C H A P T E R

1
The Role of Economics in
Environmental Management
The supreme reality of our time is the vulnerability of our planet.
John F. Kennedy (19171963)

I
n the twenty-first century, society must understand and accept the challenge of
protecting and preserving the earths resources while continuing to develop econom-
ically. The rapid growth and advancing technology that began in earnest with the
Industrial Revolution have taken a toll on the natural environment. Manufacturing
processes, mass transit systems, telecommunications, and synthetic chemicals are responsible
both for the highly advanced lifestyle that society enjoys and for much of the environmental
damage that has occurred. With 20/20 hindsight, we now recognize that the trade-off
between economic growth and environmental quality has been significant.
An important objective, therefore, is to understand the critical relationship between
economic activity and nature and to use that knowledge to make better and wiser deci-
sions. Of course, there will always be some amount of trade-offprecisely what eco-
nomic theory conveys. We cannot expect to have perfectly clean air or completely pure
water, nor can we continue to grow economically with no regard for the future. But
there is a solution, although it is a compromise of sorts. We first have to decide what
level of environmental quality is acceptable and then make appropriate adjustments in
our market behavior to sustain that quality as we continue to develop as a society.
The adjustment process is not an easy one, and it takes time. As a society, we are
still learningabout nature, about market behavior, and about the important relation-
ships that link the two together. What economics contributes to this learning process
are analytical tools that help to explain the interaction of markets and the environment,
the implications of that relationship, and the opportunities for effective solutions.
In this chapter, we support these assertions with a simple but powerful model that
illustrates the link between economic activity and nature. As we will discover, the under-
lying relationships motivate economic analysis of environmental issues, which is for-
mally defined through two disciplines: natural resource economics and environmental
economics, the latter of which is our focus in this book. With this model as a founda-
tion, we lay the groundwork for our course of study, starting with an introduction of
basic concepts. From there, we identify and discuss major objectives in environmental
economics and then present an overview of public policy development and the role of
economics in that process.
2
 CHAPTER 1 The Role of Economics in Environmental Management 3

ECONOMICS AND THE ENVIRONMENT

One of the most pervasive applications of economic theory is that it logically explains
what we observe in reality. For example, through microeconomic analysis, we can
understand the behavior of consumers and firms and the decision making that defines
the marketplace. This same application of economic theory can be used to analyze
environmental problemswhy they occur and what can be done about them. Stop to
consider how pollution or resource depletion comes aboutnot from a sophisticated
scientific level, but from a fundamental perspective. The answer? Both arise from deci-
sions made by households and firms. Consumption and production draw on the earths
supply of natural resources, and both activities generate by-products that can contami-
nate the environment. This means that the fundamental decisions that comprise
economic activity are directly connected to environmental problems. To illustrate this
relationship, we begin by presenting a basic model of economic activity. Then, we
expand the model to show exactly how this connection arises.

Circular Flow Model

The basis for modeling the relationship between economic activity and the environment is
circular flow model the same one that underlies all of economic theorythe circular flow model, shown in
Illustrates the real and Figure 1.1. Typically, this is the first model students learn about in introductory economics.
monetary flows of
First, consider how the flows operate, holding all else constant. Notice how the
economic activity
through the factor real flow (i.e., the nonmonetary flow) runs counterclockwise between the two market
market and the output sectors, households (or consumers) and firms (or producers). Households supply
market. resources or factors of production to the factor market, where they are demanded by
firms to produce goods and services. These commodities are then supplied to the
output market, where they are demanded by households. Running clockwise is the
money flow. The exchange of inputs in the factor market generates an income flow to

FIGURE 1.1 Circular Flow Model

Supply
rvices of go
s and se ods
d and
goo Output
ser
for market vic
nd es Reven es
ma nditur ues
Expe
De

Households Firms
Cengage Learning 2013.

Incom
e Costs
Sup s
ply rce
of resou Factor r resou
rces d fo
market Deman
4 MODULE 1 Modeling Environmental Problems

households, and that flow represents costs incurred by firms. Analogously, the money
flow through the output market shows how households expenditures on goods and ser-
vices are revenues to firms.
Now, think about how the volume of economic activity and, hence, the size of the
flow are affected by such things as population growth, technological change, labor pro-
ductivity, capital accumulation, and natural phenomena such as drought or floods. For
example, holding all else constant, technological advance would expand the productive
capacity of the economy, which in turn would increase the size of the flow. Similarly, a
population increase would lead to a greater demand for goods and services, which would
call forth more production and lead to a larger circular flow.
Notice that by analyzing how the flows operate and how the size of an economy can
change, we can understand the basic functioning of an economic system and the market
relationships between households and firms. However, the model does not explicitly
show the linkage between economic activity and the environment. To illustrate this
interdependence, the circular flow model must be expanded to depict market activity as
part of a broader paradigm, called the materials balance model.

Materials Balance Model

The explicit relationship between economic activity and the natural environment is illus-
materials balance trated by the materials balance model shown in Figure 1.2.1 Notice how the real flow
model of the circular flow model is positioned within a larger schematic to show the connec-
Positions the circular tions between economic decision making and the natural environment.
flow within a larger
schematic to show the
connections between Flow of Resources: Natural Resource Economics
economic decision Look at the linkages between the upper block representing nature and the two market
making and the sectors (households and firms), paying particular attention to the direction of the
natural environment. arrows. Notice that one way an economic system is linked to nature is through a flow
of materials or natural resources that runs from the environment to the economy, specif-
ically through the household sector. (Recall that, by assumption, households are the
owners of all factors of production, including natural resources.) This flow describes
natural resource how economic activity draws on the earths stock of natural resources, such as soil,
economics minerals, and water. It is the primary focus of natural resource economics, a field of
A field of study
concerned with the
study concerned with the flow of resources from nature to economic activity.
flow of resources from
nature to economic Flow of Residuals: Environmental Economics
activity. A second set of linkages runs in the opposite direction, from the economy to the envi-
ronment. This flow illustrates how raw materials entering the system eventually are
residual released back to nature as by-products or residuals. Most residuals are in the form of
The amount of a
gases released into the atmosphere, and in the short run, most are not harmful. In fact,
pollutant remaining in
the environment after some are absorbed naturally through what is called the assimilative capacity of the
a natural or environment. For example, carbon dioxide emissions from the combustion of fossil fuels
technological process (i.e., oil, coal, and natural gas) can be partially absorbed by the earths oceans and for-
has occurred. ests. Other released gases are not easily assimilated and may cause harm, even in the

1
Kneese, Ayres, and DArge (1970). See Chart 1, p. 9, in this source for a more detailed depiction of
this model.
 CHAPTER 1 The Role of Economics in Environmental Management 5

FIGURE 1.2 Materials Balance Model

ure Nature
m nat tion Res
fro nsump idua
n co ls f
aw rom
dr from pr
ls od

es
ua u

rc
ou

sid
very

ct
res Recovery d services Supply co

Re

ion
an of go re
ods Output od
r go
ral

o re s an
d f c market ds
Natu

an erv

g
lin
yc
em ice

yc
lin
D

rec
g

s
se
reu
se
Households Firms

Reu
Su e s
ppl urc
y of
reso Factor for reso
urces d
market Deman

Source: Based on Kneese, Ayres, and DArge (1970).

short term. There are also liquid residuals, such as industrial wastewaters, and solid resi-
duals, such as municipal trash and certain hazardous wastesall of which are potential
threats to health and the ecology. Notice in Figure 1.2 that there are two residual out-
flows, one leading from each of the two market sectors, meaning that residuals arise
from both consumption and production activity. This set of flows is the chief concern
environmental of environmental economics.
economics It is possible to delay, though not prevent, the flow of residuals back to nature
A field of study through recovery, recycling, and reuse. Notice in the model that there are inner flows
concerned with the
flow of residuals from
running from the two residual outflows back to the factor market. These inner flows
economic activity show that some residuals can be recovered from the stream and either recycled into
back to nature. another usable form or reused in their existing form. For example, Application 1.1 dis-
cusses how Germanys BMW Group has made advances in automobile design to facili-
tate recycling once a vehicle has reached the end of its economic life.
Although recycling efforts are important, keep in mind that they are only short-
term measures, because even recycled and reused products eventually become residuals
that are returned to nature. Indeed, what the materials balance model shows is that all
resources drawn from the environment ultimately are returned there in the form of resi-
duals. The two flows are balanced, a profound fact that is supported by science.

