UNIVERSITY COLLEGE LONDON MASTER OF SCIENCE IN ENVIRONMENTAL AND RESOURCE ECONOMICS pdf

Objectives At the end of the course, students should: • have a good appreciation of the economic theory of externalities in the form of pollution and environmental hazards, the market

UNIVERSITY COLLEGE LONDON MASTER OF SCIENCE IN ENVIRONMENTAL AND RESOURCE ECONOMICS

Economic Principles and the Environment

Professor Stephen Smith

Course outline and reading list, 2007/2008

Course lecturer

Stephen Smith Office hour: Mondays, 3.30 - 4.30 pm Room 3.27 Drayton House email: stephen.smith@ucl.ac.uk

Lecture and tutorial class times

9 two-hour weekly lectures, on Mondays, 10-12, starting 8 October

4 tutorial classes to discuss problems and written work, 4pm, Mondays 6/11, 13/11, 27/11, 11/12

Aims

To provide students with a thorough understanding of core economic theory concerning environmental problems and policies, as a foundation for subsequent study of environmental problems and policies within the degree programme, and

as one of the key elements in the professional training of an environmental economist

Objectives

At the end of the course, students should:

• have a good appreciation of the economic theory of externalities in the form of pollution and environmental hazards, the market failures that can arise from externalities in an unregulated market economy, and the scope and limits of individual "Coasean" bargaining to resolve externalities without regulatory intervention;

• have a good understanding of the economic theory relating to the choice of instruments for pollution control, including the relative merits of policies based on "command-and-control" and "market mechanisms";

• have the ability to read and interpret economic models of externalities and environmental regulation expressed

in standard mathematical notation, and have had some experience of reading and interpreting original journal articles on this subject

Syllabus

This course sets out the economic theory relating to pollution and other externalities It covers:

• the definition of externalities, economic welfare in the presence of externalities, the Coase theorem, public goods, problems of preference revelation;

• the choice of instruments for environmental protection, including the relative merits of regulatory standards and

"market mechanisms" such as Pigouvian taxes and tradeable permits;

• economic analysis of the enforcement of environmental regulations;

• problems in the efficient regulation of environmental hazards

• the theory of environmental policy in a multi-jurisdictional world

Required coursework

• A class presentation (jointly with another student), based on readings to be assigned

• Preparation of answers to a set of short-answer questions, to be submitted by the lecture in week 8 Question set to

be distributed later

• An essay (maximum 1500 words) to be submitted by the end of term Titles to be distributed later

• Note that although the coursework grades do not count in the final assessment, the coursework is compulsory

Examination format

The course will be examined by a two-hour written examination This will consist of two parts, each accounting for half

This course outline tries to give a brief flavour of the material which will be covered in the course, highlighting the debates and issues which the course addresses Although the course is a theory course, the selection of the material to

be covered aims, as far as possible, to concentrate on theory which will be useful in understanding policy debates Many

of the issues studied in this course will reappear in other parts of the degree programme (for example in the policy courses on "European Environmental Policy", "Global Environmental Problems" and "Environment and Development" in the second term)

The function of this course is to equip you with an understanding of the theory which underpins these policy issues, and with the ability to read and interpret theoretical papers in this field The course therefore makes considerable use of formal theory and notation Although it is most important that you should understand the intuition behind the theoretical models (the "essence" of the argument), it is also important that you should feel comfortable with the way in which theoretical models are expressed

Reading

Much of the reading list consists of journal articles, making key advances in the theoretical literature You should try to read these carefully, at least one or two a week, in parallel with the course You may not find this easy Some of them, for example, make references to other papers which you will not have read, or presume familiarity with a debate which was current at the time when they were written However, you will find some of the other readings helpful in providing explanations or alternative formulations of the arguments You should not expect to understand everything at first reading, and you will probably find that if you re-read the first papers after you have finished the course as a whole that you understand much more than you did the first time

Also, if you have not read original economic theory papers before (or indeed, if you have not done much economics before), you may find these papers quite a shock Don't be unduly alarmed, and don't let yourself get stuck for too long with a paper that you can't understand Move on to something else, and come back to it after a few weeks; you'll often find that what you have learned in the meantime has helped to make sense of the paper

Textbooks

The textbook for this course is:

Charles D Kolstad, Environmental Economics, Oxford University Press, 2000

Chapters 1 to 12 of this book provide a good introduction to the topics covered in this lecture course The book is not highly-mathematical, although mathematical notation is used where it helps to make things clearer I like the book, and have chosen to adopt it as a textbook because it provides clear explanations of the intuition behind the theoretical models discussed It is rigorous and precise in its analysis, without overcomplicating things that can be explained straightforwardly and simply It also covers important issues, such as audit, enforcement, and the regulation of hazards, which are neglected in most other environmental economics textbooks

