to increase to point 1, the marginal costs would exceed the marginal benefits, meaning it would not economically efficient. If the quantity were to decrease to
point -1, some of the surplus would be lost, which would also indicate inefficiency. CBA aims to
achieve point Q, where marginal benefit and marginal cost are equal in order to maximize economic efficiency. The uncertainty of these forecasts can create a fundamental problem when policymakers rely entirely on CBA to make a decision. Critics argue that cost-benefits analysis does
not include equity considerations. Ecological valuation and discounting are other controversial
aspects of CBA because there are many different values that certain natural resources could assume, and the discount rate chosen will have significant implications for the resulting analysis

4.9 REGULATORY POLICY VS ECONOMIC INCENTIVES

Command-and-control is comforting to politicians and people: governments know what they are
asking for, people know what they are getting, companies know what they are supposed to deliver;
the only people who do not like it are economists.
~ The Economist, September 2, 1989

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Environmental regulation in the United States has traditionally relied on command-and-control
policies in which regulators typically the government set standards or limits and apply them
uniformly to a broad category of sources. There are three types of command-and-control mechanisms that regulators can choose to implement: ambient, emissions, or technology standards.
An ambient standard sets the amount of a pollutant that can be present within a specific environment. An example of this would be when a regulator sets a limit on ground level ozone [parts per
million or ppm] allowable within a citys limits. This is also an example of an indirect regulation
because although emissions from individual sources are being restricted, the ambient level is what
the standard is attempting to control. Emissions standards are much more common as they seek
to limit the amount of emissions released by a firm, industry, or area. It differs from an ambient
standard because its use does not determine the ambient level of a pollutant in the environment;
rather, it attempts to reduce the overall amount of a pollutant released on a firm-by-firm basis.
Finally, regulators can choose to implement a technology-based standard which would force polluters to use a particular pollution control technology that they deem reasonably cost-effective, such
as installing scrubbers on smokestacks. It is believed by many that the primary advantage of using
command-and control mechanisms is that they provide a clear outcome. It is also comparatively
simple to monitor compliance since regulators only have to make sure that the standard has been
met. Therefore, it is possible that an emissions reduction goal can be reached; if not, the violators will pay a fine. However, command-and-control mechanisms have several drawbacks. One
key element is information uncertainty. It is not only very costly for regulators to gather necessary
information; they often have to collect it from the sources that they are regulating, creating the
possibility for inaccurate or dishonest reporting. Another significant concern is that polluters have
very little choice about how to meet the standard since some standards are strictly dictated by the
regulators. Therefore, there is no incentive for the sources to research new and creative ways to
further reduce their own pollution emissions. However, in the case of emission standards, sources
are often able to decide how they can best meet the standard. Finally, since command-and-control
mechanisms are uniformly applied across broad categories of sources, it is unlikely that it can be
the most cost-effective way to decrease pollution levels or emissions. Because the marginal costs
for limiting pollution will vary among the sources, it also essentially guarantees that equity will
not be achieved. Under this scenario, polluters are not charged for the marginal cost of pollution
that they continue to emit; only for the pollution they abate, which is economically inefficient.
Economic incentives which have been debated by economists for decades have only recently
begun to play a larger role in both national and international environmental policy. As regulators
seek to meet increasingly costly environmental quality goals, they have begun to look at incentives
as a more flexible, lower cost alternative. It is expected that the regulatory system can be made
more effective by promoting environmentally efficient choices with less government interference.
Incentive-based policies aim to encourage polluters to find innovative, low-cost ways to reduce
their environmental emissions by offering rewards or by doling out punishments in the form of
taxes or fees, marketable permits, or liability.

