Module IV

ENVIRONMENT AND ECONOMICS

As an extension of 'environmental crisis' this module group out the causes of such
cases and methods to control it. First of all there is need to identify the natural
endowments / resources of a nation and categorize them into renewable and non-
renewable resources. The rate of use of these resources makes up the total social
cost to any nation. If the rate of usage is greater then the 'social cost' or 'royalty' is
very high. This then leads to depletion of a resources as well as pollution.

Therefore each nation needs to carry out a social cost benefit analysis to weigh the
pros and cons of over- utilization of resources for faster rate of growing and
development. An equilibrium level of resource utilization keeps pollution under
control. Various methods of pollution control have been discussed in this module. All
these measures would lead to sustainable development or ‘growth with stability’.

Environmental Crisis

Environmental crisis is global phenomenon. More recently there has been major over
the environment protection and environmental development. The rapid economic
development, Technological and scientific advancements have increased their
impact on the natural environment. They have added to the environmental
degradation and ecological imbalances. Increasing damage to the environment and
ecological imbalance has created a fear in the mind of developing and developed
countries. In this direction the Stockholm Conference in 1972 is a significant
landmark which emphasized how to deal with the myriad aspects of the environment.
After the conference all the countries made environmental protection enactments on
various aspects from time to time.

 Protection of Environment (Link to be created, Dogra, 1998)

State of environment in developed and developing countries

National and International Initiatives, Global Network, Issues at UNCED, Ways of
Cutting Bio-diversity Losses, Wildlife Conservation and Eco-Development of
Sanctuaries, Local Sharing of some of the issues in the Non-use Values of
Biodiversity, Sustainable Use of Bio-diversity, Situ Conservation relates to Research
and Training, Free Exchange of Germplasm, Initiatives on the follow-up of the
Convention on Biological Divesity, Identification of Action Points, and Transfer of
Genetic Resources, Ratification of the Convention.

The Genetic Revolution is related to, The Colonization of Human Regeneration, The
Colonization of Plant Regeneration, Food Crises, Biotechnology and the Third World,
United Nations Efforts, Fewer Varieties, Narrowing the Genetic Base, Intense
Farming, Access to Seeds, Gene Bank, What are Genetically Engineered Foods ?,
Breeding Uniformity, Jurassic Park is Science Fiction, BST : Biotech and Cows,
Soybean Drought Resistant Crop, Corn Fever, The Seed, Corporate Control of the
Seed Industry, Who Controls the Seeds ?, Women, Ecology and Biotechnology,
Genesis, Fewer Crops, A Roulette-Wheel for Farmers, Third World Strategies to
Reverse the Trends, Program Areas : Increasing the Availability of Food, Feed and
Renewable Raw Materials, Basis for Action, Objective, Data and Information,
International and Regional Co-operation and Co-ordination, Means of
Implementation, Financing and Cost Evaluation, Improving Human Health, Basis for
Action, Objectives, Activities, Management-Related Activities, Data and Information,
International and Regional Cooperation and Co-ordination.

NATURAL RESOURCE ECONOMICS

Natural resources are generally divided into different parts depending on the time scale related to
their use. They are -

1. Expandable or constant flow resources.

2. Renewable resources.
3. Depletable or exhaustible resources.

Expandable (Continuous flow) Resources: - The main feature is that use at one
particular point of time will not affect the amount that can be used in the future and
exhibit continuous flows, through time. Agricultural products, solar radiation and the
waves in the tides, the ability of the environment to absorb non-persistent pollution
etc may be assumed as examples.

Renewable Resources: - The essential feature of renewable resources is that they

can be increased as well as decreased. It will increase if the stock is allowed to
regenerate. However, there is a maximum stock: no renewable resource can
regenerate to the levels above the carrying capacity of the ecosystem in which it
exists. An obvious example of this kind of resources is a forest or a single species of
fish. Use of such resources today usually affects future utilization possibilities. This
means that the rational utilization policy must take into account the time dimension

during which the resources are regenerated. Biologically regenerating resources are
often characterized by emphasizing that they are ‘renewable but exhaustible’. This
refers to minimum variable population size. Harvesting a population smaller in size or
harvesting over and above its potential only causes 'extinction' (i.e. if the rate of
harvest exceeds the natural growth of the resources).

Non-renewable Resources: - In this case the inter-temporal sum of the services

provided by a given stock of exhaustible resources is finite. This definition highlights
the importance of the long term perspective. The resource will be depleted so long
as the use rate and the harvest rate is positive. The central economic problem of
these resources is thus how to allocate their fixed amount inter temporally that is
between different points over time or between different generations.

Table 1 shows example of all these three kinds of natural resources. Among these
three kinds of natural resources we will now concentrate over optimal use of renewal
resources.

EXAMPLES OF NATURAL RESOURCES

Among these three kinds of natural resources we will now concentrate on the
optimal use of renewable and non-renewable resources.

Renewable Resources : To obtain an optimal solution let us consider a single fish

species and assume that its stock (or biomass) exhibits a logistic growth through
time shown in fig 1. The curve shown is logistic function: at low level of stock the
fish multiply, but as they begin to complete for food supplies their rate of growth
slows down and eventually the stock converge on some maximum level X max, the
ecosystem is carrying capacity for the species.