Using Science to Understand the Materials Balance

first law of
According to the first law of thermodynamics, matter and energy can neither be cre-
thermodynamics
Matter and energy ated nor destroyed. Applying this fundamental law to the materials balance model
can neither be created means that in the long run, the flow of materials and energy drawn from nature into
nor destroyed. consumption and production must equal the flow of residuals that run from these
6 MODULE 1 Modeling Environmental Problems

APPLICATION 1.1 BMW Groups Sustainable Decisions and Design for Recycling

In addition to BMW Groups venerable reputation for well-
engineered automobiles, it is also recognized for another
distinction. The German automaker is firmly committed to
sustainable corporate decisions and therefore to
developing and building BMWs in an environmentally
responsible manner.
Thanks to disassembly analyses conducted at its
Munich Recycling and Dismantling Center in Lohhof,
Germany, BMW Group is developing what it calls
solutions for environmentally and economically sensible
recycling. These analyses determine the time and
resources needed to dismantle a vehicle at the end of its
useful life. This information is then integrated into vehicle
construction plans. Such an approach is called Design for
Disassembly (DFD)a manufacturing method aimed at
building a product to facilitate end-of-life recycling. Along
with other major corporations such as Volkswagen, 3M,
and General Electric, BMW Group is investigating ways
to manufacture a DFD product that is economically
competitive and that stands up to the companys high
standards for quality engineering. As a consequence of
these and other efforts, today 85 percent of the materials
in a BMW Group vehicle are recyclable, with another
10 percent available for use in energy generation.
BMWs research in DFD is part of a long-term
commitment to environmentally responsible production
decisions. The company has been recycling its catalytic
converters since 1987. A year later, it introduced its limited-
production Z1 roadster. The two-seater is totally recyclable
and is considered the first DFD product ever made.
Subsequently, BMW Group built a pilot plant in Bavaria
dedicated solely to researching the DFD approach to
manufacturing. Teams of workers at the facility systematically
dismantle cars, beginning with the fluids and oils and ending
with the removal and sorting of interior materials.
Sources: BMW Group (2009; 2007; 2003; 2001); Protzman (July 4, 1993); Knepper (January 1993); Nussbaum and Templeman
(September 17, 1990).
A major objective is to build an automobile that can
be dismantled at a relatively low cost. Long hours for
disassembly elevates costs, which ultimately forces up
car prices and reduces competitivenessan outcome
no carmaker can afford. Another key goal is to ensure
that parts can be readily sorted. This is particularly
critical for plastics, which are more complex to recycle
but are increasingly used to lower vehicle weight and
to improve fuel efficiency. Using materials flow mana-
gement, BMW Group and various partners have
developed separation techniques for polyurethane foam
and pure-grade plastics. Taking this a step further, the
firm also uses plastic recyclables to build its new cars. In
fact, plastic recyclables in BMW Group vehicles account
for 15 percent of the total weight of plastic components,
a proportion that the company intends to increase to
20 percent.
Closing the loop, BMW Group and selected recycling
partners have established a network of automobile take-
back and recycling centers throughout the European
Union (EU). This infrastructure is aimed at making it more
convenient for BMW, MINI, and Rolls-Royce owners to
dispose of their cars at the end of their economic life. In
fact, beginning in January 2007, the return of end-of-life
vehicles has been available to consumers free of charge.
Although an EU Directive called for such networks in
2000, BMW Group had developed its own in the early
1990s, long before the directive was in place. Today,
approximately 2,000 recovered automobiles are dis-
mantled and recycled at the Munich Recycling and
Dismantling Center, which is the leading center of its
kind in the world. Further development of this vehicle
return process is among BMW Groups sustainable
objectives in the area of product responsibility. More
detail is available at www.bmwgroup.com/recycling.

activities back into the environment. Put another way, when raw materials are used in
economic activity, they are converted into other forms of matter and energy, but noth-
ing is lost in the process. Over time, all these materials become residuals that are
returned to nature. Some arise in the short run, such as waste materials created during
production. Other resources are first transformed into commodities and do not enter
the residual flow until the goods are used up. At this point, the residuals can take vari-
ous forms, such as carbon monoxide emissions from gasoline combustion or trash dis-
posed in a municipal landfill. Even if recovery does take place, the conversion of
residuals into recycled or reused goods is only temporary. In the long run, these too
end up as wastes.
 CHAPTER 1 The Role of Economics in Environmental Management 7

There is one further point. Because matter and energy cannot be destroyed, it may seem
second law of as though the materials flow can go on forever. But the second law of thermodynamics
thermodynamics states that natures capacity to convert matter and energy is not unlimited. During energy
Natures capacity to conversion, some of the energy becomes unusable. It still exists, but it is no longer available
convert matter and
to use in another process. Consequently, the fundamental process on which economic activity
energy is not without
bound. depends is finite.
These scientific laws that support the materials balance model communicate impor-
tant, practical information to society. First, we must recognize that every resource
drawn into economic activity ends up as a residual, which has the potential to damage
the environment. The process can be delayed through recovery but not stopped.
Second, natures ability to convert resources to other forms of matter and energy is
limited. Taken together, these assertions provide a comprehensive perspective of environ-
mental problems and the important connections between economic activity and nature.
It is the existence of these connections that motivates the discipline of environmental
economics.

UNDERSTANDING ENVIRONMENTAL DAMAGE

Although it is not necessary to master the rigors of environmental science, it is impor-
tant to become familiar with the basic concepts used to identify environmental damage
and to describe policy solutions. To that end, what follows is a brief overview of selected
terms and concepts in environmental economics. A useful online glossary of environ-
mental terms is available at the Environmental Protection Agencys (EPA) Web site at
www.epa.gov/OCEPAterms.
Environmental economics is concerned with identifying and solving the problem of
pollution environmental damage, or pollution, associated with the flow of residuals. Although
The presence of pollution is defined differently in different contexts, it can be thought of generally as
matter or energy the presence of matter or energy whose nature, location, or quantity has undesired
whose nature,
location, or quantity
effects on the environment. Virtually any substance can cause pollution solely on the
has undesired effects basis of a single characteristic, such as its fundamental constituents, its location, or its
on the environment. quantity. What this implies is that finding solutions to environmental damage depends
critically on identifying the causes, sources, and scope of the damage.

Causes of Environmental Damage

How do we identify which substances are causing environmental damage? One way is to
natural pollutants distinguish them by their originthat is, whether they are natural pollutants arising
Contaminants that from nature or anthropogenic pollutants resulting from human activity.
come about through
nonartificial Natural pollutants arise from nonartificial processes in nature, such as particles
processes in nature. from volcanic eruptions, salt spray from the oceans, and pollen.
Anthropogenic pollutants are human induced and include all residuals associated
anthropogenic with consumption and production. Examples include gases from combustion and
pollutants chemical wastes from certain manufacturing processes.
Contaminants
associated with Of the two, anthropogenic pollutants are of greater concern to environmental econ-
human activity. omists, particularly those for which nature has little or no assimilative capacity.
8 MODULE 1 Modeling Environmental Problems

