Short summary of environmental economics with clarifications from book to the slides!
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Module
Environmental Economics, (30L304B6)
Institution
Tilburg University (UVT)
Book
Natural Resource and Environmental Economics
This summary comprises both the book and the lecture slides. As the slides are somewhat vague sometimes, I read the book and added this to the summary to make things more concrete.
Week 1: chapter 2
How can we alleviate poverty while also considering environmental perspectives?
There are different types of natural resources:
- Resource economics: here, the resources are used as input in the production
o Examples include non-renewables and renewables
- Environmental economics: here, the resources are used as services
o Life support (water, air), recycling, amenity (direct welfare)
- Complex interactions
o River (serves as drinking water, cooling for plants, waste sink, landscape,
etc.).
o Climate change
This course covers the following topics:
- Non-renewable resources
o Hotelling rule is known as the rule that helps us to decide at an oil producer
(for example) would like to sell his stock, or the optimal path of extraction.
o The main characteristic of non-renewables is the finite cumulative supply and
that those are the essential inputs in production.
o Important to early industrial economics
o Fossil fuel combustion is an irreversible process in that there is no way in
which the input fuel can be even partially recovered after combustion. In so far
as coal, oil and gas are used to produce heat, rather than as inputs to chemical
processes, they cannot be recycled. Minerals used as inputs to production can
be recycled.
- Renewable resources
o This will help us to determine the optimal management of forests and fish
stocks: how much do we harvest each year, will the optimal choice lead to
depletion of the stocks?
o Main characteristic is that the resources regenerate, but they can become
exhausted (=extinct).
o Important for economies where harvesting possibilities exceed the natural
regeneration capacity.
o Important for economies that have access to open resources (open sea).
- Complex environmental interactions
o Rivers, acid rain, climate change.
o For climate change: what is the optimal level of pollution? How much is
acceptable each year?
o Main characteristic of these interactions is that it regenerates, but it is
complicated and sometimes irreversible.
o Important for economies where emissions exceed the natural absorption
capacity.
, o Important for economies that share the same environmental recourse.
Substitution in resource economics
In resource economics, the main option for management is substitution. Meaning that people
try to find alternative resources instead of the (non-)renewables. For example, this could
include greenhouses with artificial light and heating for land, reproducible capital (wind,
solar, bio) or substituting vegetables for meat. The main problem with this is mainly
technical. Innovation stops us from doing these things in some cases.
Substitution in environmental economics
In environmental economics, we find less polluting production methods, end-of-pipe cleaning
technology. There are economists that favor weak sustainability and believe in good
substitution. This means that people believe that there are good substitution options in
preference sets (people are okay with giving up certain species to get a higher wealth; money
substitutes for nature), and this promotes weak sustainability. However, some economists
believe the opposite. The problem of substitution in environmental economics is mainly on
either technology, preferences or ethics.
IPAT identity
The drivers of environmental impact are identified using the IPAT identity:
I = P*A*T
Where,
I = impact (e.g., CO2 emissions, waste), measured in tCO2/year
P = population, measured in billions of people
A = per capita affluence, measured in €/cap year (also known as GDP per capita)
T = technology (resource use per unit), measured in tCO2/€
The terms on the right-hand side need to be independent. This is the reason why some
economists do not believe in this identity. You need to take into account that there is a
composition effect in most cases. When the population decreases, there is less capacity to
produce. Reducing the number of rich people, also decreases waste more than when poor
people die.
Poverty and inequality
There may be so many poor in relation to the size of the better-off group that the
redistributive solution to the problem of poverty is simply impossible – the cake is not big
enough to provide for all, however thinly the slices are cut.
Growth can be the solution to alleviate poverty, but redistribution or equal chances might be a
solution as well. The problem, however, is that poverty and environmental degradation have
the same cause: corrupted institutions.
Growth models
Meadows c.s claimed that environmental limits would cause the collapse of the world
economic system in the middle of the twenty-first century. He assumes exponential growth
and concludes that this is impossible with a finite earth.
Green growth = direct innovation towards quality of products, efficient processes, a circular
economy, reducing material throughput.
Sustainable development
, - Ecological sustainability (“planet”)
- Economical sustainability (“profit”)
- Social sustainability (“people”)
this course is focused on interaction between economy and ecology.
Week 2: chapter 15
What is the optimal extraction path over time for non-renewable resources?
We will discuss a 2-period model with non-renewable resources with the following
assumptions:
- Price function is the derivative of the utility function. P(R) = a-bR where R is the
quantity of the non-renewable resource.
- Utility depends on resource extraction.
- Elasticity of the price function = -P/R * dR/dP. The elasticity decreases when supply
drops to zero. Elastic in the case that elasticity exceeds |1|, inelastic otherwise.
- Demand increases if a increases or b decreases. A is the choke price, b is the
sensitivity of demand for prices (not elasticity).
- CS = utility – P*R
- 2 types of demand functions; a linear demand and a constant-elasticity demand.
o Constant elasticity demand =
- Time preference is indicated with the real interest rate: 𝜌 = 𝑟
- NPV utility = U = U1 + U2/(1+r) utility in period 1 + utility in period 2 discounted
by the interest rate. Utility measures the social welfare from consuming the resource.
- CS = CS1 + CS2/(1+r). CS in linear demand case = ½ (a-P)Q
- No environmental externalities
- No technological change
- Known fixed initial stock of the resource: S (sometimes R)
- For the producer, we assume zero extraction costs, such that the PS = profits.
- PS = P1*R1 + P2*R2/(1+r)
- Economic exhaustion is not about how much resources there are available (physical
exhaustion), but about how much to extract and still make profits.
2-period model, welfare optimization
When we maximize welfare in this 2-period model, we do the following:
This can be solved using the Lagrangean:
Set all first order conditions (with respect to R1, R2 and S) equal to 0 and solve using
substitution.
However, a much easier way is to apply Hotelling’s rule: 𝑃2 = (1 + 𝑟)*𝑃1
The Hotelling rule comes from a no-arbitrage relationship between period 1 and 2. This is
because the owner of the resource can choose to extract one more unit now and receive P1,
and have (1+r)*P1 in the next period, or he can choose to extract the unit in the second period
and receive P2. To be indifferent between those choices, the Hotelling rule applies.
Hotelling rule in continuous time:
Hotelling’s rule says that resource prices (net of extraction costs) grow at the interest rate.
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