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Taxes or fees charge the polluter a certain amount per unit of pollution, the value of which
is determined by the regulator. Marketable permits allow companies to pollute at a level that
is marginally cost-effective. It allows them to buy additional permits as needed if they fail to
meet their targets internally, and to sell excess permits if they exceed their internal pollution
reduction targets. Liability involves establishing a precautionary level that allows for the greatest benefit to society, and holding firms to that standard if a problem arises. While more flexible
than true established standards, it puts the burden on the firm to take certain levels of precaution with respect to environmental issues or to be held accountable for any negative results.
Incentives have several advantages, including allowing the source to play a role in determining the most
cost-effective way to reduce their emissions and, thereby, in meeting their marginal costs. All three
types of incentives attempt to maintain the equi-marginal principle, or when the marginal control
costs are equal across all sources. This creates an efficient or least cost overall solution. Also, when
compared to command and control mechanisms, the regulator requires less information under an incentive program since there is greater motivation for polluters to devise their own innovative solutions.
Therefore, the regulator does not need to know how cost-effective various control options will be,
or what the cost is at any particular installation, because the source will be held accountable for all
of their actions and will pay both pollution control costs and damage costs. Although many may be
in favor of using economic instruments when it comes to taxes the affected sources are often in
opposition. These affected groups begin to perceive economic policy instruments as imposing higher
costs than command-and-control regulations. Taxes also present political obstacles since no industry
likes to see increased taxes, and politicians do not want to lose support by passing legislation that
includes more taxes. Of additional concern is the view of added complexity as regulators attempt to
address pollution issues across diverse areas and/or industries. However, pollution taxes are sometimes desired by companies if they are applied to all since the equal taxation is viewed to be fair.
In the case of environmental policy, politicians are primarily concerned that something be done and
less interested in the specific choice or design of the policies. Oftentimes, economic incentives have
to be approved by a political system where the bargaining processes become important, and the
issues to be sorted out between officials, experts, and the affected parties become more technical
and legal in nature. However, while command-and-control regulation is still common, more and more
legislation is beginning to use market mechanisms, or a combination of command-and-control along
with market mechanisms, in order to best meet the demands of the environmental issues at hand.

4.10 SUMAARY

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4.10 BIBLIUOGRAPHY

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UNIT FIVE
ENVIRONMENTAL
VALUATION: PRINCIPLES,
TECHNIQUES AND APPLICATIONS
5.0 INTRODUCTION
From scenic beauty and recreational opportunities to direct inputs into the production process, environmental resources provide a complex set of values to individuals and benefits to society. Coastal
areas, for example, offer scenic panoramas and radiant sunsets. Fish and other edible sea life caught
in coastal areas provide a rich and nutritious source of food to consumers. Beaches are also excellent
recreation areas, used for relaxation, exercise, or bird watching. These are only the direct benefits.
There are also values that are not directly tied to use, such as climate modulation, physical protection,
and stewardship for future generations. All of these benefits are relevant in environmental valuation.

UNIT CONTENTS
Learning Outcomes

5.2 LEARNING OUTCOMES


By the end of this Unit, you should be able to:

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Figure 1: Environmental valuation topics covered on this Web page.

5.3 ENVIRONMENTAL VALUES


Use values, such as fishing and hiking, are the more direct and quantifiable category of environmental
values, but they capture only a portion of the total economic value of an environmental asset. Indirect-use
values, non-use values, and intrinsic values are also associated with preserving environmental resources.
Total economic value is represented by the following equation:
Total economic value = direct-use value + indirect-use value + non-use value + intrinsic value
Indirect-use values associated with coastal areas include biological support, physical protection,
climate modulation and global life support. Non-use values are less direct, less tangible benefits to
society and include option and existence values.
The option value is the value an individual places on the potential future use of the resource, for example, benefits a beach would offer during future trips to the coastal area. Existence values include bequest, stewardship, and benevolence motives. Bequest value is the
satisfaction gained through the ability to endow a natural resource on future generations.
The stewardship motive is derived from an altruistic sense of responsibility toward the preservation
of the environment and a desire to reduce environmental degradation. The benevolence motive
reflects the desire to conserve an environmental resource for potential use by others. Finally, the
intrinsic value of nature reflects the belief that all living organisms are valuable regardless of the
monetary value placed on them by society. Table 1 presents a typology of environmental values.