Sources of Environmental Damage

stationary source Once pollutants have been identified, the next step is to determine the sources responsi-
A fixed-site producer ble for their release. Polluting sources are many and varied, ranging from automobiles to
of pollution. waste disposal sites. Even a seemingly pristine setting such as farmland can be a pollut-
ing source if rainwater transports chemical pesticides and fertilizers to nearby lakes and
mobile source
streams. Because polluting sources are so diverse, they are usually classified into broad
Any nonstationary
polluting source. categories that are meaningful to policy development. Depending on the environmental
media (air, water, or land), sources of pollution are generally grouped by (1) their
point source mobility (stationary source or mobile source) or (2) their identifiability (point source
Any single identifiable or nonpoint source). See Table 1.1 for detail.
source from which
pollutants are
released.
Scope of Environmental Damage
Although environmental damage is a universal concern, some types of pollution have
nonpoint source detrimental effects that are limited to a single community, whereas others pose a risk
A source that cannot over a large geographic region. The point is, the extent of the damage associated with
be identified pollution can vary considerablyan observation vitally important to policy formulation.
accurately and
degrades the
Consequently, environmental pollution is often classified according to the relative size of
environment in a its geographic impact as local, regional, or global.
diffuse, indirect way
over a broad area. Local Pollution
Local pollution refers to environmental damage that does not extend far from the
local pollution polluting source and typically is confined to a single community. Although the
Environmental negative effects are limited in scope, they nonetheless pose a risk to society and can
damage that does not
extend far from the
be difficult to control. A common local pollution problem is urban smog. Visible as
polluting source. a thick yellowish haze, smog is caused by pollutants that chemically react in sunlight.
It is particularly severe in major cities like Beijing, Los Angeles, and Mexico City, as
Figure 1.3 illustrates.
Another local pollution problem that is receiving increasing attention is solid
waste pollution. Poor waste management practices can allow contaminants such as

TABLE 1.1 Sources of Pollution

SOURCES GROUPED BY MOBILITY
Type Description Examples
Stationary A fixed-site producer of pollution. Coal-burning power plants, sewage
treatment facilities, manufacturing
plants
Mobile Any nonstationary polluting source. Automobiles, trucks, airplanes

SOURCES GROUPED BY IDENTIFIABILITY

Cengage Learning 2013.

Type Description Examples

Point Any single identifiable source from Factory smokestack, effluent pipe,
which pollutants are released. a ship
Nonpoint A source that cannot be identified Agricultural runoff, urban runoff
accurately and degrades the
environment in a diffuse, indirect
way over a relatively broad area.
 CHAPTER 1 The Role of Economics in Environmental Management 9

FIGURE 1.3 Pollutants Contributing to Urban Air Pollution in Major Cities

New York-Newark
Nitrogen dioxide

Los Angeles Sulfur dioxide

Particulate matter
London

Madrid

Mexico City

Tokyo

Berlin

Paris

Beijing

Toronto

Sao Paulo

0 20 40 60 80 100 120 140

Concentration, micrograms per cubic meter (g/m3)
NOTES: Particulate matter refers to fine suspended particles less than 10 microns in diameter, such as dust, soot, smoke, and other contaminants.
Data are for the most recent year available: 2006 for nitrogen dioxide, and 2001 for sulfur dioxide and particulate matter.
Source: World Bank (2010), Table 3.14, pp. 206207.

lead and mercury to leach into soil and water supplies. Beyond measures aimed at
improving waste management are efforts to reduce the amount of waste being gener-
ated in the first place. Look at the per capita estimates of municipal waste generation
and gross domestic product (GDP) for selected countries given in Table 1.2. Note that
these data generally suggest a positive relationship between waste generation and
industrialization.

Regional Pollution
Environmental pollution that poses a risk well beyond the polluting source is
regional pollution called regional pollution. An important example is acidic deposition, which arises
Degradation that from acidic compounds that mix with other particles and fall to the earth either as
extends well beyond dry deposits or in fog, snow, or rain. Acidic deposition is commonly known as
the polluting source.
acid rain. Acid rain is characterized as regional pollution because the harmful
emissions can travel hundreds of miles from their source. Another example of
10 MODULE 1 Modeling Environmental Problems

TABLE 1.2 Per Capita Municipal Solid Waste Generation for Selected Countries
Country Waste (kilograms per capita) 2008 GDP ($ per capita)
United States 745 43,250
Netherlands 623 38,035
Germany 581 33,663
Spain 575 27,747
United Kingdom 546 34,356
Italy 545 28,245
France 543 30,624
Sweden 515 33,744
Norway 490 49,416
NOTES: Waste and GDP figures shown are for 2008.
GDP values are in 2005 U.S. dollars.
Sources: European Commission, Eurostat (January 17, 2011), Table 4; U.S. Census (2011), Table 373, p. 229, Table 1348, p. 847.

regional pollution is the Gulf Oil Spill that occurred in 2010, which is discussed in
Application 1.2.

Global Pollution
global pollution Some environmental problems have effects so extensive that they are called global
Environmental effects pollution. Global pollution is difficult to control, both because the associated risks are
that are widespread widespread and because international cooperation is needed to achieve effective solutions.
with global
implications.
Consider, for example, the problem of global warming. Also known as the greenhouse
effect, global warming occurs as sunlight passes through the atmosphere to the earths
surface and is radiated back into the air where it is absorbed by so-called greenhouse gases
(e.g., carbon dioxide). Although this warming process is natural, activities such as fossil
fuel combustion add to the normal level of greenhouse gases, which in turn can raise
the earths natural temperature. These climate disruptions may affect agricultural pro-
ductivity, weather conditions, and the level of the earths oceansall effects that are
worldwide in scope.
Global warming falls under the broader heading of climate change, although the
two are often used interchangeably. Climate change refers to a major alteration in any
climate measure, including temperature, wind, and precipitation, that is prolonged
(decades or longer).2 Such an alteration in climate can arise from natural phenomenon,
such as changes in oceanic circulation or variances in the suns intensity; it can also be the
result of human activities like fossil fuel combustion or deforestation. For further detail, visit
the EPAs site on climate change, www.epa.gov/climatechange/index.html.
Similarly widespread are the risks of ozone depletion, a thinning of the earths ozone
layer. The ozone layer protects the earth from harmful ultraviolet radiation, which can
weaken human immune systems, increase the risk of skin cancer, and harm ecosystems.

