Economics & the Environment

Kolstad: Chapter 1

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 Introduction
• Kolstad defines the following three fields of study in economics namely, environmental

economics, ecological economics and resource economics

• The broad definition of these fields and their paradigm is given as follows:

ENVIRONMENTAL ECONOMICS

• Environmental economics tend to involve economists with their discipline being environmental

economics

• This branch of economics often tends to be positive i.e. “what is” 2

• According to Kolstad, environmental economists believe “the value of a good stems

from its embodied content of multiple scarce factors (including energy) as well as how

much value individual people place on the final good and it involves question of

excessive production of pollution by the market or insufficient protection of the

natural world due to the market failure”

• It is concerned with the issues like why markets would not function correctly and why

as a consequence there will be too much of certain things (like pollution) and too less

of certain things (like wild animals, forests, scenic areas, etc.)

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 ECOLOGICAL ECONOMICS
• Ecological economics tend to involve ecologists who study humans and economy which has a

multi – disciplinary involving practitioners from a wide variety of fields who wish to study

environment – society interface

• According to Kolstad, “this branch is primarily normative i.e. what society should do rather

than what it does and takes a biophysical view of value as they would measure value in

terms of embodied energy content

• In this paradigm, while comparing a type writer and computer, the appropriate question

would be which took more energy to create?

• The less energy is used, the better it is” 4

 RESOURCE ECONOMICS

• Resource economics is concerned with production and use of renewable and non –
renewable natural resources
• This economics’ branch is concerned with dynamic issues i.e. time involved
• According to Kolstad, “essentially it is the time what makes the resources renewable
(fisheries, forests, etc) and non – renewable (Alps, species of plants and animals, etc)
• How fast we extract the non – renewable resource will determine its scarcity and its price
in future
• For instance, if we log a forest slowly enough, the forest can regenerate itself and we can
continue to log indefinitely
• It is, therefore, time rather than failure of markets to operate properly that is the essence
of environmental problems”
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• Envt. Economics is concerned with:

1. Impact of Environment on Economy

2. Impact of Economy on Environment

3. Appropriate way of regulating economic activity to ensure balance

between environmental, economic and other social goals.

• The essence of environmental problem is economy (producer

behavior + consumer desire).
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 Scope of Environmental Economics as a Discipline

• Environmental economics is considered both as positive (what is) and normative

science (what ought to be)

• It also covers both micro and macro aspects of different pollution problems

Why is it a positive science (more quantitative)?

• Environmental economics is an application of scientific theories and general

application of welfare economics

• When we study the cause and effect relationship, it covers the positive aspect8
 Why is it a Normative Science??

• If the problem is related to policy measures, then it is considered as

normative aspect

• Therefore, environmental economics is a normative science because it

prescribes the goals of environmental policy

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 Environmental Policy

• The neoclassical economics mainly deals with efficient allocation of resources through
market mechanism

• In the production process, in addition to the private (or public) good, public 'bad' also
emerges in the form of solid, liquid, gas or noise pollution

• For example, when production of cement takes place, there is emission of dust and
harmful chemicals into the atmosphere

• Neoclassical theory with its emphasis on market mechanism takes care of the production
of cement (in this case) but ignores the management (production, pricing, control) of air
pollution arising out of cement production
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• Public bad is produced not only during production activities and but also in the

course of consumption

• For example, when we consume packaged food, we throw away the polythene

cover (which is not biodegradable) here and there as a result of which land

pollution takes place

• The management of public bad is beyond the scope of the neoclassical analysis

and therefore is usually ignored

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Environmental Quality

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 ENVIRONMENTAL REGULATION 

• Different economies have responded to the environmental problems in different ways

• Kolstad, in this Chapter focuses on primarily the two ways – Regulatory Approach and
Economic Incentives – which are used to deal with environmental problems in three
economies namely USA, European Union and Russia 
EUROPEAN UNION 
1.) REGULATORY APPROACH – Kolstad in this Chapter, explains two basic principles of EU
environmental policy

