Lecture Changing perspectives on the environment

Main Principles of Environmental Economics

Environmental economics is based on the application of several mainstream economic theories and principles to environmental issues. We can identify the core of environmental economics as being comprised of four concepts:

1. 
   The theory of environmental externalities
   
2. 
   The optimal management of common property and public goods
   
3. 
   The optimal management of natural resources over time
   
4. 
   The economic valuation of environmental goods and services
   

Economists since the time of Adam Smith in the eighteenth century have asserted that voluntary market exchanges between buyers and sellers leave both parties better off than when they started. But market exchanges can also impact parties other than the buyers and sellers, either in a positive or negative manner. For example, someone buying gasoline affects other people, such as those exposed to air pollution from producing and burning the gasoline. Economists have long recognized that these “third-party” impacts, known as externalities, need to be considered when assessing the overall costs and benefits of market activity. Economic theory provides guidance on devising effective policies in the presence of externalities.

Externalities are an example of market failure—situations in which an unregulated market fails to produce an outcome that is the most beneficial to society as a whole. Another important instance of market failure is the allocation of common property resources such as the atmosphere and the oceans, and public goods such as natural parks and wildlife preserves. Because these resources are not privately owned, we normally can’t rely upon markets to maintain them in adequate supply, and in general the principles governing their use are different from those affecting privately owned and marketed goods.

A third application of mainstream economic theory deals with the management of natural resources over time. According to this perspective, natural resources should be managed to provide society with the highest aggregate benefits summed across generations. A critical question in this analysis is how we value benefits that occur in the future relative to benefits received in the present.

The final core concept in environmental economics is that most environmental goods and services can, in principle, be valued in monetary terms. Environmental economists use a set of methods for estimating the monetary value of such things as asthma cases caused as a result of air pollution, the benefits of endangered species, or the value of a scenic view. By measuring these impacts in monetary terms, economists seek to determine the “optimal” degree of environmental protection based on a comparison of costs and benefits.