Table 1: Examples of natural Resources

Physical Properties
Availabilty Biological Non- Energy Environment
Energy
Expendable Most agricultural Salt Solar radiation Noise pollution
products for Hydro power Non-persistent
example corn, ethanol air water
grains pollution
Renewable Forest product .... Wood for Groundwater
fish live stock burning air persistent
harvested wild Hydropower Air and water
wood animal geothermal pollution
wood whales power forests.
flowers insects
Depletable Endangered Most Petroleum Virgin
species minerals for natural gas wilderness
example coal uranium ozone layer
gold, iron oil shall water in some
ore, bauxite aquifers.
top soil
Fig 1: Logistic growth curve of a renewable resource.

Fig 2: Pure compensation growth curve

The curve begins at X min, which is the critical minimum level of population. If the
members go below this level the species is driven to extinction (X zero). Now if we
assume that there is no critical minimum population ignore the segment of the
curve in fig 1 between X min and X zero, then fig 2 plot the same information as in
(1), with X = the rate of change in X with respect to the time the growth of the
resources on the vertical axis and X = the level of stock on the horizontal axis.
Fig. 2 shows that the rate of growth of the resource stock is positive at the first,
reaching a maximum and then declines as the stock gets bigger.

Thus if we leave the resources alone it will grow continuously in size in terms of its
total biomass until it reaches the carrying capacity of its environment at X max,
where the growth rate of the resources reaches a maximum. This point (X max)
represents the ‘maximum’ sustainable yield (MSY) of the resource.

This concept is important because if we harvest the renewable resources in such a

way that it is equal to the MSY: the resources will regenerate itself and reviews for
ever. The level of exploitation or harvest (or yield) of the resources is expressed as.
The effort expended in harvesting and is equal to the ratio of the actual harvest H,
to the sock X.

That is, (1)

The larger the effort, the greater the proportion of the stock that would be
harvested. We can rewrite this equation as H = EX (2)

The rate of harvest is shown in fig 3, which shows how the choice of the effort level
will determine the harvest (H) and the stock level (X) i.e. where ‘EX’ is equal to the
rate of growth of the resources.

Any harvest level along the line EX to the right or left of X* will mean that the
harvest is greater (lesser) than the sustainable field through natural regeneration
and the stock will fall (grow). (It should be noted here that H* is not the maximum
sustainable yield but we could easily introduce a management policy which says
that effort should be changed so as to take the MSY. Here E becomes the
instrument of management and the harvest rate is set equal to E ‘x as in fig: (3).
Thus introducing the effort level helps us to determine the harvest and stock level
but tells us nothing about the desirable level of exploitation. To get this we need to
introduce the concepts of costs and revenues.

Fig 3: Effort growth equilibrium

In order to do this we transform fig: (3) into fig: (4) showing the relationship
between the harvest or yield and the level of effort. In fig: (4 a) we find various
equilibrium for various degrees of effort where E4>E3>E2>E0 (E is the slope of the
line E x). Now plotting the levels of the effort in the horizontal axis of fig 4 b and the
associated harvest levels in the vertical axis, we get the effort harvest (or effort
yield curve).

This curve looks very much like growth harvest curve and the yields are read off
from fig: (4 a) in such a way that they appear mirror image of the lower half. Thus,
X max corresponds to zero effort and X o to E in fig 4.
4a

4b

Fig 4: From growth effort to the effort harvest function.

Now, if we assume that effort is the only factors of production involved then total
cost, TC, will be equal to the level of effort multiplied by the prices of effort (W). If
the wage rate (W) is assumed to be constant then TC = WE 3. Also if the price of
the harvested product is constant at P, then total revenue (TR) from the harvest will
be TR = PH 4. Since P and W are assumed constant the total revenue curve will
have the same shape as the effort harvest function in fig: (4) the total cost function
with a constant slope equal to the wage rate or “price per unit effort” is shown in fig:
(5).

Fig: 5(a) profit maximum

Fig: 5(b) marginal conditions

Now, for profit maximization producer requires :

1) maximum to the difference between TR and TC or

2) slope equate marginal revenue (MR) with marginal cost (MC) and the MC must
have a steeper slope than MR curve or MC must cut MR from below (shown in fig
5b).
Under the profit maximization hypothesis two possible equilibrium are possible
(shown fig 6).

1. Common property equilibrium.

2. Open access equilibrium.

A common property equilibrium or resource is one that is owned by some defined

group of people a community or a nation. It is possible that within this group of
people there will be open access and it is harvested.
An open access equilibrium or property means that no one owns the resources and
access is open to all. There are no limit on new entrants (e.g. sea fisheries).

Fig: 6 Profit maximization and open access equilibrium

If the renewable resources can be placed under single ownership or joint

ownership in such a way that the owners’ act collectively, we can assume that the
resources will be managed to maximise profit. In the fig: (5a) and (6);
A is the point of maximum profit with H PROF = Hπ = as the harvest rate
Eπ = as the effort rate
However private ownership is not typical or applicable for all the resources e.g.
major forest or sea fishes. Instead we may have either territorial ownership or no
territorial ownership (Internationally common property). In either case we get the
‘Open access solution’.