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Table 1. Categories of Environmental Values (adapted from Spurgeon 1998)
________________________________________
(a) Direct-use values: goods and services directly consumed by users
- Products (e.g., edible, ornamental, medicinal, inputs into production process)
- Recreation
- Waste assimilation
- Research
- Education
(b) Indirect-use values: indirect benefits arising from ecological systems
-Biological support links to other species and habitats
-Physical protection coastal defense function
-Climate regulation
-Global life support functions that aid in supporting life on Earth
(c) Non-use values
-Option value
-Existence value
Bequest motive
Stewardship motive
Benevolence motive
(d) Intrinsic value: organisms have a worth of their own regardless of usefulness to humans
________________________________________

It is important to note that there are certain environmental assets that are absolutely essential
to the support of animal life, and that the total value of these assets is not definable. Marginal
changes, however, in the productivity and security of even irreplaceable environmental assets
(e.g., the degradation of part of a large ecosystem or environmental resources essential to human
life) can be captured in terms of total economic value. For example, the total economic value of
air and water quality are immeasurably large because extreme degradation of either would result
in irreversible and catastrophic damage to the capacity of this planet to support human and other
life. However, we can observe the finite value that society places on small losses of even those
assets that are absolutely essential for sustaining life. For instance, society has proven willing to
accept some degradation of air quality to improve the efficiency and convenience of transportation. In this particular example, individual choices are not a good indicator of the value of air
quality since most of the costs of reduced air quality are externalized or passed on to others.
5.4 METHODS FOR VALUING THE ENVIRONMENT
Environmental valuation is largely based on the assumption that individuals are willing to pay for
environmental gains and, conversely, are willing to accept compensation for some environmental

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losses. The individual demonstrates preferences, which, in turn, place values on environmental
resources. That society values environmental resources is certain; monetizing the value placed on
changes in environmental assets such as coastal areas and water quality is far more complex. Environmental economists have developed a number of market and non-market-based techniques to
value the environment. Figure 2 presents some of these techniques and classifies them according to
the basis of the monetary valuation, either market-based, surrogate market, or non-market-based.

Figure 2: Environmental Valuation Methods


Market-Based Methods. Economists generally prefer to rely on direct, observable market interactions to place monetary values on goods and services. Markets enable economists to measure an
individuals willingness to pay to acquire or preserve environmental services. In turn, consumers
reveal their preferences through the choices they make in allocating scarce resources among
competing alternatives. There are a number of market-based methods of environmental valuation.
This article identifies and discusses three market-based techniques: a) factor of production approach, b) change in producer/consumer surplus, and c) examination of defensive expenditures.
The value of a natural resource can be monetized based on its value as a factor of production. An
Economic View of the Environment notes that the output of any firm is a function of several important
inputs (e.g., land, capital, natural resources), which are collectively known as factors of production.
In their role as factors of production, raw materials and environmental inputs are used in the production of other goods. When a natural resource has direct value as a factor of production and the
impact of environmental degradation on future output of that resource can be accurately measured,
the resultant monetary value of the decline in production or higher cost of production can be measured. For example, a decline in water quality could have a direct and detrimental impact on the productivity and health of shellfish beds. This technique is methodologically straightforward; however,
it is limited to those resources that are used in the production process of goods and services sold in
markets. Because many goods and services produced by the environment are not sold in markets,
the factor of production method generally fails to capture the total value of the resource to society.
The standard method used to measure the net economic benefit of a good or service
market involves an examination of consumer and producer surplus. As noted in An
nomic View of the Environment, consumer surplus is the difference between what each
tomer is willing to pay and the price of the good or service and is represented by the

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Ecocusarea

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falling above the price line and below the demand curve. Consumer surplus in Figure 3 is represented by Area abc. Producer surplus is the difference between what a producer is paid for a good
or service and what it costs to supply, and is represented by Area bcd. The total economic benefit
of a sale is the sum of the consumer and producer surplus.