In earlier years when I have taught this course the textbook used was:

W J Baumol and W E Oates, The Theory of Environmental Policy, Second Edition, Cambridge University Press,

Cambridge 1988

This is more formal and mathematical than Kolstad, and more limited in scope (it has nothing on hazards or

enforcement, for example) In many places, it isn't so much a textbook as a compilation of the authors' own papers, and

it feels, to my mind, rather unbalanced in the coverage it gives to different topics However, it has been written by two of the great scholars in this field, and you may find it useful as a supplement for Kolstad on certain topics (and, in some cases, as a bridge between the relatively accessible analysis in Kolstad and the more technical presentation of academic journal articles)

If you find Kolstad, Baumol and Oates and the recommended journal papers too heavy going, there are a number of other rather less technically-demanding textbooks which you may find useful, especially at the start of the course You

might, for example, try:

Perman, R., Y Ma, J McGilvray and M Common (2003), Natural Resource and Environmental Economics,

Harlow: Longman (Chapters 5-8 are the most relevant for this course)

Hanley, N, JF Shogren, and B White, (1997), Environmental Economics in Theory and Practice, London:

Macmillan (Chapters 2 - 6 are the most relevant to this course)

However, don't be tempted to rely on these less-technical books and nothing else You do need to be able to master the material in Kolstad by the end of the course, and you do need to be reasonably familiar with the notation and methods which the theoretical papers use

To begin with

An overview of many of the issues covered in this course (and also of some issues addressed in next term's course on Techniques of Environmental Valuation) is given in:

Cropper, M L and W E Oates (1992), "Environmental Economics: A Survey", Journal of Economic Literature,

Vol XXX, pp 675-740

Lecture schedule

Week

3 Introduction: market failure and externalities

4 Optimal pollution abatement and the Coase Theorem

5 Public goods: Information and preference revelation

6 Market mechanisms versus Command and Control

[Reading week - week 7]

8 Uncertainty and Instrument Choice

9 The Pigovian Tax: Further topics

10 Regulatory compliance and enforcement

11 Hazards

12 Inter-jurisdictional issues

Tutorial class schedule

Week

5 23 October The Coase Theorem

8 13 November Efficiency: Market mechanisms versus Command-and-Control

10 27 November Emissions trading

12 11 December Regulation of environmental hazards

Coursework and tutorial class instructions to follow

Topic 1

Externalities and Public Goods

In economic analysis of environmental policy, a central role is played by the concept of an externality A large number of environmental problems involve externalities - including the human health effects from lead emissions by motor vehicles, the nuisance caused to local residents by aircraft noise at airports, the various social and economic consequences of climate change due to "greenhouse gas" emissions, etc We will start by defining the concept of an externality

If there are no externalities present, and given certain other conditions, an unregulated, perfectly-competitive market economy may achieve the socially-optimal ("efficient") outcome If externalities are present, however, the outcome from

an unregulated market economy may fall short of the social optimum We will consider the meaning of these claims, and set out a formal model in which an externality leads to an inefficient, sub-optimal, outcome We will then go on to consider some cases where an efficient solution might be possible even where externalities are present

The problems arising from externalities are closely linked to the definition of "property rights" A key paper by Coase (1960) argues that bargaining between individuals will achieve efficient solutions to externality-type problems, if property rights are clearly defined We will consider the circumstances in which the "Coase theorem" holds, and will introduce some of the problems which arise with bargaining solutions when many individuals are involved A key idea here is the idea of the "prisoner's dilemma" - even though it may be in everyone's interest that cooperation should take place (for example to get together to bribe a local polluter to stop polluting), it may be in no-one's individual interest to cooperate (everyone may do better by trying to "free ride" on the collective actions of others, without contributing anything

themselves)

This leads us to think more generally about the problems of information which arise when externalities are present If individuals try to "free ride", how do we know how much environmental protection they want? We discuss some of the

"preference revelation" mechanisms (including the Clarke/Groves/Ledyard mechanisms and Lindahl prices) which have been suggested as ways to obtain accurate information about individual preferences, uncontaminated by incentives for various types of "strategic" response

Readings:

You might find it useful to start by reading a standard textbook treatment of externalities, such as:

Varian, HR (1987) Intermediate Microeconomics A Modern Approach, New York and London: Norton, Chapter 31