2
U.S. EPA, Office of Air and Radiation, Office of Atmospheric Programs, Climate Change Division
(April 14, 2011b).
 CHAPTER 1 The Role of Economics in Environmental Management
APPLICATION 1.2 The Gulf Oil Spill of 2010
In a speech to the American people in June 2010,
President Obama called the Deepwater Horizon blowout
the worst environmental disaster America ever
faced. Deepwater Horizon is the name of the offshore
drilling rig that was positioned in the Gulf of Mexico in
the Macondo prospect, which is owned and operated by
British Petroleum (BP). On April 20, 2010, an explosion
and fire took place on the rig, which damaged the
wellhead, causing millions of gallons of crude oil to leak
into the Gulf. There were significant human losses.
Eleven workers on the rig lost their lives, and another 17
were injured. Damage to the environment extended well
beyond the rig site, resulting in nontrivial, regional pollution
that has not yet been fully identified.
Crude oil spilled out of the well into the Gulf of Mexico
for three months before the wellhead was capped. Over
that period, officials estimate that more than 170 million
gallons of crude oil despoiled the gulf, making it the
largest marine oil spill accident in the history of the
United States. The massive spill is responsible for both
environmental and economic damage, but scientists have
not yet identified the magnitude and extent of the losses.
Part of the difficulty is the absence of comprehensive data
on ecological conditions in the area prior to the accident to
serve as a benchmark to which post-spill conditions could
be compared. Another challenge is the limited scientific
knowledge about deepwater ecosystems, which were
subjected to the oil pollution.
At risk are all types of marine life, including fish, sea
turtles, dolphins, seaweed, and plankton. Of particular
concern are those that are endangered based on the
Endangered Species Act. The National Oceanic and
Atmospheric Administration (NOAA) reports that all
28 species of marine mammals living in the Gulf of
Mexico are protected, and 6 of these are endangered.
Also at risk are seabirds and shorebirds that rely on
the ocean and coastal estuaries for food, such as bald
eagles and falcons. Oil that reaches shorelines threatens
ecosystems living in such coastal habitats as salt marshes
and beaches. Reportedly, more than 650 miles of coastal
habitats along the Gulf were oiled, and of these, over
130 miles have been identified as heavily oiled. These
shorelines affected four statesLouisiana, Mississippi,
Alabama, and Florida. Less apparent but nonetheless
Sources: National Commission on the BP Deepwater Horizon Oil Spill and Offshore Drilling (January 2011); Grunwald (August 9, 2010).
11
cause for concern is the possibility of a deepwater
plume, defined as clouds of tiny oil droplets and
dissolved gases moving far below the oceans surface.
Scientists are concerned that these substances may
detrimentally affect oxygen levels that support marine
species.
Beyond the damage to the natural environment, the
Gulf spill also caused economic losses, particularly to the
fishing and tourist industries. In addition to negative
effects from actual damages to the region were those
arising from public perception and uncertainty about the
ocean and area beaches as well as the safety of fish and
shellfish caught in the Gulf. Diminished hotel bookings and
restaurant reservations served as anecdotal evidence of
reduced profits to local economies because of the well
blowout.
Taken together, the human, environmental, and
economic losses linked to the Gulf spill are significant. But
testing and monitoring of ecosystems over the long term
are necessary to more accurately identify the magnitude
and extent of the associated damage, which will take
time. Nonetheless, officials are reporting that the damages
might not be as extensive as originally feared. For example,
initial reports indicate that spill-related bird kills were less
than 1 percent of those linked to the Exxon Valdez spill.
Why? For one thing, ocean currents and winds prevented
most of the oil from reaching shorelines. For another, the
warmer temperatures in that region are said to have
facilitated evaporation and degradation of the spilled oil, in
part because the oil-eating bacteria used to combat the spill
function better in warmer waters. Also, the oil in this spill
was much lighter and degradable than that released in the
Exxon Valdez spill.
Scientists and public officials continue to monitor
the region, collecting samples and gathering data, to
better understand and assess the magnitude of loss
linked to this unprecedented environmental disaster.
Hence, a full assessment of the associated effects will
not be known for some time. In the interim, ongoing
data and reports are available at various Web sites,
including the U.S. governments official site on the spill,
www.restorethegulf.gov, and the site of the National
Commission on the BP Deepwater Horizon Oil Spill and
Offshore Drilling at www.oilspillcommission.gov.
12 MODULE 1 Modeling Environmental Problems

In 1985, scientists discovered that a previously observed thinning of the ozone layer over
the Antarctic region had become an ozone hole the size of North America. Ozone deple-
tion is caused mainly by a group of chemicals known as chlorofluorocarbons (CFCs),
which had been commonly used in refrigeration, air conditioning, packaging, insulation,
and aerosol propellants. Although national governments have controlled CFC usage, the
main policy thrust has arisen through international agreements because of the global
nature of the problem.

IDENTIFYING ENVIRONMENTAL OBJECTIVES

Just as fundamental environmental problems are universal, so too are the overall objec-
tives. However, articulating the specifics of these objectives and accepting the trade-offs
that such goals imply is a process that is not without debate. Indeed, such is the sub-
stance of environmental summits, where national leaders, industry officials, and
environmentalists gather to exchange ideas about appropriate objectives and to garner
cooperation from one another. A case in point was the 2011 United Nations climate
conference in South Africa at which negotiations continued on the Kyoto Protocol.
A more comprehensive environmental agenda was addressed at the United Nations
Conference on Environment and Development (UNCED) held in Rio de Janeiro, Brazil,
in 1992. Known as the Earth Summit, the event marked the twentieth anniversary of the
first worldwide environmental conference in Stockholm and was attended by 6,000 dele-
gates from more than 170 countries.3
Although the objective-setting process has been difficult at times and is often immersed
in political debate, it is nonetheless moving forward. Today, virtually every environmental
decision is guided by what have become worldwide objectives: environmental quality,
sustainable development, and biodiversity.

Environmental Quality
Given the pervasive problems of local, regional, and global pollution, few would debate
environmental including environmental quality among the worlds objectives. However, there is a
quality lack of consensus about how to define this concept in practice. Most of us consider
A reduction in environmental quality to mean clean air, water, and land. However, when environmental
anthropogenic
contamination to
quality is being defined to guide policy, we have to decide just how clean is clean.
a level that is The debate usually begins with asking why environmental quality should not mean
acceptable to the absence of all pollution. The answer is that such an objective is impossible, at least
society. in a pure sense. Recall that some pollution is natural and therefore not controllable. Fur-
thermore, the absence of all anthropogenic pollutants could be achieved only if there
were a prohibition on virtually all the goods and services that characterize modern liv-
ing. This means that a more rational perception of environmental quality is that it
represents a reduction in anthropogenic contamination to a level that is acceptable to
society. This acceptable level of pollution will, of course, be different for different con-
taminants, but in each case, certain factors are considered in making the determination.

3
Council on Environmental Quality (January 1993), p. 140.
 CHAPTER 1 The Role of Economics in Environmental Management 13

Among these factors are the gains to human health and ecosystems, expenditures
needed to achieve the reduction, availability of technology, and the relative risk of a
given environmental hazard.
Although the world has made progress toward achieving environmental quality,
there is still work to be done. In some parts of the world, such as Eastern Europe and
developing nations, environmental pollution is extreme, and progress toward reducing
the effects is slow. Application 1.3 discusses some of the environmental problems China
is experiencing as it strives to advance economically.
Recognizing environmental quality as a worldwide objective has triggered an aware-
ness of its importance over a longer time horizon. Society has begun to realize that pursu-
ing economic growth could so adversely affect the natural resource stock that the
productive capacity and welfare of future generations could be threatened. The potential
of such an intertemporal trade-off has prompted a sense of obligation to the future that
has materialized into two related objectives: sustainable development and biodiversity.

Sustainable Development
Economic growth is defined as an increase in real gross domestic product (GDP).
Although growth is a favorable outcome, there are long-term environmental implica-
tions, as the materials balance model suggests. Achieving an appropriate balance
sustainable between economic growth and the preservation of natural resources is the essence
development
of the objective known as sustainable development, which calls for managing the
Management of the
earths resources such earths resources to ensure their long-term quality and abundance.4 This reminds us
that their long-term that the circular flow of economic activity cannot be properly understood without
quality and abundance recognizing how it fits into the larger scheme of the natural environment. Yet only
are ensured for future in the recent past have economists and society at large begun to accept this broader
generations. and more realistic view. For example, new initiatives have been proposed to capture
the ecological effects of growth in macroeconomic performance measuresan issue
discussed in Application 1.4. More on sustainability is available at www.epa.gov/
sustainability.
On a much broader scale, the Rio Declaration, drafted at the Rio Summit, outlines
27 principles to serve as guidelines for global environmental protection and economic
development. Similar commitments are given in the summits 40-chapter document,
Agenda 21, an international agenda of comprehensive environmental goals. Agenda 21
is dedicated in large part to sustainable development, with an emphasis on regions
where achieving this objective is particularly critical, such as in developing nations. In
celebration of the Rio Summits tenth anniversary, another worldwide event was held in
South Africathe Johannesburg Summit 2002. As in Rio, thousands of people attended,
including heads of state, national delegates, and business leaders, all coming together to
biodiversity discuss issues relating to the goal of sustainable development.
The variety of distinct
species, their genetic Biodiversity
variability, and the
variety of ecosystems Another environmental objective that addresses the legacy left to future generations is
they inhabit. biodiversity. This refers to the variety of distinct species, their genetic variability, and