Figure 3: Producer and consumer surplus for striped bass.


Measuring the producer surplus often involves the use of complicated econometric (economic
statistical) techniques. As noted in Lipton and others (1995), however, the careful measurement of
a small number of variables sometimes can be used to estimate the impact of an action on producer
surplus. This study presents a hypothetical scenario in which habitat degradation leads to reduced
catches of striped bass in Chesapeake Bay. In this example, the catch falls from 8,000 to 5,000 pounds
per day. The before-after portrait of the producer surplus in this scenario is presented in Table 2.

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Table 2. Impact of Habitat Degradation on Producer Surplus
________________________________________
Before
Catch rate per day (pounds) = 8,000
Ex-vessel price1 = $0.70 / pound
Variable cost per pound = $0.40
Total days fished in season = 16
Total revenue = 16 * 8,000 * $0.70 = $89,600
Total variable cost = 16 * $0.40 * 8,000 = $51,200
Producer surplus, therefore, equals $89,600 - $51,200 = $38,400.
After
Catch rate per day = 5,000
Ex-vessel price = $0.70 / pound
Variable costs per pound = $0.50
Total days fished in season = 16
Total revenue = 16 * 5,000 * $0.70 = $56,000
Total variable cost = 16 x $0.50 * 5,000 = $40,000
Producer surplus after the habitat degradation is $56,000 - $40,000 = $16,000

________________________________________

Table 2 shows that the decline in habitat has reduced the daily catch by 3,000 pounds. In turn,
commercial fishermen are expending more resources (fuel, labor) per pound of fish caught. That
is, as the fish population declines, variable costs rise because more effort is required to land the
same catch. Finally, this analysis holds the price-per-pound constant, although the basic principles
of supply and demand suggest that prices would likely increase as the supply of fish declines. In
reality, the ex-vessel price would likely rise in response to the declining catch rate as consumers
bid up the price for the dwindling supply of striped bass (a discussion on consumer surplus follows). Based on this analysis, the producer surplus resulting from the commercial fishing of striped
bass has declined by $22,400 ($38,400 - $16,000) as a result of habitat degradation.
Producer surplus is only half the total economic picture. To capture the entire economic impact
of the decline in the striped bass catch, the analyst must also measure the change in consumer
surplus. When measuring consumer surplus, a demand curve must be constructed to quantify the
area of Figure 2 represented by Area abc. Measuring the consumer surplus, however, generally involves the use of econometric techniques and requires time series information on the market price
of the good or service and the quantity consumed at each price level, along with other factors
affecting the demand for the product. Provided all of this information is available, the analyst can
construct a product demand curve to measure the expansion or contraction of consumer surplus
in response to changing environmental conditions and corresponding shifts in the quantity

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supplied and price. A final market-based valuation method is that of defensive expenditures, which
are made on the part of industry and the public either to prevent or counteract the adverse effects of
pollution (Feather 1995) or other environmental stressors. The defensive expenditures method, also
known as the averting behavior approach, monetizes an environmental externality by measuring the
resources expended to avoid its negative impacts on a surrounding community. Types of defensive
expenditures include water purification devices, beach nourishment, and replanting seagrasses.
Surrogate Market Methods. In the absence of clearly defined markets, the value of environmental
resources can be derived from information acquired through surrogate markets. The most common
markets used as surrogates when monetizing environmental resources are those for property and
labor. The surrogate market methods discussed below are the hedonic price method and the travel
cost method, with a brief look at the use of random utility models for environmental valuation.
The hedonic price method of environmental valuation uses surrogate markets for placing a value on
environmental quality. The real estate market is the most commonly used surrogate in hedonic pricing
of environmental values. Air, water, and noise pollution have a direct impact on property values. By
comparing properties with otherwise similar characteristics or by examining the price of a property over
time as environmental conditions change and correcting for all non-environmental factors, information
in the housing market can be used to estimate peoples willingness to pay for environmental quality.
The travel cost method is employed to measure the value of a recreational site by surveying travelers on the economic costs they incur (e.g., time and out-of-pocket travel expenses) when visiting
the site from some distance away. These expenditures are considered an indicator of societys
willingness to pay for access to the recreational benefits provided by the site.
To better understand the travel cost method, consider the case of coastal pollution resulting in closure of a recreational beach. To estimate the associated lost value of recreational benefits, the first
step of a travel cost analysis would be to survey individuals about the number of trips and expenses
incurred during each trip to the beach. The second step is to examine the relationship between the
expense incurred and the total number of trips taken (Table 3). Thus, the travel cost method enables
the analyst to develop an implicit demand curve for the recreational benefits offered by the site
per person, which can then be multiplied by the number of people in each cost category (generally
judged by estimating costs associated with various distances from the site). In turn, the demand
curve can be used to measure consumer surplus and monetize the direct, use value of the site.