"Externalities"

Joseph E Stiglitz (2000) Economics of the Public Sector, Norton Chapter 9 Externalities and the Environment

(a) Definition of externalities

W J Baumol and W E Oates, The Theory of Environmental Policy, Second Edition, Cambridge University Press,

Cambridge 1988 Chapters 2 and 3

Newbery, DMG (1980) "Externalities: the Theory of Environmental Policy", Chapter 4 (pp 106-149) in GA Hughes and

GM Heal (eds) Public Policy and the Tax System, London: Allen and Unwin

Cornes R and Sandler T, (1996) The Theory of Externalities, Public Goods and Club Goods, Second Edition, Cambridge

University Press Chapter 3, "Theory of Externalities"

(b) Public goods

Varian, HR (1987) Intermediate Microeconomics A Modern Approach, New York and London: Norton, Chapter 32

"Public goods"

Joseph E Stiglitz (2000) Economics of the Public Sector, Norton Chapter 6 Public Goods and Publicly-Provided Private

Goods

(c) Formal model with inefficiency

Newbery, DMG (1980) "Externalities: the Theory of Environmental Policy", Chapter 4 (pp 106-149) in GA Hughes and

GM Heal (eds) Public Policy and the Tax System, London: Allen and Unwin

Cornes R and Sandler T, (1996) The Theory of Externalities, Public Goods and Club Goods, Second Edition, Cambridge

University Press Chapter 4, "Externalities, Equilibrium and Optimality"

Baumol, WJ and Oates, WE, (1988), The Theory of Environmental Policy, Second Edition, Cambridge University Press

Chapter 4

(d) Property rights and the Coase theorem

Coase, R (1960), "The problem of social cost" Journal of Law and Economics

Turvey, R (1963) "On divergences between social cost and private cost", Economica

Regan DH (1972) "The problem of social cost revisited", Journal of Law and Economics, 15, 427-37

Cooter RD and Ulen (1996) Law and Economics, second edition

Cooter, RD (1989) "The Coase Theorem", in J Eatwell, M Milgate and P Newman (eds) The New Palgrave Allocation,

Information and Markets Macmillan

Stephen, FH (1988), The Economics of the Law, Brighton, Wheatsheaf Books Chapter 3, "The Coase Theorem"

Cornes R and Sandler T, (1996) The Theory of Externalities, Public Goods and Club Goods, Second Edition, Cambridge

University Press Chapter 5, "Externalities and private information"

A Allan Schmid, (1995) "The environment and property rights issues" in Daniel W Bromley (ed) The Handbook of

Environmental Economics, Blackwell Publishers

Joseph Farrell (1987) "Information and the Coase Theorem" Journal of Economic Perspectives, Vol 1, No 2, pp 113-129

Paul Milgrom and John Roberts (1992) Economics, Organization and Management, Prentice Hall Chapter 9 "Ownership

and property rights"

(e) Problems of preference revelation

Mueller, DC (1979) Public choice, Cambridge University Press Chapter 4, "Some new processes for revealing

preferences on public goods"

Cornes R and Sandler T, (1996) The Theory of Externalities, Public Goods and Club Goods, Second Edition, Cambridge

University Press Chapter 7, "Alternative mechanisms for the provision of public goods"

Topic 2

Instrument Choice

Externalities, as we have seen, may give rise to a need for government intervention This intervention could, in principle, take a number of forms The level of polluting emissions from a particular source could be reduced, either through various forms of direct regulation (requiring the polluter to use certain specified pollution control measures, for example,

or to reduce emissions below a given threshold), or through the use of various forms of "market mechanism", including pollution taxes, tradeable permits, or abatement subsidies In this section of the course, we consider the respective merits of the various policy instruments that could be employed

We consider, first, the debate between proponents of direct regulation (or "command- and-control" as it is sometimes characterised) and market mechanisms What are the advantages and disadvantages of each approach?

One central issue in instrument choice is the performance of different instruments under conditions of uncertainty Here the distinction is between instruments which regulate pollution by setting a "price" and those which regulate pollution by setting a "quantity" This does not exactly coincide with the choice between "command-and-control" and market

mechanisms; tradeable pollution permits, for example, are a market mechanism but they fix an aggregate pollution quantity Under what circumstances is a policy which fixes quantity preferable to one which fixes price, and vice versa?

Other issues which we consider in this section include: the problems which "non-convexity" creates for the analysis of efficient instrument choice; the performance of "Pigovian" taxes under monopoly; choice between pollution taxes and subsidies; and the efficient treatment of "victims" (should they be compensated for the pollution "damage" they

experience?)

