What is Environmental Economics? Explained

1. Introduction
2. Fundamentals Of Neo Classical Economics
3. Birth Of Environmental Economics
4. Analytical Approach Followed In Environmental Economics
5. Internalizing The Externalities
6. Conclusion

Introduction

• Existence of a complete set of perfect markets: All goods and services exchanged through a market system should be exchanged individually through a competitive market. The efficiency argument in favour of a market system will be nullified in case market does not either exist even for a product (service) or operates inefficiently (in a sense of being imperfect). 
• Rationality: Every participant in a market, either as a producer or as a consumer, wants to maximize her objective – satisfaction while consuming and profit while producing. This is possible, because everyone prefers more of satisfaction or profit to less and none is satisfied with what is available. 
• Perfect knowledge: Both the producer and consumer have perfect knowledge while they make an economic decision. Each of them not only knows prices of all goods and services procured from market, but also everything about their qualitative features. Further, they are aware of the behavior of other buyers and sellers operating in the market. They also know about the steps to be taken by the government. So there is no risk or uncertainty about future and the predictions about future outcome made by them are absolutely on spot. 
• Property rights: Property right on the product or service exchanged through a market is well defined and such a right shifts from the seller to the buyer immediately and in a costless manner as and when the exchange happens in a market. 
• Diminishing returns: Marginal satisfaction from an increased unit of a good or a service goes down gradually as its consumption level increases. 
• Equality of sale and purchases: This condition is necessary to ensure equilibrium. In case of a seller running with an inventory, they are considered to have been sold or not to have been produced. To ensure such equality, it is also assumed that transactions are instantaneous and costless. 
• Unique equilibrium: Equilibrium is reached when both the buyer and the seller are satisfied with maximized objectives – satisfaction for the buyer and profit for the seller. Convexity in the choice and production sets ensures that the equilibrium is unique with no possibilities of multiple equilibrium. 
• Many participants, with freedom to enter and leave the market: to ensure an optimal equilibrium, it is imperative that neither the buyer nor the seller dominate the market process and influence the price. This assumption takes care of such a requirement. Else the market outcome may turn out to be an inefficient equilibrium. 
• Independence of demand and supply: Buyers’ behavior is distinct from that of sellers, so that the act of buying does not affect selling, and vice versa. They interact only through the mechanism of the market. 
• Only “goods” are exchanged: All goods and services produced and sold give positive utility to consumers and hence positive profit to the producers. There is no possibility of production of “bads” that has the potential to yield negative utility to buyers if consumed. 
• And finally, no externality: Externality refers to a situation where the act of exchange between a buyer and a seller does not affect the wellbeing or interest of a third individual. This condition is ensured by the assumption that all consumers are identical in terms of their choice pattern and so also are all the sellers in terms of their production behaviour. Further, one’s economic activity does not affect that of another. Externality may thus be considered a consequence of an economic activity which affects other parties without this being reflected in market prices.

Birth Of Environmental Economics

• Existence of a complete set of perfect markets: Markets do not exist for many of the effluents generated out of a production process and thrown into air, land or water as pollutants. So their economic prices are indeterminate. 
• Perfect knowledge: Neither the producer nor the consumer have perfect knowledge about the implications and impact of the pollutants. So they may not decide on their optimum choice.
• Property rights: Property right on these effluents are difficult to be defined unambiguously.
• Diminishing returns: This assumption may not be effective for a product – in fact, pollution -- that gives negative satisfaction on consumption. 
• Equality of sale and purchases: Environmental economics is concerned with products that have producers but no willing purchasers. 
• Unique equilibrium: Production set of environmental pollutants may be non-convex leading to possibilities of multiple equilibrium. 
• Many participants, with freedom to enter and leave the market: the producers dominate the exchange process as no market exists for environmental pollutants. 
• There is only possibility of production of “bads” that has the potential to yield negative utility to buyers if consumed. 
• Environmental goods, being indivisible in consumption, are often subject to externalities.

Analytical Approach Followed In Environmental Economics

• Incorrect prices and possible ways to adjust them by using taxes or subsidies, pollution cess on automobiles or fuel surcharge are examples of taxes, while subsidies to locals through developmental support for protecting forests are some such examples. 
• Missing markets and possible solution in creating a market for pollution, use of tradable permits for carbon emission, fishing efforts are some such examples. 
• Imperfect property rights which may be rectified through defining unambiguous property rights, like Forest Rights Act, in India or increasing demands for community management of environmental resources.

Conclusion