Environmental Economics

For centuries, traditional economics has been used to explain how people can create wealth and improve their lives through the supply and demand of goods and services. Starting in the 1960s, however, people began to realize that traditional economics failed to take into account other factors that greatly influenced quality of life, such as social welfare and the environment. Thus, environmental economics was born.
Environmental economics seeks to measure the external environmental effects, or costs, of economic decisions and propose solutions to mitigate or eliminate those costs to better manage natural resources and promote social well-being. Unlike traditional economics, which focuses on private ownership of property, environmental economics primarily concerns itself with the management of common or public property, such as lakes, rivers, game and parks.

Environmental economics functions on the theory of “market failure.” Simply stated, market failure occurs when markets fail to efficiently allocate limited resources in a way that benefits society most. For example, assume that a town has a large, freshwater lake. A parts manufacturing facility, responding to a market demand for car parts, moves into the town and begins using the lake water to process the parts. Without pollution controls in place, the water is soon contaminated, becoming unsafe to drink and killing all the fish. Since the lake was the town’s main source of food, recreation and drinking water, its citizens are forced to move away to find a new water source–leaving the manufacturing facility without a ready labor pool or a nearby consumer base. As a result, the company’s labor and shipping costs increase dramatically. Though the company simply responded to market forces by using the lake, its actions resulted in massive inefficiency caused by environmental degradation. Environmental economists seek to remedy such inefficiency by establishing environmental regulations, pollution quotas and property rights so that market suppliers can become wealthy without negatively impacting others.

Types of market failure include externality, non-exclusion and non-rivalry. Externality refers to the effect of an economic choice that is not factored into a product’s price. Non-exclusion exists when restricting someone’s access to a resource would be too costly. Non-rivalry means that a benefit provided to one individual, business or country can be enjoyed by others, reducing the incentive for economic actors to contribute to the public good. Some aspects of all of these can be seen in the example above. Because the lake was common property, the manufacturing facility was able to use it freely (non-exclusion). With unlimited use of the resource and no pollution controls in place, the facility could cheaply produce many parts to meet demand (externality). The townspeople had up until then kept the lake clean and properly managed, from which the company benefited without ever contributing to it (non-rivalry).

In order to address these market failures, environmental economists must first assess the value of environmental resources and assets. This can be quite tricky, since environmental resources are often viewed as having value beyond their economic use. People may want to preserve resources for undiscovered future use, to bequeath to future generations, or to simply enjoy their existence. Economists can calculate a resource’s non-use value by researching nearby land values, surveying the public, or examining what people are willing to pay to access or protect the resource. Once the value of the environmental asset is determined, economists can then establish policies that will preserve the long-term viability of the resource while still allowing it to be used for economic gain. Thus, environmental economics plays an important role in managing and allocating scarce natural resources.