4
Council on Environmental Quality (January 1993), p. 135.
14 MODULE 1 Modeling Environmental Problems
APPLICATION 1.3 The High Price of Chinas Economic Advance
Chinas rapidly growing economy has become a double-
edged sword. Although Chinas 1.3 billion residents are
enjoying greater prosperity, the quality of the nations air,
water, and land resources has severely deteriorated.
Despite significant sums dedicated to environmental
clean-up, some ecological damage is going virtually
unchecked. In fact, much of the abatement effort to date
has been aimed at highly visible, large urban centers, such
as Beijing and Shanghai, leaving smaller cities and rural
communities to bear a disproportionate burden of the
nations contaminated water and severe air pollution.
Beijing had become a particular focus as the designated
host city for the 2008 Olympic Games. Unfortunately,
much of the environmental success associated with
Olympics preparation has been short-lived, as air quality
in the city has begun to deteriorate back to pre-Olympic
levels.
As is sometimes the case in developing economies,
environmentalism is perceived as an obstacle to economic
advance that can frustrate industrial development. But in
China, the environmental damage has become so severe
that its economic advance is being diminished by a lack of
clean water, reduced productivity associated with
pollution-induced health problems, and other damages
that limit production. Official estimates suggest that this
drag on Chinas growth may be as much as 5.8 percent
of GDP annually, a considerable increase from the
3 percent estimate in the mid-1990s. Such a backlash
has prompted a more aggressive response to the
nations environmental decline.
Over the 20062010 period, Chinese officials spent
1.4 trillion (yuan), or about $207 billion, on environ-
mental protection and will likely spend an estimated
3.1 trillion over the next five-year period through 2015
(almost $460 billion). Nonetheless, it is not clear that
the Chinese government is doing enough to protect the
environment. The agency responsible for putting these
sums of money to work is the Ministry of Environmental
Protection (formerly the State Environmental Protection
Agency [SEPA]). Reportedly, the SEPA lacked the power
and influence to effect significant improvements, and it
was thought that most of the designated funds might
have gone to other national agencies, such as the State
Forestry Administration, or local environmental bureaus,
which generally suffer from conflicts of interest. Unless
the Ministry of Environmental Protection corrects these
problems, grassroots efforts may play a greater role in
Sources: Sim and Rong (September 17, 2010); Asia: Dont Drink the Water and Dont Breathe the Air; Environmental Protection in
China (January 26, 2008); Roberts (October 27, 2003); Biers (June 16, 1994).
effecting environmental change than the Chinese
government. According to ministry officials, 51,000
protests relating to the environment took place in 2005,
and more than 600,000 environmental complaints were
made in 2006.
Poor air quality in China is pervasive, accounting
for serious respiratory problems and poor visibility.
Although both industrial and automobile emissions are
contributors, Chinas air pollution can be traced mainly to
the countrys heavy reliance on coal. During the 1980s, its
coal consumption increased from 620 million tons to more
than 1 billion tons. Industrial centers, such as Chongqing,
suffer the effects of severe acid rain linked to the use of
high-sulfur coal. Documented damages range from
erosion of buildings to the destruction of crops and other
plant life. Reportedly, trees along city streets have had to
be replaced three times in a 30-year period.
Chinas water resources also are at risk. Sewage
treatment is often inadequate, even nonexistent in some
locations, and industrial wastes are contaminating many of
the countrys rivers and streams. These are nontrivial
problems, as evidenced by a recent estimate suggesting
that about 700 million people in China drink some form of
contaminated water.
For a time, Chinese officials had been reluctant to
allocate resources away from economic development
and toward environmental cleanup and protection.
Instead, China relied on financial support from other
countries and organizations. For example, Denmark has
helped Chongqing build a modern sewage treatment
plant, and the World Bank has provided loans to fund
major environmental efforts, including a multimillion-
dollar project to clean up Beijing. Despite this
international support, recent estimates indicate that China
must spend between 2 and 4 percent of its GDP to clean
up its environment.
What does China stand to gain economically from
intensified environmental policy development? If China
can halt its environmental deterioration, production and
productivity should improve, allowing it to recapture the
nearly 6 percent of GDP it now loses to pollution. More-
over, its stepped-up environmental investments are
estimated to increase 14.5 percent per year, reaching
2.3 trillion (about $340 billion) by 2020. Such invest-
ments in emissions testing, water purification, and the
development of cleaner energy will also add to Chinas
national production and overall job growth.
 CHAPTER 1 The Role of Economics in Environmental Management 15

APPLICATION 1.4 Environmental-Economic Accounting and GDP: A Worldwide

Initiative

Without question, measuring a nations macroeconomic Proponents of environmentally adjusted performance

performance is a complex, yet important, undertaking.
The objective is to monetize total production and use the
result to assess and monitor a nations growth. Currently,
the accepted method for measuring economic activity
follows the System of National Accounts (SNA) endorsed
by the United Nations (UN), a universal accounting
framework for calculating such performance measures
as GDP.
Conventionally, GDP is defined as the monetized
value of all final goods and services produced in a country
each year. Although designed to be a comprehensive
measure of productive activity, GDP is admittedly flawed.
For example, difficulties in attempting to capture the
so-called underground economy or the value of nonmar-
keted goods, such as do-it-yourself projects, necessarily
bias the measure. Beyond these well-known flaws, other
inherent biases have caused some to question the validity
of GDP as a measure of economic welfare. Among these
is the absence of consideration for ecological damage and
natural resource depletion associated with economic
activity.
Recognizing this shortcoming, many have argued for
making environmental adjustments to the GDP measure.
The justifications for such revisions are based on the fol-
lowing considerations. Just as the SNA allows for the
depreciation of physical capital, so too should it recognize
the devaluation of natural resources associated with
economic activity. If pesticides leach into underground
springs, the damage to drinking water should be mone-
tized and reflected in the GDP measure. Likewise, if a for-
est is destroyed to make way for urban development, then
that loss should be recorded. In both cases, natural assets
would be depreciating, and that depreciation should be
captured in the SNA to avoid a serious bias.
Sources: United Nations Statistics Division (2011); United Nations, European Commission, International Monetary Fund, Organization
for Economic Co-operation and Development (OECD), and World Bank (2003); Banzhaf (2003); Nordhaus (November 1999); Repetto
(September 1992); Repetto (June 1992).
measures also claim that ignoring the economic value of
natural resources perpetuates societys failure to acknowl-
edge the effect of economic growth on future generations.
In fact, in some cases, current accounting practices falsely
record environmental deterioration as a contribution to
economic welfare. An example would be increased
medical spending associated with the effects of a toxic
chemical leak, which ironically elevates a nations GDP.
An explicit accounting of resource depletion and environ-
mental damage would correct this outcome and restore
accuracy to national product and income accounts.
Officials in many nations are aware of this environ-
mental bias, and many have undertaken initiatives to
address the problem. An important case in point is the
2003 revision to the Handbook of National Accounting:
Integrated Environmental and Economic Account, known
as the SEEA (for the System of Integrated Environmental
and Economic Accounting) published by the UN. This revi-
sion was a collaborative effort of the UN, the European
Commission, the International Monetary Fund, the Organi-
zation for Economic Co-operation and Development, and
the World Bank, and provided a detailed set of guidelines
for countries to integrate environmental assets into their
national economic accounting methods. These guidelines
have been recognized as an important step toward reduc-
ing the environmental bias inherent in GDP measures. In
fact, the United Nations Statistical Commission decided in
2005 that these guidelines should become an international
statistical standard, which will become known as the
revised SEEA when completed.
To learn more about the status of this effort and spe-
cific country applications, visit the UNs environmental-
economic accounting site at http://unstats.un.org/unsd/
envaccounting/default.asp.

the variety of ecosystems they inhabit.5 There is still much that scientists dont know
about the diversity of life on earth. Although approximately 1.8 million species have
been identified, most estimates suggest that the actual number may be at least 5 to
10 million, and some biologists believe there may be as many as 100 million.6 Although