Here, if less than normal profit are being made (TR<TC) some resource exploiters
will go out of business and if abnormal profit (TR>TC) are being earned new
entrants will come in. At equilibrium profits point are dissipated (TR =TC) and each
resources exploiter recurs normal profit only. In fig: (6) equilibrium is at point B with
a harvest rate HOA and effort rate EOA equal.

From the two-equilibrium solution it can be said that the profit maximization solution
can only be optimal in the social sense if the preference of conservation imply zero
‘preservation value’ for the resource. In order to get socially optimal solution we try
to accommodate externalities in our analysis. For example, if conservationists
prefer larger to smaller stocks their utility loss will be a function the difference
between the maximum possible stock (the natural equilibrium or carrying capacity
stock) and the actual stock that results from the amount resources use.

UC = f (Xmax – XE)
Where UC = the loss of utility of the conservationists & XE = the various equilibrium
levels of stock.

The valuation function consistent with this function is shown in fig: 7. How ever we
should remember that depending upon the ‘reference point’ (here X max) the
valuation function may differ (e.g. if we take X MSY the reference point or most
desired point). Now it is most likely that at very low levels of stock the preservation
value function will be discontinuous.

From the above discussion we can conclude that the addition of externalities in the
normal situation following things happens.
 1. When the aim is to maximise net benefit in contrast to simple profit
maximization the optimal stock of the resource will be higher.
2. If the external costs are very large the resources will be ‘optimally’ managed
if it is left alone to reach its natural equilibrium.
3. Introduction of social cost also does not confer any particular emphasis on
the social desirability of the stock levels corresponding to MSY.

In order to get the optimal solution economics principles underlying the analysis of
non-renewable resource scarcity we will use the model by Hotelling. According to the
classic article published in 1931 by Hotelling, for non-renewable resources our main
objective should be the allocation of a given amount of resources stock over different
moments of time in order to maximize the utility or benefit from consuming the
resource. Even though during the last several years the economic analysis become
much more complicated but the basic insight remains the same.

Since the size of non-renewable resources is fixed, consuming and extracting a unit
of the resources implies that there is less of the stock of resources for future
consumption. Thus, in addition to extraction costs, there is another kind of cost
associated with it i.e. the reduced level of future benefit due to fewer resources being
availabl
e called
Non-Renewable Resources
‘royalty’
or ‘users cost’. Hotelling assumed that.

1. The marginal utility of consuming the resources is decreasing.

2. Marginal extraction cost constant.
This means that along an economically optimal expansion path the marginal utility of
consuming the resources must be equal to the sum of constant unit of extraction
costs and the royalty. Thus marginal utility of using the resources is greater than the
marginal cost of extracting the resources and difference is royalty. It reflects the
value of an un extracted marginal resources unit with respect to future consumption
possibilities. This ‘Royalty’ cost implies the fact that the society must be much more
conservative in consuming non-renewable resources compared to other ordinary
goods the production cost of which do not include royalty.

The concept of royalty and optimum utilization decision is explained in fig C1. On the
vertical axis we measure marginal utility from consuming the resources marginal cost
of extracting the resources whereas the horizontal axis we measure the level of
resources utilization over one year.

Here, MU curve shows the marginal utility of consuming the resources, which is
diminishing. For normal commodities (whose stock is not prefixed) the optimal
production occurs at Q** where marginal utility of the resources equal marginal cost.
How ever for non-renewable resources this will not be the case since today’s
consumption of the resources involves opportunity costs, Royalty. At the level of
royalty (AB) the optimal level of resources extraction and consumption is Q*

.
Fig C1: Optimum Resource Utilization

We need to analyse the question that how the level of royalty evolves over time.
According to ‘the Hotelling rule’ royalty must increase wit h time at rate equal to the
rate of discount. This means that the net marginal utility of consuming the resources
must also increase at a rate equal to the rate of discount. This implies the fact that
from the current point of view the net benefits from the marginal units consumed in
every period (the discounted value of net utility) are equal/same. Again the equality
emphasizes the fact that it is not possible to increase the total level of discounted net
utility from resources consumption via changing the extraction of the resources over
time. Thus ‘the Hotelling rule’ established that royalty increases exponentially and
the level of resources utilization decrease over the time. The higher (lower) the rate
of discounts the higher (lower) the rate at which the level of resource consumption
falls over time.

Up to now we have discussed optimal renewable resource utilization only when the
rate of resources utilization can be directly controlled by the government or society.

But in a market economy profit maximizing private firms usually utilize resources.
Now the question is how the level of resource utilization will be affected by this
owner ship?

In contrast to our general idea, Hotelling shows that private ownership will not
accelerate resources utilization. The reason behind this is as follows since the
marginal utility curve shows the maximum amount that consumers (or firms who use
the resources as input) are willing to pay for consumption of another unit of the
resources it is also the demand curve of the industry in the market. To maximise the
present value of profit the industry must apply such a rate of extraction that royalty
increase exponentially over time. This means that the industry will also follow a
resources extraction policy that maximises the profit for the industry “the socially
optimal resource utilization policy”.
The higher the level of royalty the higher will be the market price of the resources
which implies that market price of non-renewable resources must increase over time.