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TABLE 3: TRIP EXPENSE AND NUMBER OF TRIPS TO A RECREATION BEACH
Trip Expense
Number of Trips
<$20
100
$20-$40

45
$40-$60
32
$60-$80
17
$80-$100
9
>$100
4

The travel cost method can be used to measure not only the elimination of a site but also the impact of access restrictions and changes in environmental quality. The travel cost method, however,
is limited in application and captures only direct recreational benefits and only when there are
measurable travel costs to examine. Finally, the travel cost method does not measure non-use and
intrinsic values or other sources of value, such as commercial values. Random utility models (RUMs)
are econometric models that, among other uses, permit the estimation of preferences among different recreational areas with varying characteristics. The RUM, with its ability to assess competing
multiple sites with varying recreational characteristics, holds considerable appeal for economists.
Consider three beaches with characteristics that vary based on location, water quality, landscape features, access, existence of lavatories, and other services. These characteristics can be transformed into discrete and continuous variables used to assess consumer preference by examining location preference and the total cost of trips taken (Table 4).
Based on the data collected through surveys of various sites, the RUM estimates the probability that an individual will visit one site out of several sites based on site characteristics. Varying the quality of those characteristics (e.g., water quality, landscape features) permits the analyst to assess how recreational travelers value changes in environmental quality at particular
sites. A RUM is not specific to surrogate market techniques. Rather, a RUM is an estimation
procedure that can be combined with surrogate and non-market techniques used in valuing, for
example, recreational areas and wetland area restoration. Travel cost studies often use RUMs;
however, they may also be applied in stated preference studies that use choice experiments.

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Table 4: Expenditures per Trip and Number of Trips Taken (Adapted from Lipton 1995)
Individual

Travel Costs /

Site I

Site II

Number of Trips

Travel Costs

$20

$40

Number of trips

Travel Costs

$52

$26

Number of trips

Travel Costs

$30

$30

Number of trips

Site III

$50
2
$15
2
$45
1

Non-Market Methods. The Contingent Valuation Method (CVM) is a non-market-based technique that elicits information concerning environmental preferences from individuals through
the use of surveys, questionnaires, and interviews. When deploying the contingent valuation
method, the examiner constructs a scenario or hypothetical market involving an improvement
or decline in environmental quality. The scenario is then posed to a random sample of the population to estimate their willingness to pay (e.g., through local property taxes or utility fees)
for the improvement or their willingness to accept monetary compensation for the decline in
environmental quality. The questionnaire may take the form of a simple open-ended question
(e.g., how much would you be willing to pay) or may involve a bidding process (e.g., would
you accept $10, would you accept $20) or take-it-or-leave-it propositions. Based on survey
responses, examiners estimate the mean and median willingness to pay for an environmental improvement or willingness to accept compensation for a decline in environmental quality.
5.5 SUMMARY

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5.6 BIBLIOGRAPHY

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