• The first one is the principle of “subsidiarity” – which leaves all the power to the
individual member states unless there is an abiding reason to take action at the 
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 2.) THE USE OF ECONOMIC INCENTIVES 
• Kolstad outlines in this Chapter the long history of EU of using economic incentives for
the purpose of economic regulation among which the predominant type is – emission fee

• It is important to note that the economic incentives given in EU are more of revenue
raising in nature rather than incentive giving i.e. the charges are way too low to provide
any incentive to firms to reduce the pollution, rather these charges were only sufficient
to cover the administrative costs of the pollution controlling agencies

• For example, Kolstad notes that the German water pollution charge which was instituted
in 1976 and implemented in 1981 is just a charge which covers administrative costs

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• However, in some member states in EU the use of economic incentives seem

to be more effective

• For instance, the fee charged in the Netherlands on the discharge of the

organic material into sewer systems was efficient because rather than a flat

rate it was based on the amount of load of the sources that is put into the

treatment plant

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 RUSSIAN FEDERATION
1. REGULATORY APPROACH – Kolstad discusses this approach as adopted in 1970s in Russia

• Some additional air and water pollution controls were set up and the regulatory approach
was dependent on the health based ambient standards which in turn, were based on the
national level health information

• The author notes that the best feature of these standards were/are that they aren’t
absolute and depend upon the ambient environment

• For instance, the ambient standard for water would vary according to the use of water –
for drinking, for fishing or for recreation 

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2.) THE USE OF ECONOMIC INCENTIVES – Kolstad notes that Russia makes use of emission
fee extensively

• The original intent of charging emission fee was for financing of environmental funds and
these funds were used to pay for the environmental protection as well as for the correction
of damages

• Each polluter was required to contribute to this fund depending o their emission levels

• There are two levels of emission fee – (a) A base level for the emissions under the emission
limits for the facility and (b) A level 5 times higher than the prescribed limit for the
emissions higher than the limit

• However, it has been noted that for most of the times, most of the emission fee charged
was too low to provide any incentive for pollution control 34
 UNITED STATES OF AMERICA 

1. REGULATORY APPROACH – Kolstad in this Chapter notes that major national environmental
legislation was passed in 1960 and emission standards were established for the automobiles

• In order to control the existing sources, states were free to decide the ways and means and
charges or fee if any, were to be charged

• This was followed by a regulation for the automobile manufacturing where manufacturers were
required to install anti-pollution devices in new cars and for the new sources of pollution

• Central / Federal government passed on the rules on ambient environment quality and states
were supposed to draw up the plans specific to their local conditions which would be then
approved by the Federal government
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• The Environmental Protection Agency (EPA) established in 1970 decided for the
existing and for the new sources – an industry by industry pollution control plan

• Toxic regulation for different categories is done in three different ways – toxic
governed by the occupational safety and Health Administration; the
generation, transportation and disposal of the toxic is regulated by the
Environmental Protection Agency and the regulation regarding accident causing
toxic (accidents caused due to improper handling or accidental leakage) or the
discovery of an old toxic site is governed by Comprehensive Environmental
Response, Compensation and Liability Act (CERCLA) of 1978 
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2.) THE USE OF ECONOMIC INCENTIVES – Kolstad finally discusses the major
experiment that was done for the first time i.e. giving economic incentives, as a part of
the environmental regulation in USA

• Author notes that experiment with marketable emission permits for sulphur has been
one of the best or most successful experiments in US for decades

• Under this experiment, a system of marketable permits was established the projected
level of costs or price per tonne of sulphur was $500 but after the permits were issued
and were marketable then the price dropped to $65 per tonne

• In the present chapter, Kolstad discusses more such experiments or a type of

economic incentives  37
• Widespread adoption of the volume based pricing for municipal solid
waste i.e. a fixed monthly fee to the household paying for each bag
(the per bag pricing) for disposal services

• Another marketable permit system was used to phase out the lead in
gasoline in early 1980s which was very successful

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 Question
1.) Explain the link between economy and environment. Also elaborate
on the interlinked disciplines with regard to this. What’s the
significance of environmental economics today? (15 marks)

2.) Explain the significance of environmental regulation (10 marks)

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