5
Council on Environmental Quality (January 1993), p. 135.
6
Raven, Berg, and Hassenzahl (2008), p. 377.
16 MODULE 1 Modeling Environmental Problems

there are many unknowns, consensus within the scientific community is that the variety
of species on earth is important to the ecology. Beyond the preservation of a species for
its own sake, it is also the case that all life on earth is inexorably connected. Hence, the
loss of one species may have serious implications for others, including human life.
The longevity of any biological species can be directly threatened by exposure to
pollutants or by other human actions, such as commercial or sport hunting. The major
threat to biodiversity, however, is natural habitat destruction linked to changes in land
use, which affects entire ecosystems. Population growth and economic development are
primarily responsible for this destruction, which includes the harvesting of tropical
forests and the engineered conversion of natural landmasses into alternative uses.7
For example, of the more than 220 million acres of wetlands believed to have existed in
the contiguous United States, less than half remain today, estimated to comprise about
107.7 million acres. Indeed, over the 19982004 period, an estimated 361,000 acres of
coastal wetlands in the eastern United States were lost, despite an overall net gain in
U.S. wetlands acreage of about 192,000 for the period.8 Biodiversity can also be jeopar-
dized by habitat alteration, which is often attributed to environmental pollution. For
example, acid rain has been linked to changes in the chemical composition of rivers
and lakes as well as to forest declines in Europe and North America. Such disturbances
in the natural conditions to which biological life has become adapted can pose a threat
to the longevity of these species.
The extent of biodiversity loss is not known. There are, however, indications that
concern about diversity loss is warranted. As of 2012, over 1,380 plant and animal
groups have been classified as endangered or threatened in the United States and more
than 600 in other nations, as shown in Table 1.3. That this issue is one of global

TABLE 1.3 Threatened and Endangered Species as of 2012

ENDANGERED THREATENED TOTAL
U.S. International U.S. International U.S. International
Mammals 70 256 13 20 83 276
Corals 0 0 2 0 2 0
Birds 76 204 16 14 92 218
Herptiles (reptiles, amphibians) 28 74 33 17 61 91
Fish 77 11 68 1 145 12
Invertebrates (snails, clams, 171 7 33 0 204 7
crustaceans, insects, arachnids)
Plants 644 1 150 2 794 3
TOTAL 1,066 553 315 54 1,381 607

Source: U.S. Department of the Interior (DOI), Fish and Wildlife Service (FWS) (January 6, 2012).

7
Raven, Berg, and Hassenzahl (2008), pp. 38586.
8
Stedman and Dahl (2008); Dahl (2006); U.S. EPA, Office of Water, Office of Wetlands, Oceans, and
Watersheds (February 22, 2006).
 CHAPTER 1 The Role of Economics in Environmental Management 17

concern is evidenced by the Convention on Biodiversity, executed by 153 nations at the

Rio Summit. Among the conventions mandates are devising measures that identify
which species are in decline and discovering why the declines have occurred.
Collectively, the goals of environmental quality, sustainable development, and
biodiversity set an ambitious agenda. This means that all of society must work
toward developing effective environmental policy initiatives. Central to this effort is
a planning process in which public officials, industry, and private citizens partici-
pate. In the context of environmental problems, this process involves a series of
decisions about assessing environmental risk and responding to it, as the following
overview explains.

ENVIRONMENTAL POLICY PLANNING: AN OVERVIEW

An important observation to make about environmental policy planning is that it
involves the interdependence of many segments of society, including government agen-
cies, private industry, the scientific community, and environmentalists. Each group of
participants, albeit from a different vantage point, plays a significant role in formulating
policy, and each offers expertise to the outcome.

Policy Planning in the United States

We can categorize the individuals who are instrumental to environmental policy plan-
ning in various ways. Using the broadest classification, there are two major groups: the
public sector and the private sector. In the United States, the EPA acts as a sort of
liaison between the various constituents of each sector, as shown in Figure 1.4. Estab-
lished in 1970, the EPA was created by President Nixon from various components
of existing federal agencies and executive departments. Today, the EPA operates as an
independent agency headed by a president-appointed administrator who oversees its

FIGURE 1.4 Parties Involved in Environmental Policy Planning

PRIVATE SECTOR PUBLIC SECTOR

Environmentalists Executive Branch

Private Industry Congress

Scientists Judiciary
ENVIRONMENTAL
Economists PROTECTION Food and Drug Administration
AGENCY
Labor Unions Occupational Safety and
Health Administration
Private Citizens
Other Administrative Agencies

State and Local Governments

Source: Based on Vaupel (1978), Figure 5-3, p. 75.

18 MODULE 1 Modeling Environmental Problems

vast infrastructure. To better understand this vast federal agency, read about the EPAs
mission statement and its strategic plan online at www.epa.gov/aboutepa/index.html.

The National Environmental Policy Act (NEPA)

As Figure 1.4 implies, some environmental issues fall under the jurisdiction of federal
agencies other than the EPA. For example, issues relating to the contamination of foods
or the use of food additives are the responsibility of the Food and Drug Administration
(FDA). To coordinate these efforts, the National Environmental Policy Act (NEPA) of
1969 directs the integration of tasks across agencies, executive departments, and
branches of government. This act guides the formulation of all U.S. federal environmen-
tal policy and requires that the environmental impact of public policy proposals be for-
mally addressed. Among NEPAs provisions is a requirement for an Environmental
Impact Statement (EIS) on proposals for legislation or major federal actions. Since the
NEPA was passed in 1969, literally thousands of EISs have been completed by a variety
of federal agencies.9 For more information, visit the EIS database at www.epa.gov/
compliance/nepa/eisdata.html.
In the United States and around the world, environmental policy planning relies on
careful research and analysis, which in turn depends on individuals with expertise in
many disciplines, among them biology, chemistry, economics, law, and medicine. Input
from these and other fields is used to evaluate data and make decisions that ultimately
lead to specific policy prescriptions. The underlying tool that guides this policy-
planning process is risk analysis, which comprises two decision-making procedures:
risk assessment and risk management.

Risk Assessment
At any point in time, a number of environmental objectives must be met with a limited
amount of economic resources. This means that as problems are identified, they have to
be prioritized. In general, this is done through scientific assessment of the relative risk to
risk assessment human health and the ecology of a given environmental hazarda procedure known as
Qualitative and risk assessment. The assessment must determine whether or not a causal relationship
quantitative exists between the identified hazard and any observed health or ecological effects. If cau-
evaluation of the risk sality is determined, scientists then attempt to quantify how the effects change with
posed to health or the
increased exposure to the hazard. These findings are critical, because they determine
ecology by an
environmental hazard. whether or not a policy response is necessary and, if so, how immediate and how strin-
gent that policy should be.
risk management
The decision-making Risk Management
process of evaluating
and choosing from Assuming that the risk assessment findings warrant it, the planning process enters its
alternative responses next phase: risk management. This refers to the decision-making process of evaluating
to environmental risk. and choosing from alternative responses to environmental risk. In a public policy

9
Council on Environmental Quality (1997), pp. 4753.
 CHAPTER 1 The Role of Economics in Environmental Management 19

context, risk responses refer to various types of control instruments, such as a legal limit
on pollution releases or a tax on pollution-generating products. The objective of risk
management is clearto choose a policy instrument that reduces the risk of harm to
society. What is less obvious is how public officials determine the level of risk society
can tolerate and on what basis they evaluate various policy options.