A project will be profitable if the benefits of the project exceed the costs. The concept
of profitability requires calculation of the stream of a project is future benefits and
costs period by period and conversation of this stream of benefits and costs into
some simple measure expressed as a number. The commonly used measures are
the net present value (NPV) and the internal rate of return (IRR). The net present
value may be define as:

Where are benefits in year t ; are costs, including investment in year t

r is the rate at which future benefits and costs are discounted ;n is the life of the
project

Discounting reduces the value of future benefits and costs. Why future benefits and
costs are discounted and how is this rate of discount determined? The answer to the
first part of the question is that cash received in the future is less valuable than the
same amount of cash received immediately because in the interim the firm could
invest these funds and earn interest on them. For a private individual or firm the
correct rate of discount is the market rate of interest. If a firm can lend at 10 percent
it would have no reason to choose a project that costs Rs. 1000 today and yields
only Rs. 1080 next year because by lending this amount it would get Rs. 1100 next
year. Similarly if it barrows at 10 percent it would not invest in such a project which
fields only 8 percent return. On the other hand a firm would have no reason to reject
a project that costs Rs. 1000 today and yields Rs. 1110 next year. Even if it does not
have the money it can borrow it at 10 percent and make net profit of Rs. 10. As long
as a project has a positive NPV it is considered desirable. If funds are available a
firm should select those entire project which have positive NPV. If however because
of resource constraints a firm has to choose one project out of several competing
projects the one with the highest NPV should be selected. A positive NPV means
that benefits of a project are higher than costs. This ratio of benefits to costs in that
case would be greater than 1.

The benefit cost ratio (BCR) is defined as

Thus serves the same purpose as the NPV a measure of project desirability. An
interest rate for which the net present value of a project is zero is called the “internal
rate of retrieve (IRR)” of the project. The IRR is an alternative measure of project
desirability. A project with an IRR higher than the market rate of interest is
considered desirable project. If NPV of project at alternative discounts rates is
plotted as shown in Fig. 1 point A gives the IRR for the project.

Fig 1: NPV at alternative discount Rates

One difficulty with the IRR criteria is that it is quite possible that the NPV of a project
may become zero at more than one rates of interest i.e. a project may have several
internal rates of return. However, if a project incurred negative net cash glows up to
a certain point in time (when initial investments are made) and there after yielded
positive net cash flows, its IRR would be unique. For this reason the problem of
multiple internal rates of return is not considered very serious.

Which one of the two measures NPV or IRR is a better measure of project
desirability? If choice of one project does not rule out another, we can use either of
the two selection rules they both will give same answer so long as NPV always goes
down as the discount rate is raised. If the market rate of interest is lower than the
IRR, the NPV of a project will be positive. Such a project should be selected.

The problem arises when all desirable projects cannot be undertaken. In such a
situation the two decision criteria may provide conflicting choices. This is illustrated
in fig.2: -

Fig. 2: NPV and IRR Criteria

Project A has 20% IRR whereas for project B, the IRR is 15%. Thus by the IRR
criteria project A is better. However at 10% rate of discount, Project B is preferable to
Project A by the NPV criteria.

If the market rate of interest at which the firm borrows is known with certainty, it is
better to use the NPV criteria than the IRR. The NPV criteria are better than the IRR
for one more reason: the former provides a measure of total gains which the latter
does not. When cost- benefit analysis is employed by a private firm to assess a
project, market prices of inputs and outputs are used in calculations of costs and
benefits of the project. This commercial profitability criteria is however not suitable
for assessing public sector projects, because for various reasons elaborated below
the market prices of inputs and outputs do not necessarily reflect their social costs
and social value respectively. In order to allocate resources in a way most profitable
to society, social cost benefit analysis in recommended for the appraisal of public
sector projects.

Market prices of goods, labour, foreign exchange and capital may be distorted
through taxes, subsides, tariffs and import quota and government control of various
kinds such as minimum wages, interest rate controls and price controls. Prices set
by monopolists and public utilities are also distorted, as they are different from
competitive market prices. Because of the presence of externalities market prices of
goods do not reflect their true social value. The externalities could be positive or
negative. Externalities refer to the effects that work outside the market. Positive
externalities occur when it is not possible to charge the beneficiaries for the benefits
they receive. It may be for several reasons: access to the facilities may be difficult
and costly to control; An example of such a situation is when a firm trains the labour
force in the region. This may not enhance the firm’s profits since after training the
workers are free to leave. Large infrastructure projects such as dams, roads and
railroads have important positive externalities. For example in case of a hydroelectric
dam many people not connected with the project also derive substantial benefits.
The downstream farmers may witness increased production become the dam
prevents floods. May other cases of positive externalities could be cited however it is
the negative externalities, which are concern because they are more prevalent, and
have very severe adverse social impacts. Negative externalities occur when firms or
individual do not pay for damages their actions cause to other industrial firms for
example give rise to negative externalities in polluting air and water. It is a serious
problem not only in the industrial world but also in the developing countries since the
firms do not bear the cost inflicted on the society by pollution, their profits do not
decrease. Externalities are very important in social decision-making. Their presence
provides a sufficient reason why commercial profitability should not be used as a
guide in public policy.