Readings:

(a) Efficiency arguments for "market mechanisms" rather than "command-and-control"

Baumol, W J (1972), "On taxation and the control of externalities", American Economic Review, vol 62, pp 307-22

Baumol WJ and Oates WE, The Theory of Environmental Policy, Second Edition, Cambridge University Press,

Cambridge 1988 Chapters 11 and 12

Tietenberg, T H (1990), "Economic instruments for environmental regulation", Oxford Review of Economic Policy, vol 6,

no 1, pp 17-33

Atkinson, S E and D H Lewis (1974), A Cost-Effectiveness Analysis of Alternative Air Quality Control Strategies",

Journal of Environmental Economics and Management, vol 1, pp 237-50

Seskin, E P., Anderson, R J., and Reid, R O (1983), "An empirical analysis of economic strategies for controlling air

pollution", Journal of Environmental Economics and Management, vol 10, pp 112-24

(b) "Price" versus "quantity" regulation

Baumol WJ and Oates WE, The Theory of Environmental Policy, Second Edition, Cambridge University Press,

Cambridge 1988 Chapter 5

Adar, Z and JM Griffin (1976) "Uncertainty and the Choice of Pollution Control Instruments" Journal of Environmental

Economics and Management, Vol 3, pp 178-188

Roberts, MJ and Spence, M (1976) "Effluent charges and licenses under uncertainty", Journal of Public Economics, Vol

5, pp 193-208

(c) Monopoly and Pigovian taxes

Baumol WJ and Oates WE, The Theory of Environmental Policy, Second Edition, Cambridge University Press,

Cambridge 1988 Chapter 6

James M Buchanan (1969) "External Diseconomies, Corrective Taxes and Market Structure" American Economic

Review, Vol 59, pp 174-177

Oates, W E and Strassmann, D L (1984) "Effluent fees and market structure", Journal of Public Economics, vol 24, pp

29-46

(d) The choice between taxes and subsidies

Baumol WJ and Oates WE, The Theory of Environmental Policy, Second Edition, Cambridge University Press,

Cambridge 1988 Chapters 14

Rajah, N and Smith, S (1993), "Taxes, Tax Expenditures and Environmental Regulation", Oxford Review of Economic

Policy, Vol 9, No 4, pp 41-65

(e) Indirect Pigovian taxation

Sandmo, A (1976), "Direct versus indirect Pigovian taxation", European Economic Review, vol 7, pp 337-349

Topic 3

Enforcement

This section of the course sets out an economic analysis of the enforcement of environmental regulations The mere existence of a law or regulation restricting polluting emissions may not guarantee that polluters will comply with it, if they see some benefit to them from non-compliance, and if they perceive little corresponding cost in terms of the sanctions for non-compliance Raising the sanctions for non-compliance might be expected to increase the probability that

polluters will comply with the law

The costs involved in non-compliance could be increased either by increasing the risk that non-compliance will be detected (through greater enforcement effort, for example, by increasing the frequency of pollution monitoring and inspection), or by increasing the fines for offenders who are caught What is the optimal balance between these two approaches to enforcement? Should be rely on high fines, or on a lot of monitoring? And are there strategies we can employ for monitoring which are likely to be more cost-effective than simply randomly monitoring each site?

Readings:

(a) General

Charles D Kolstad, (2000) Environmental Economics Oxford University Press Chapter 11: "Audits, enforcement and

moral hazard"

Heyes, Anthony, (1998) "Making things stick: enforcement and compliance" Oxford Review of Economic Policy, Vol 14,

No 4, Winter 1998 Pages 50-63

(b) Optimal enforcement: detection versus penalties

Stigler, GJ, (1970), The optimum enforcement of laws, Journal of Political Economy, Vol 78, 526-36

Polinsky, AM and Shavell S (1992), "Enforcement costs and the optimal magnitude and probability of fines", Journal of

Law and Economics, Vol 35, 133-48

Lee, DR (1984), "The economics of enforcing pollution taxation", Journal of Environmental Economics and Management,

Vol 11, 147-60

(c) Enforcement strategies - revelation

Kaplow, L and S Shavell (1994) "Optimal law enforcement with self-reporting of behavior", Journal of Poliitical Economy,

Vol 102, pp 583-606

Reinganum JF and Wilde LL (1985), "Income tax compliance in a principal-agent framework", Journal of Public

Economics, Vol 26, 1-18

Swierzbinski, J (1994), "Guilty until proven innocent - regulation with costly and limited enforcement", Journal of

Environmental Economics and Management, Vol 27, 127-46.