Policy Evaluation Criteria

A number of risk management strategies have been devised to guide these important
policy decisions. These strategies use criteria to evaluate policy options. In general,
these criteria are based on measures of risk, costs, or benefitseither singularly or in
comparison to one another. Two criteria that are economic in motivation are allocative
allocative efficiency and cost-effectiveness.
efficiency
Requires that
Allocative efficiency requires that resources be appropriated such that the addi-
resources be tional benefits to society are equal to the additional costs incurred.
appropriated such that Cost-effectiveness requires that the least amount of resources be used to achieve
the additional benefits an objective.
to society are equal to
the additional costs. In practice, the choice of criteria is mandated, or at least implied, by law. For
example, some provisions in U.S. legislation prohibit cost considerations in policy for-
cost-effectiveness mulation, implicitly blocking either an efficient or a cost-effective outcomea result
Requires that the that is frequently debated in the literature and one that we will analyze in later
least amount of
chapters.
resources be used to
achieve an objective. Although both efficiency and cost-effectiveness are rooted in resource allocation,
environmental justice has a different perspective. It is an environmental equity crite-
rion that considers the fairness of the risk burden across geographic regions or segments
of the population. More information about this criterion is available at www.epa.gov/
compliance/environmentaljustice. U.S. policy officials have recognized the importance
environmental of environmental justice. In 1994, President William Clinton signed Executive Order
justice 12898, which directed all federal agencies to incorporate environmental justice into their
Fairness of the decision-making process. Since that initial signing, however, implementation of that
environmental risk directive has been slow. In fact, according to the Inspector Generals office, the EPA
burden across
under George W. Bushs administration failed to fully incorporate and implement the
segments of society or
geographical regions. requirements under Clintons Executive Order.10
Recognizing the need for further progress, the EPA under the Obama administra-
tion drafted a new strategy in 2010 aimed at improving the integration of environmental
justice into EPA programs. The four-year plan, called EJ2014 to mark the twentieth
anniversary of Executive Order 12898, outlines specific goals to protect and empower
overburdened communities and to establish partnerships at all levels of government to
improve these populations. For more detail on the plan and its implementation, visit
www.epa.gov/compliance/environmentaljustice/plan-ej/index.html.

10
U.S. EPA, Office of Inspector General (2004).
20 MODULE 1 Modeling Environmental Problems

Governments Overall Policy Approach

An important element of risk management is the regulatory approach used by
government. Policies calling for direct regulation of pollution are indicative of a
command- command-and-control approach. This form of regulation uses rules or standards to
and-control control the release of pollution. In practice, standards either set a maximum on the
approach amount of residuals polluters may release or designate an abatement technology that all
A policy that directly
sources must use. In either case, polluters have little or no flexibility in deciding how
regulates polluters
through the use of they comply with the law. The command-and-control approach has been the predominant
rules or standards. one used in the United States over the past several decades, but in recent years, more eco-
nomic incentives have been integrated into strategic policy plans. This suggests a shift
toward a market approach to policy.
market approach The market approach is incentive-based, meaning it attempts to encourage conser-
An incentive-based vation practices or pollution-reduction strategies rather than force polluters to follow a
policy that encourages specific rule. Many policy instruments can achieve this result, such as a fee on pollutant
conservation practices releases or a tax levied on pollution-generating commodities. What all such instruments
or pollution-reduction
have in common is that they tap into natural market forces so that polluters optimizing
strategies.
decisions will benefit the environment.
Think about how private firms are motivated by profit. What a market approach
does is strategically use this motivation to design environmental policy. For example,
if a profit-maximizing firm were discharging a chemical into a river, a market
approach might be to charge that polluter a fee for every unit of chemical released. In
so doing, the firm would have to pay for the damage it caused, which would erode its
profits. This tactic is sometimes called the polluter-pays principle. The expected
outcome is that the profit-maximizing firm will reduce the chemicals it releases, using
the least-cost method available. The favorable outcomes are that society enjoys the
benefit of a cleaner environment and that the associated costs to achieve that gain are
minimized.
That such market-based strategies can be effective is validated by experience all over the
world. In the United States and other industrialized nations, more market incentives are
being integrated within the conventional command-and-control policy approach. In cooper-
ation with the European Environment Agency (EEA), the Organisation for Economic
Co-operation and Development (OECD), which supports the polluter-pays principle, has
developed a searchable database that describes economic instruments currently in use by its
member countries. Covering over 40 nations, the database lists hundreds of examples that
illustrate how market instruments can facilitate decision making. To learn more about
specific country applications, visit www2.oecd.org/ecoinst/queries/index.htm.

Setting the Time Horizon

management Another element of risk management decision making is determining the most effective
strategies time plan for policy initiatives. One approach is to target policy at more immediate, or
Methods that address
short-term, problems. These types of initiatives are called management strategies,
existing environmental
problems and attempt since their purpose is to manage an existing problem. Here, the intent is ameliorative.
to reduce the damage In terms of the materials balance model, such strategies attempt to reduce the damage
from the residual flow. from the residual flow.
 CHAPTER 1 The Role of Economics in Environmental Management 21

FIGURE 1.5 A Closed System of Materials Flow

By modifying manufacturing processes, product design, and energy consumption, the residual flow can be reduced
throughout the economic cycle of production and consumption, achieving this cyclical flow of materials. This is a
more comprehensive approach than controlling residuals after they have been generated.

Energy efficiency Energy efficiency

Design
for safe
Materials landfilling,
efficiency composting,
Manufacturing Product use
and
incineration

Design for recycling Design for reuse

Waste prevention

Source: U.S. Congress, OTA (October 1992), as cited in Gibbons (September/October 1992), p. 31.

An alternative approach addresses the potential of future deterioration and

pollution is therefore preventive in purpose. This long-term strategy is referred to as pollution
prevention (P2) prevention (P2). It is implemented by reducing the residual flow and/or minimizing
A long-term strategy
harmful components of residuals, such as toxic chemicals. By modifying energy con-
aimed at reducing the
amount or toxicity of sumption, manufacturing processes, and product design, as BMW Group does in its
residuals released to DFD method (discussed in Application 1.1), the residual flow can be reduced through-
nature. out the economic cycle of production and consumption. We model this as a cyclical
flow of materials, as shown in Figure 1.5. Notice that this is a more comprehensive
approach than controlling residuals after they have been generated. Preventive strate-
gies are becoming more prevalent in U.S. policy. In fact, the nation made a formal
commitment to pollution prevention when Congress enacted the Pollution Prevention
Act of 1990.

CONCLUSIONS
Concerns about the risks of pollution and the threat of natural resource depletion have been
expressed by private citizens, the business community, and governments all over the world.
In large part, this perspective has come from a growing awareness of the delicate balance
between nature and economic activity. The materials balance model illustrates the strength
of this relationship and the consequences of naive decision making that ignores it.
Recognizing the implications, many nations have made measurable progress in
identifying problems and setting an agenda to address them. As that work continues,
comparable efforts are under way to develop and implement solutions. To that end,
22 MODULE 1 Modeling Environmental Problems

policy reform, collaborative arrangements between government and industry, and

international summits are being aimed at resolving environmental problems. Scien-
tists are working to learn more about the ecology, the diversity of species, and envi-
ronmental risks. Laws are being changed to incorporate more preventive measures as
well as incentive-based instruments that encourage pollution reduction and resource
conservation. As this process evolves, society is changing the way it thinks about the
earths resources, the long-term consequences of its decisions, and its obligation to
the future.
Economics has much to contribute to this evolution, in large part because of
the interdependence between market decisions and nature. The fundamental con-
cepts of price and optimizing behavior can be used to analyze the effectiveness of
environmental policy and to develop alternative solutions. As we explore the disci-
pline of environmental economics, we will use these same concepts to study the
effects of pollution as well as the public policy and private responses to the associ-
ated risks.
As this chapter suggests, there is a lot of ground to cover, but the importance and
relevance of the issues justify the effort. Environmental economics, much like the prob-
lem it examines, presents both a challenge and an opportunitya characterization
drawn from the opening address to the Rio Summit:
The Earth Summit is not an end in itself, but a new beginning. The road beyond Rio
will be a long and difficult one; but it will also be a journey of renewed hope, of excite-
ment, challenge and opportunity, leading as we move into the 21st century to the dawn-
ing of a new world in which the hopes and aspirations of all the worlds children for a
more secure and hospitable future can be fulfilled.11