Market prices may diverge from their social values because of the fact that the prices
of factors of production may not reflect the opportunity costs of using these factors.
Take the case of labour in developing countries; unskilled workers in modern sectors
often get wages which are much higher than what the opportunity cost criteria would
suggest. In these developing countries there is widespread under employment of
labour in rural sector. When modern industrial sector or government draws labour
from the rural sector its opportunity cost if the loss of output in the rural areas i.e.
labour’s marginal contribution to production, which is quite low. The wages paid to
these unskilled workers are much higher. The domestic market price of the other
primary factor, capital also tends to be distorted in developing countries. The capital
market intermediates between those making saving and investment decisions. In a
perfect capital market the social return from one unit of current drawings is equal to
the social values of one unit of current consumption at the margin. In the absences
of market distortions this equality between the two sides is established through
market rate of interest. The distortions are caused by the presence of monopolistic
elements and government intervention (fiscal distortions). Further more in many
developing countries export earnings and foreign investment are not adequate to
meet import requirements. Scarcity of foreign exchange is a serious problem in many
developing countries with chronic balance of payment problems. It is observed that
in these counties, quite often official exchanges rates over value local currency. It
does not reflect the real scarcity of foreign exchange. There are several interest
rates prevailing in the market at the same time. The differences in interest rate are
too enormous to be justified as the basis of differential risks. These are caused by
capital market rigidities.

Price distortions can possibily be removed by suitable fiscal methods of lump sum
taxes and subsidy. But for various reasons it is very difficult to implement such
policies and they are usually not undertaken. If price distortions in the economy
cannot be removed then project appraisal method should be such that corrects for
price distortions. Instead of using market prices, which are distorted, it is
recommended to use imputed values, which reflect real opportunity costs to the
society in cost-benefit analysis of the projects. This is referred to as shadow pricing.

Shadow prices are determined by the interaction of national objective of the resource
constraints facing the economy. Shadow price, i.e. opportunity costs of a resource,
which using scarce tends to be high. The reason for high opportunity costs is that
such resource have many competing uses and the forgone benefit in the best
alternate that must be given up is high. On the other hand, shadow price of a
resource available in abundance will tend to be low. Shadow prices usually differ
significantly from market prices in developing countries because for various reasons
noted above, market prices are distorted and thus do not correctly reflect scarcity of
resources.

As discussed earlier, the opportunity cost of labour in a labour surplus economy is

very low. Labour in modern sector is, however paid considerably more than its
opportunity cost. The shadow wage, lies somewhere between the opportunity costs
of labour (equal to its marginal productivity) and the industrial wage.To settle on a
particular figure however, requires a great deal of judgement. It is a common practice
to use a specific conversion factor (or the standard conversion factor) to convert
market rate into shadow wage.

As discussed above, official foreign exchanges rate in many developing countries

overvalues local currency. In social cost benefit analysis a corrected exchange rate,
referred to as shadow exchange rate which reflects the true opportunity costs of
foreign exchange is used. One method of calculating shadow exchange rate involve
comparison of the domestic prices of imported commodities with the official foreign
exchange prices of there commodities. For example, if an import item can be sold in
the domestic market at a price which is 50% higher than the price calculated on the
basis of official exchange rate, it means that the domestic currency if overvalued by
50%. It should be devalued by 50% to reflect its true value.
In the conventional approach the social cost-benefit analysis all traded and non-
traded goods are measured in one currency either foreign or local. Traded goods in
foreign prices are converted into domestic prices or alternatively non-traded goods in
domestic price are converted into foreign prices using shadow exchange rate.

An alternate approach recommended by Little and Mirrlus requires that all goods
should be valued at world prices because these represent a country’s actual trading
opportunities. It is argued that is a better measure of the social valuation of goods
than the other non-traded goods at domestic price and traded goods at their
international price. In the latter method domestic and foreign goods are made
comparable using a shadow exchange rate, which may itself be distorted.

There is no need to calculate shadow exchange rate if all goods traded and non-
traded are measured at world prices. The values of goods can be expressed in any
currency local or foreign. Since all values will retain a constant relationship to each
other it does not matter what currency they are measured. The values can be
converted form one currency to other using any exchange rate.

Non-traded goods are those, which normally cannot be imported. For example,
electricity, construction, local transport and labour are non-traded goods or inputs.
Since these goods are not traded internationally their valuation at ‘world prices’
poses a problem. The way out is to take each non-traded input and break it down
into traded and non-traded components. The latter are in turn broken down into
traded and non-traded components. This way it is possible, at least theoretically, to
reduce all non-traded inputs and goods into traded items. Land is not considered
very important in industrial projects. Regarding labour it is argued that it can be
valued in terms of its own inputs (i.e. into consumption) which consist of traded
items. A detailed input output table for the economy, as a whole is required to
conduct these exercises. Such a table will however be available only in a few
developing countries. Some critics have pointed out that all this trouble of conversion
of non-traded items into traded items in order to avoid using a foreign exchange rate
official or shadow, is not worth it. The cure, it is alleged is worse than the disease. It
may be just as accurate to use properly adjusted shadow exchange rate to convert
values in domestic currency into foreign currency.
METHODS OF POLLUTION CONTROL

Market Mechanism does not allocate resources efficiently if production involves pollution externalitie
may emit pollutants into the atmosphere, which result in damage to others. The pollutants may adve
to pollution, pollutants released into air or water may cause property damage or may have adverse
area.

