Environmental

Economics -
Introduction
RAMA PAL
H&SS, IITB
Why Environmental Economics?
Economics is the study of efficient allocation of scarce resources

It helps us understand how much money society should spend on

environmental quality and how environmental policies should be
formulated.

Economics helps us to understand benefits, costs and welfare effects of

any environmental policy

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Some “Environmental” Problems
Global climate change Water pollution and water scarcity
Greenhouse gases
Ozone depletion

Local air pollution Others

Traffic pollution Loss of biodiversity
Factory emissions Irreversible eco-system change
Smogs Soil fertility losses

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Economic Activity and Environment
Environment goods – consumption

Environment – input in production process

Impact on environment is usually long-term

long

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Green National Accounts
Society’s use of natural environment

Depreciation of natural assets – long term impacts

Resources’ shadow prices

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Global Issues and International
Policies
Global warming
◦ Kyoto Protocol
◦ Doha Amendment

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Why Is Environment Different?
Environmental goods –jointly
jointly consumed

Supply is usually fixed

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Efficiency of Markets: A Recap
Do the equilibrium price and quantity maximize the total welfare of
buyers and sellers?

Market equilibrium reflects the way markets allocate scarce resources.

Whether the market allocation is desirable can be addressed by welfare

economics.

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Welfare Economics
Equilibrium in the market results in maximum benefits, and
therefore maximum total welfare for both the consumers and the
producers of the product.

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Consumer Surplus
Willingness to pay is the maximum amount that a
buyer will pay for a good.

It measures how much the buyer values the good or

service.

Consumer surplus is the buyer’s willingness to pay for a

good minus the amount the buyer actually pays for it.

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The Demand Curve
Price of
Album

100 Anita ’ss willingness to pay

80 Sita ’s willingness to pay

70 Kareena’s willingness to pay

50 Priya ’s willingness to pay

Demand

0 1 2 3 4 Quantity of
Albums
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Measuring Consumer Surplus with the
Demand Curve

Price of
Album

100
Anita’ s consumer surplus

80
70

50

Demand

0 1 2 3 4 Quantity of
Albums

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Measuring Consumer Surplus with the
Demand Curve
Price of
Album
100

80
70

Total
50 consumer
surplus (40)

Demand

0 1 2 3 4 Quantity of
Albums

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Using the Demand Curve to Measure
Consumer Surplus
The area below the demand curve and above the price
measures the consumer surplus in the market.

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Consumer Surplus
Price
A

Consumer
surplus
P1 B C

Demand

0 Q1 Quantity

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What Does Consumer Surplus Measure?
Consumer surplus, the amount that buyers are willing to pay for a
good minus the amount they actually pay for it, measures the
benefit that buyers receive from a good as the buyers themselves
perceive it.

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Producer Surplus

Producer surplus is the amount a seller is paid for a

good minus the seller’s cost.

It measures the benefit to sellers participating in a

market.

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Using the Supply Curve to Measure
Producer Surplus

The area below the price and above the supply curve
measures the producer surplus in a market.

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Measuring Producer Surplus
Price
Supply

900
800

600
500
producer
surplus (100)

0 1 2 3 4
Quantity
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Producer Surplus
Price
Supply

B
P1
C
Producer
surplus

0 Q1 Quantity
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Efficiency

Efficiency is the property of a resource allocation of

maximizing the total surplus received by all members of
society.

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Total Surplus in the Market Equilibrium
Price A

D
Supply

Consumer
surplus
Equilibrium E
price
Producer
surplus

Demand
B

0 Equilibrium Quantity
quantity
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