Topic 4

Hazards

An important class of environmental problems are those involving an unpredictable outcome - environmental hazards, such as the risk of contracting disease through exposure to asbestos at work, or losing the amenity value of a coastline through an oil-spill from a tanker What are the economic issues involved in efficient regulation of environmental hazards such as these?

One key issue is whether the exposure to the hazard arises as the result of an economic transaction between related parties, or whether the hazard affects third parties, previously unconnected in any way In the first case, it is possible that the transaction between the parties has been adjusted to reflect the risks involved; workers in hazardous occupations may, for example, receive higher wages than if they worked in otherwise-equivalent jobs involving less risk How far is it then possible to argue that such voluntary transactions between consenting parties do not require any form of

government regulation?

Another key issue has to do with the choice between two routes to controlling hazards: governments can either try to regulate the types of behaviour liable to give rise to hazards, or they can rely on the courts to provide an incentive for individuals and firms to avoid exposing others to hazards In the latter case, the possibility of tort actions (being sued for compensation) after an accident has occurred gives individuals and firms an incentive to take care to reduce the risk of accidents taking place How should the legal system operate to achieve the most efficient outcomes: should an individual

or firm who causes an accident always be liable to pay compensation ("strict liability"), or should they only be required to pay compensation when they have been negligent ("negligence rule")? What are the circumstances in which policy should rely on tort actions to control hazards, and when should policy step in and regulate hazardous activities directly?

Readings:

Charles D Kolstad, (2000) Environmental Economics Chapter 12: "Risk and Uncertainty" Oxford University Press

Cooter RD and Ulen, T (1996) Law and Economics, second edition Chapter 8, "An economic theory of torts"

Stephen, FH (1988), The Economics of the Law, Brighton, Wheatsheaf Books Chapter 7, "Tort"

Kathleen Segerson, (1995) "Liability and penalty structures in policy design" in Daniel W Bromley (ed) The Handbook of

Environmental Economics, Blackwell Publishers

Shavell, S (1980), "Strict liability versus negligence", Journal of Legal Studies, Vol 9, 1-25

Kolstad CD, Ulen TS, and Johnson GV, (1990), "Ex Post Liability for harm vs Ex Ante Safety Regulation: Substitutes or

Complements?", American Economic Review, vol 80, no 4, 888-901

Shavell, S (1984), "A model of the optimal use of liability and safety regulation", Rand Journal of Economics, Vol 15, No

2, 271-80

Symposium on the Economics of Liability, Journal of Economic Perspectives, Summer 1991, Vol 5, No 3, pp 3-136

(papers by Shapiro, Cooter, Viscusi and Menell)

Paul Burrows (1994) "Products Liability and the Control of Product Risk in the European Community", Oxford Review of

Examination information

The course will be examined by a two-hour written examination

The examination consists of two parts Each part accounts for half the total marks available for the examination, and you are advised to divide your time accordingly

Part A aims to test the breadth of your knowledge of the material taught in the lecture course There are five questions, from which four must be answered There is therefore limited choice, but the questions in part 1 relate closely to the lecture material If you have attended the lectures, and read the textbook readings covering the lecture material, you should be in a position to answer all of the questions on this part of the paper The questions require short, specific answers These questions may, for example, ask to you define or explain a particular concept, explain a diagram or equation, interpret some data, or give a brief answer in response to a specific question You should expect to devote no more than an hour to Part A

You can achieve full marks for Part 1 by giving a precise, clearly-explained answer to the questions set You will not gain extra marks for material other than that needed to answer the question Vague or imprecise answers, inadequately-captioned diagrams or graphs, and inadequate explanations for your answers will, however, be penalised heavily

Part B aims to test the depth of your understanding of the material, and your understanding of its context and

implications There are four questions in Part B, from which you should answer one These questions will require longer answers, in which you will be expected to draw on the lecture material and your wider reading You will be expected to demonstrate your ability to set out a logical, well-organised answer, drawing as appropriate on economic theory, relevant empirical evidence, and practical "real-world" knowledge

You should not expect the questions in Part B simply to ask you to reproduce material from the lectures You need to be able to contribute your own "added value" over and above the lecture material, in the form of your independent reading and thinking about the issues raised in the course

The attached "sample" paper is provided as a guide to the format of the paper and the likely style of the questions

Past papers can be obtained from the library website Note that the course has at times been taught by a different lecturer, and the style of the questions, and the topics covered, have varied