The affected individuals are not compensated for damages. This causes divergence between privat
resulting in inefficiency in resources allocation. This happens because the affected individuals are n
making process.

In a free market economy in which companies seek to maximize their profit, if private costs of produ
is excessive production of the commodity as well of the associated pollution. Figure 1 illustrates this

Figure 1

This industry also produces pollution as by-product, which is not compensated. BC represents the m

There are costs borne by the producers and they do not involve externalities. BE represents the orig
addition to marginal private costs, these costs include marginal costs to the society caused by pollu
for the commodity. It shows the price which buyers are prepared to pay for the various quantities of

As discussed earlier, the demand curve is equivalent to the marginal benefit curve: it shows the ma
production of the commodity.
This form of the market is assumed to be perfectly competitive here. It is socially optimal to produce
level of output, the product’s marginal social benefit is just equal to its marginal social cost of produ

In a unregulated market, the producers do not take into consideration the environmental costs. In su
produce Q2 output. At this level of output, the product’s marginal benefit (or the price of the product
costs of production. An unregulated market thus, produces output which is in excess of socially des
pollution level is also higher than the socially desirable level.

Pigou (1932) 1 suggests that the excess production of the commodity can be reduced to the sociall
suitable tax on the commodity (see Fig. 2). If Rs. KL per unit tax is imposed on the commodity, the m
upwards by a vertical distance of Rs. KL. The marginal (private) cost curve with tax will be GH. The
now be Q 1, which is the socially desirable level of output as discussed earlier.

If the market is not competitive, the Pigou taxation method may not be relied upon to achieve the de
question has only one producer (a monopoly situation), then the firm would produce an output lowe
and charge higher price from the consumers as shown in figure 3.

As the monopolist equates the products marginal (private) costs with the marginal revenue AM sho
with various levels of output, Q 3 output would be produced. It is lower than the competitive market
lower then Q 1, the socially desirable level of output. If tax on output is imposed, the monopolist will
moving further away (lower from Q 1, in case Q 3 is less than Q 1).

In Pigovian approach, the pollution is control is achieved through reduction in output. In this sense,
control.

Figure 3

It is argued that a direct method involving taxation of the particular input in the production process,
may be more efficient method. This method is discussed a little later. The Pigovian method, despite
liked by some economists because it is relatively easy to implement. Since output is the tax base in
monitor and enforce the regulations. To arrive at the desired level of output and pollution, a few tria
does not require very precise of measurement of effluents since effluent discharge is not the tax ba

A simple model used by economists for discussing the efficient level of environmental quality is bas
of emission of pollutants. Small reduction in emission of pollutants can be achieved easily using ine
Higher levels of emission control are, however, more expansive to obtain than lower levels. More so
must be used to achieve emission control after certain level. The total costs of pollution abatement
Figure 4 the curve TC shows the relationship between the total costs of pollution abatement and the
Figure 4

The slope of TC curve at any given level of environmental quality gives the marginal cost of pollutio
The marginal costs of pollution abatement rises with improvement in environmental quality because
emission control can be achieved only at higher costs.

Emission of pollutants causes damage to people, plants, animals and physical assets. Control of em
environmental quality which in turn increases social welfare. The benefits to society of emission con
monetary terms. Although their actual measurement in practice poses a great many problems, conc

Figure 5
The total benefits of pollution abatement. In the beginning small reductions in emission of pollutants
However, after the first improvements, the total benefits increase at decreasing rates. The slope of
(MB) curve. As shown in the figure marginal benefit of pollution abatement declines as the environm

The efficient level of environmental quality is given by the part of intersection of the MB and MC cur
emissions as long as the marginal benefits of doing so are higher than the marginal costs.

Figure 6

In Figure 6 the socially optimal level is shown by E. At this level, marginal benefit and marginal cost
each other. Further reduction in emissions would result in costs higher than benefits.

The desirable level of environmental quality (E) can be achieved by regulatory approach, Governme
emission of pollutants for all polluting firms. This approach which calls for direct government involve
economic activity is criticized on the ground that it is wasteful and leads to sub-optimal outcomes. T
based on ‘economic incentives’, which can reduce the inefficiencies inherent in a regulatory approa
below.

The efficient level of environment quality (E) could be achieved by imposing a tax of Rs. T per unit o
reduce emission of pollutants than paying taxes, the polluters would choose the former. In other wo
pollution abatement is less than the tax (per unit) on the emission of pollutants, it would be advanta
emissions. On the other hand, if the marginal cost of pollution abatement is higher than the per uni
polluters would prefer to pay taxes. The equilibrium would be reached at E* which is the socially op
Coase (1960) has suggested another method, which could be used to achieve the desired objective
the parties damaged by pollution) pay (bribe) polluters to reduce their level of pollution. This is, how
practice but is also ethically unjustifiable.