11
Maurice F. Strong, UNCED secretary-general, in his opening address to the UNCED Conference on
Environment and Development, Rio de Janeiro, Brazil, June 3, 1992, as cited in Haas, Levy, and
Parson (October 1992), p. 7.
 CHAPTER 1 The Role of Economics in Environmental Management
Summary
The circular flow model is the basis for modeling
the link between economic activity and nature.
The relationship between economic activity and the
natural environment is illustrated by the materials
balance model.
The first law of thermodynamics asserts that
matter and energy can be neither created nor
destroyed. The second law of thermodynamics
states that the conversion capacity of nature is
limited.
Pollution refers to the presence of matter or energy,
whose nature, location, or quantity produces unde-
sired environmental effects. Some pollutants are
natural; others are anthropogenic.
Sources of pollution are sometimes grouped into
mobile and stationary sources. Another common
classification is to distinguish point sources from
nonpoint sources.
Local pollution problems are those whose effects do
not extend far from the polluting source.
Regional pollution has effects that extend well
beyond the source of the pollution.
Global pollution problems are those whose effects
are so extensive that the entire earth is affected.
Among the most critical environmental objectives
are environmental quality, sustainable develop-
ment, and biodiversity.
Review Questions
1. a. State how each of the following factors affects
the materials balance model: (i) population
growth; (ii) income growth; (iii) increased
consumer recycling; (iv) increased industrial
recycling; (v) increased use of pollution preven-
tion technologies.
b. Assume that stringent pollution controls are
placed on the flow of residuals released into
the atmosphere. According to the materials
balance model, what does this imply about
the residual flows to the other environmental
media and/or the flow of inputs into the
economy?
23
The National Environmental Policy Act (NEPA)
guides the formulation of U.S. federal environmental
policy and requires that the environmental impact of
all public policy decisions be formally addressed.
The underlying tool that guides policy planning is
risk analysis, which comprises two decision-making
procedures: risk assessment and risk management.
Risk assessment is a scientific evaluation of the rel-
ative risk to human health or the ecology of a given
environmental hazard. Risk management refers to
the process of evaluating and selecting an appropri-
ate response to environmental risk.
Two economic criteria used in risk management
are allocative efficiency and cost-effectiveness.
Environmental justice, an environmental equity
criterion, considers the fairness of the risk burden
across geographic regions or across segments of the
population.
A command-and-control policy approach uses limits
or standards to regulate environmental pollution.
A market approach uses economic incentives to en-
courage pollution reduction or resource conservation.
Management strategies have a short-term orienta-
tion and are ameliorative in intent.
Pollution prevention strategies have a long-term
perspective and are aimed at precluding the poten-
tial for further environmental damage.
2. a. Why is design for recycling, as practiced by
BMW Group and discussed in Application 1.1,
important to the environment?
b. Explore the design for recycling approach
employed by another automobile manufac-
turer, such as Toyota or another manufac-
turer, and compare it to that of BMW
Group.
3. Faced with the oil crisis of the mid-1970s, the U.S.
Congress instituted Corporate Average Fuel
Economy (CAFE) standards. These have been
increased over time, most recently in 2010 for the
20122016 model years. (For detail on the CAFE
24 MODULE 1 Modeling Environmental Problems
standards, visit the Web site of the National Highway
Traffic Safety Administration, www.nhtsa.dot.
gov/fuel-economy.) These standards are aimed at
increasing the fuel economy, or miles per gallon
(MPG), of automobiles.
a. Briefly describe the expected environmental
effect of increasing the MPG of automobiles,
holding all else constant.
b. Serious criticism has been lodged against the
CAFE standards because U.S. automakers res-
ponded by using more plastics in automobiles
(to make the cars lighter in weight) to meet the
more restrictive CAFE standards. Explain how
the use of this technology affects your answer
to part (a). Are there any other relevant issues
associated with this manufacturing decision?
Additional Readings
Anonymous. Money Can Grow on Trees. The Econ-
omist (September 25, 2010), p. 6.
Aronsson, Thomas, and Karl-Gustaf Lfgren. Hand-
book of Environmental Accounting. Northampton,
MA: Elgar, 2011.
Bartelmus, Peter, and Eberhard K. Seifert. Green
Accounting. Burlington, VT: Ashgate, 2003.
Beierle, Thomas C., and Jerry Cayford. Democracy in
Practice: Public Participation in Environmental
Decisions. Washington, DC: Resources for the
Future, 2002.
Bennett, Jeff, ed. The International Handbook on Non-
Market Environmental Valuation. Northampton,
MA: Elgar, 2011.
Cohen, Mark A. Deepwater Drilling: Recommenda-
tions for a Safer Future. Resources, No. 177
(Winter/Spring 2011), pp. 2327.
Commoner, Barry. Economic Growth and Environ-
mental Quality: How to Have Both. Social Policy
(Summer 1985), pp. 1826.
Gertner, John. The Rise and Fall of the G.D.P.
New York Times Magazine (May 13, 2010),
pp. 6071.
Goldman, Rebecca L. Ecosystem Services: How Peo-
ple Benefit From Nature. Environment 52(5)
(September/October 2010), pp. 1523.
4. Using the data in Table 1.2, graphically illustrate
the relationship between a countrys per capita
GDP and its per capita municipal waste genera-
tion. What conclusion can you draw from your
graphical analysis?
5. Use your knowledge of economic principles to
discuss how the market premise operates under
the polluter-pays principle.
6. Reconsider the problem of U.S. wetlands loss
and the implications for biological diversity.
Briefly contrast how a command-and-control
policy approach to this problem would differ
in intent and implementation from a market
approach.
Hahn, Robert W. The Impact of Economics on Environ-
mental Policy. Journal of Environmental Economics
and Management 39(3) (May 2000), pp. 37599.
Hecht, Joy E. National Environmental Accounting:
Bridging the Gap Between Ecology and Economy.
Washington, DC: Resources for the Future, 2005.
Klyza, Christopher McGrory, and David Sousa. Amer-
ican Environmental Policy, 19902006: Beyond
Gridlock. Cambridge, MA: MIT Press, 2008.
Landy, Marc K., Marc J. Roberts, and Stephen
R. Thomas. The Environmental Protection Agency:
Asking the Wrong Questions: Nixon to Clinton.
New York: Oxford University Press, 1994.
Metrick, Andrew, and Martin L. Weitzman. Conflicts
and Choices in Biodiversity Preservation. Journal
of Economic Perspectives 12(3) (Summer 1998),
pp. 2134.
Najam, Adil, Janice M. Poling, Naoyuki Yamagishi,
Daniel G. Straub, Jillian Sarno, Sara M. DeRitter,
and Eonjeong Michelle Kim. From Rio to Johan-
nesburg: Progress and Prospects. Environment
44(7) (September 2002), pp. 2637.
Nordhaus, William D. New Directions in National
Economic Accounting. American Economic
Review, Papers and Proceedings 90(2) (May
2000), pp. 25963.
 CHAPTER 1 The Role of Economics in Environmental Management 25

Parry, Ian W. H., and Felicia Day. Issues of the
Day: 100 Commentaries on Climate, Energy, the
Environment, Transportation, and Public Health
Policy. Washington, DC: Resources for the Future,
2010.
Polasky, Stephen. The Economics of Biodiversity Con-
servation. Burlington, VT: Ashgate, 2002.
Portney, Paul R. EPA and the Evolution of Federal
Regulation. In Paul R. Portney and Robert
N. Stavins, eds. Public Policies for Environmental
Protection. Washington, DC: Resources for the
Future, 2000, pp. 1130.
Solow, Robert M. Sustainability: An Economists
Perspective. In Robert N. Stavins, ed. Economics
of the Environment: Selected Readings. New York:
Norton, 2005, pp. 50513.
Stavins, Robert N. Environmental Economics and
Public Policy. Northampton, MA: Elgar, 2001.
Stroup, Richard L. Economics: What Everyone Should
Know About Economics and the Environment.
Washington, DC: Cato Institute, 2003.
Venkataraman, Bhawani. Why Environmental Edu-
cation? Environment 50(2) (September/October
2008), p. 8.
Wonacott, Peter. Polluters in China Feel No Pain.
Wall Street Journal Online, March 24, 2004.
______. Green Groups Move To Clean Up China.
Wall Street Journal Online, June 14, 2004.

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