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Chapter 16/Externalities, the Environment, and Natural Resources
CHAPTER 16
EXTERNALITIES, THE ENVIRONMENT, AND
NATURAL RESOURCES
The principal theme of Chapter 16 is that some simple economic principles can help us to
CHAPTER OUTLINE
PART 1: THE ECONOMICS OF ENVIRONMENTAL PROTECTION
Environmental problems have been around for a very long time but the attention we have
been giving to them collectively as a nation and throughout the world has increased
dramatically.
REVIEW—EXTERNALITIES: A CRITICAL SHORTCOMING OF THE
MARKET MECHANISM
Remember that the market tends to create an undesired abundance of damaging externalities.
In this chapter we focus on one of the most publicized externalities—pollution.
The Facts: Is the World Really Getting Steadily More Polluted?
Our society faces serious environmental problems.
However, we should realize that many of our environmental problems have improved
significantly in recent years.
The Role of Individuals and Governments in Environmental Damage
Firms create pollution, but so do private individuals and governments.
Pollution and the Law of Conservation of Matter and Energy
Nothing can disappear completely.
BASIC APPROACHES TO ENVIRONMENTAL POLICY
The three principal policy approaches are:
1. Voluntary efforts—this has proved to be unreliable, but have their place where
appeals to people’s consciences are the only alternative.
Chapter 16/Externalities, the Environment, and Natural Resources
Emissions Taxes versus Direct Controls
Direct controls have two serious problems: enforcement issues and inefficiencies in the
cleanup.
Enforcement Issues
Enforcement of direct controls requires vigilance and enthusiasm by the regulatory agency
and also depends upon the speed and rigor of the court system.
Efficiency in Cleanup
A second important advantage of emissions taxes is that they tend to cost less than direct
controls.
Advantages and Disadvantages
In three important situations, direct controls have a clear advantage:
1. An emission is so dangerous that it must be prohibited altogether.
Another Financial Device to Protect the Environment: Emissions Permits
Another way for the government to control pollution is to sell or auction emissions permits.
Emissions permits in many ways work like a tax—they make it too expensive for firms to
TWO CHEERS FOR THE MARKET
Through appropriate legislation, the forces of the market can be harnessed to correct the
market’s own failings.
Chapter 16/Externalities, the Environment, and Natural Resources
PART 2: THE ECONOMICS OF NATURAL RESOURCES
ECONOMIC ANALYSIS: THE FREE MARKET AND PRICING OF
DEPLETABLE RESOURCES
A reliable indicator of the availability of depletable resources is the price of the resource.
Scarcity and Rising Prices
As resources become scarcer, their prices will rise.
Supply-Demand Analysis and Consumption
As the stock of a depletable resource is used up, its price in a perfectly competitive market
ACTUAL RESOURCE PRICES IN THE TWENTIETH CENTURY
In fact the real prices of natural resources have grown much slower than the rate of interest, if
at all.
Interferences with Price Patterns
Three factors have interfered with the pattern of increasing resource prices:
1. Unexpected discoveries of reserves whose existence was previously not
suspected.
Is Price Interference Justified?
In a free market, quantity demanded can never exceed quantity supplied, even if a finite
resource is undergoing rapid depletion.
On the Virtues of Rising Prices
Rising prices help to control resource depletion in three ways:
1. Promote conservation by discouraging consumption and waste.
2. Stimulate more efficient resource use by industry.
3. Encourage innovation through the discovery of alternate resources and
techniques.
Chapter 16/Externalities, the Environment, and Natural Resources
PUZZLE RESOLVED: GROWING RESERVES OF EXHAUSTIBLE
NATURAL RESOURCES
MARGIN DEFINITIONS
Externality: an activity that causes incidental benefits or damages to others not directly involved
in the activity, and no corresponding compensation is provided to or paid by those who generate
the externality.
MAJOR IDEAS
1. Both planned and market economies suffer from substantial environmental problems.
2. Industrial activity causes environmental damage, but so does the activity of private
individuals and government agencies.
3. Environmental problems are often the consequence of externalities, and they can be
addressed by government policies that compensate for the externality.
ON TEACHING THE CHAPTER
This is a good occasion for students to apply the economic concepts that they have learned in
earlier chapters. The sections on environmental pollution are an expansion of the concept of
externalities that was introduced in Chapter 15, and instructors may want to refer back to that
earlier chapter. The material on natural resource depletion is based on simple ideas of supply and
Chapter 16/Externalities, the Environment, and Natural Resources
source of the problem in the first place and should therefore be supplanted. Instructors can use
this skepticism to lead their students into some genuine learning, as they grapple with the
strengths and weaknesses of the price system.