A method equivalent method to Coase’s method would be a subsidy system where by pollutants is
pollution. MC curve in Figure 7 represent the marginal amounts when polluters would require comp
pollution. If subsidy is fixed at Rs. 5 per unit on reduction of emission of pollutants than profit maxim
reduction of emissions upto level E 1. If S is fixed equal to T (as in figure 6), then E 1 would be equa
environmental quality. 3. coase, R (1960) “The Problem of Social Waste”, the journal of law and Ec

Figure 7

Dales has suggested another method of reducing emission of pollutants.

This method requires fixing of a target for reduction of pollution. Once the acceptable amount of em
polluting firms could be sold pollution rights.

Dales method of controlling pollution can be illustrated by means of figure 8.

Figure 8

Point D on the horizontal axis represents the existing level of emission of pollutants. If the target of
desirable levels of emission of pollutants are D-R. The number of pollution rights made available to
S in the figure showing fixed supply of pollution rights. Polluters’ demand for pollution rights is show
sloped curve. It is equal to the marginal cost of pollution abatement curve, MC in Figure 7. As discu
emission of pollutants can be done at very low cost, but further reductions are very costly . If the aim
only marginally then the number of pollution rights supplied to the firms would be very close to the e
case, the firms would not be willing to purchase pollution rights at a very high price. Point C on the d
situation. On the other hand, if the target of pollution reduction is very ambitions, then the number o
firms would be very low. The firms the would have to cut emission of pollutants drastically, thereby i
willing to pay high price for pollution rights. Point B on the demand curve reflects such a situation.

The intersection point of the demand and supply curves would give the equilibrium market price of p
the polluters would purchase the D-R amount of pollution rights at price P. If the target of reduction
in such a way that D-R corresponds to E*, then the market price P would be equal to Rs. T per unit
Figure 6. Dales method achieves the desired level of environmental quality at least cost to the socie
pollution reduction technology.

We have discussed four approaches to pollution control in this chapter. These are: regulatory appro
system and sale of pollution rights. We compare below these methods in terms of their revenue imp
comparison considers the efficient level of control for each system.
Figure 9, MC represents the marginal cost of pollution abatement. It is equivalent to MC in figure 6
of emission of pollutants is given by point E. The socially optimal level of emission of pollutants or th
quality is given by point D.

Figure 9

First, let us consider the regulatory approach to pollution control. If the specified limit of emission of
to reduce emissions by DE amount. The cost of reduction of emissions is given by area AED. This c
of T per unit is imposed on emission of pollutants, polluters will reduce emissions by DE amount. Th
given by area AED. This cost will be borne by polluters.

If a tax of T per unit is imposed on emission of pollutants, polluters will reduce emissions by DE am
the cost of reduction of emissions, AED, will be borne by polluters – in this care also. In addition, ho
taxes to the government for emitting OD amount of pollutants. Area OTAD gives the amount of taxe
regulatory approach, taxation approach gives government additional revenues given by area OTAD

As discussed above, control of pollution can also be achieved by sale of pollution rights. If OD amou
available to polluters, they would pay OT price for purchase of pollution rights.

In this case also they would themselves undertake reduction of emission by DE amount, incurring c
area AED. Additionally, they would spend OTAP amount to purchase pollution rights. This approach
in terms of revenue implications.
If polluters are paid a subsidy of Rs T per unit on reduction of emission of pollutants, then they wou
This would cost them area ADE. They would, however, receive subsidy-given by area ADEB. Their

A comparison of the four systems shows that costs to polluters are increased by regulation, taxation
rights, but are reduced by subsidies. Taxation of effluents and sales of pollution rights cause higher
Changes in costs of production affect individual firm’s supply curves. Industry’s supply curve, which
supply curves, is thus also affected in the process. Shift in industry’s supply curve has implications
goods as well as for total emission of pollutants.

When a regulatory system is adopted, a polluting firm’s costs of production rise. This increase in co
marginal cost (MC) upward to AC 1 and MC 1 is shown in figure 10. All polluting firms would experie

Figure 10

Industry’s supply curve is horizontal summation of all individual firms supply curves (MC curves). It
shown in Figure 11. D represents demand the commodity. Industry’s output is reduced from Q to Q
system of pollution control. Buyers would have to pay higher price for the product: Market price incr
Figure 11

With increase in costs of production each polluting firm is forced to reduce its output of final goods.
control costs will drop out of the industry. The number of firms operating in the industry thus would b
adopted. These two effects – the reduction in output produced by each firm and the reduction in num
both work to reduce the output of final goods produced in the industry.

Similar effects will be witnessed when method of taxation of pollutants or sales of pollution rights is
the direction of changes is concerned. There would, however, be a difference in magnitude of shifts

Since increase in costs of production is larger in case of taxation of pollutants and sales of pollution
regulatory system, magnitude of shift in individual firm’s cost curves and in industry supply curve wo
a result, increase in market price as well as reduction in output of final goods would be more in ther
increase is higher, the number of firms dropping out of the industry would be higher under taxation
rights systems in comparison with regulatory system.

If polluters are paid subsidies, their cost of production decreases. As a result, individual polluting fir
shown in Figure 12.
Figure 12

Industry supply curves will alone shift downward from S to S 1 as shown in Figure – 13. Unlike the t
of final goods would increase and market price would decrease in this case.

If all the required information is available, all the four methods can be used to achieve the efficient l

Under subsidy system, the number of firms operating in the industry would increase. Some new firm
are high cost firms, without subsidy, these firms would not be able to operate profitably in the marke
make their operations profitable. (This level in shown by point D in figure 9.) However, these metho
total emission of pollutants (by all sources in the industry).
Let us consider the regulatory approach first. Each firm would reduce the emission of pollutants up
firms operating in the industry would decline. Total emission of pollutants by all sources in the indus
taxation of pollutants and sales of pollution rights systems the number of firms dropping out of mark
comparison to regulatory system, these two systems would achieve greater reduction in total emiss
system also, each firms would reduce emissions of pollutants. However, given that the number of fi
increase, the net effect of subsidy systems on total emission of pollutant by all sources is not possib
Action Plan for Sustainable Development

Technology Issues, Efficient Technology Transfer Issue, Contents of Agenda 21, Priority Action, Re
International Policies to Accelerate Sustainable Development in Developing Countries and related D
Environment and Development in Decision-making, Sustainable Living, Combating Poverty, Chargi
and Sustainability, Human Health, Human Settlements, Sustainable Human Settlements Developm
Environmentally Sound Management of Solid Wastes, Urban Pollution and Health, Efficient Resour
Management, Fresh Water Resources, Sustainable Agriculture and Rural Development, Sustainabl
fragile ecosystems : Combating Desertification and Drought, Managing Fragile Ecosystem : Sustain
Fragile Ecosystems : Sustainable Development of Coastal Areas, Managing Fragile Ecosystems .

International Cooperation of accelerate Sustainable Development in Developing Countries, Combat

Patterns, Demographic Dynamics and Sustainability, Protecting and Promoting Human Health, Prom
Policy-making for Sustainable Development, An Integrated Approach to Land-Resource Use, Comb
of Deserts, Protecting Mountain Ecosystems, Meeting Agricultural Needs Without Destroying the La
Management of Biotechnology, Safeguarding the Ocean's Resources, Protecting and Managing Fre
Hazardous Wastes, Seeking Solution to Solid Waste Problems, Action for Women : Sustainable an
Environmentally Sound Technology Available to All, Science for Sustainable Development, Promoti
National Capacity for Sustainable Development, Strengthening Institutions for Sustainable Develop
and Mechanisms, Bridging the Data Gap, UNCED : An Agreement to Disagree , The Earth Summit

Issues of Negotiations, Accountability, Implementation and Reorientation in Achieving Sust

National Accountability, Environment Agency, Japan Unveils Agenda 21 Draft Action Plan, UNEP G
Activities In-Line with Programme Areas, Refocusing in Line with the CSD, Biodiversity Convention
Activities, Areas Requiring Urgent Action, Research, Data Collection and Dissemination of Informat
Cooperation and Coordination, Means of Implementation, Children and Youth, Advancing the Role
the Protection of the Environment.

Sustainable Development of Socio-Economic and Ecological Systems

Programme Areas, Promoting Sustainable Development Through Trade, Making Trade and Environ
Adequate Financial Resources to Developing Countries, Encouraging Economic Policies Conducive
on Unsustainable Patterns of Production and Consumption, Developing National Policies and Strat
Unsustainable Consumption Patterns, Developing and Disseminating Knowledge Concerning the L
Factors and Sustainable Development, Formulating Integrated National Policies for Environment an
Integrated Environment and Development Programmes at the Local Level, Protecting and Promotin
Communicable Diseases, Protecting vulnerable Groups, Meeting the Urban Health Challenge, Red
Pollution and Hazards, Promoting Sustainable Human Settlement Development.

International Cooperation

In matter of international cooperation in the sphere of environmental protection, Ministry of Environm

United Nations Environment Programme (UNEP), South Asia Cooperation Environment (SACEP), I
(ICIMOD) and Forest regional bodies and multi-lateral institutions. Coordinate all bilateral cooperati
cooperation with Netherlands, Japan, Norway, Sweden, Denmark, Great Britain, U.S.A., Russia and
important Treaties/Agreements in the field of Environment viz.
i) International Plant Protection Convention;
ii) The Antarctic Treaty;
iii) Convention on wet land of International importance specially as water Fowl Habitat.
iv) International Convention international trade in endangered species of wild flora and fauna.
v) Vienna Convention for the protection of the Ozone layer.
vi) Convention on migratory species.
vii) Convention on observation on Bio-diversity; etc.

However for making the environment protection programme more effective, the following steps nee
international co-operation.
1. Systematic information dissemination and exchange of information
2. Dissemination of research findings in the field of environment protection
3. Comparative legislation and promising solutions at regional and inter-regional level
4. Formation of international professional and scientific council for transfer of knowledge and resear
5. Publication and inter-change of international review, Newsletters, specialised information materia
Pamphlets, briefs and circulars of specific issues between the countries.
6. Technical cooperation on regional and interregional level.
7. More responsive United Nations role