ECONOMICS OF

ENVIRONMENTAL
MANAGEMENT

ABDULRAHMAN ABDULLAH NAGI AL-MEKHLAFI

WHAT IS ENVIRONMENTAL ECONOMICS?

• Environmental economics is a discipline of economics that studies the economic effects of

environmental policies around the world. Its main focus is on the efficient allocation of environmental
and natural resources and how alternative environmental policies deal with environmental damage,
such as air pollution, water quality, toxic substances, solid waste, and global warming
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:

• The theory of environmental externalities

• The optimal management of common property and public goods
• The optimal management of natural resources over time
• The economic valuation of environmental goods and services
CORE CONCEPTS OF ECOLOGICAL
ECONOMICS
The core concepts in ecological economics are somewhat harder to define, as it is a broader field than environmental
economics. There is also more variation in viewpoints and disciplinary approaches among ecological economists, including
perspectives from biology, ecology, and other sciences, as well as engineering, systems modelling, history, and philosophy.
Nonetheless, we can identify a set of core concepts to which ecological economists generally subscribe.
These three core concepts are:

1. The economic system is a subset of the broader ecological system

2. Sustainability should be defined according to ecological, rather than economic, criteria
3. It is essential to rely upon a range of academic disciplines and perspectives, in addition to economics, to provide
insight into environmental issues
ORIGINS OF ENVIRONMENTAL ECONOMICS

• Environmental economists see the environment as a form of natural capital that provides amenities and
life support functions to the earth’s inhabitants. Environmental economics was premised on the
neoclassical approach dealing with issues such as inefficient natural resource allocation, market
failure, negative externalities, and management of public goods.
SCOPE OF ENVIRONMENTAL ECONOMICS

The role of environmental economics in the design of environmental policies and their implementation is the major concern of
the discipline. Three important questions arise in environmental economics:

• What causes environmental challenges in terms of economic and institutional affairs? The question explores the concept of
market failure, which is premised on the fact that there are either non-existence or incomplete markets for environmental
goods, such as unpolluted air, clean environment, scenic nature views, etc.; hence, there is likely to be no efficient allocation
of environmental resources.
• What is the monetary value of environmental degradation through pollution and other agents, as well as the value of
developments in the prevention and eradication of environmental harm? The methods of measurement and estimation of
the variables are an important aspect of environmental economics.
• How can economic incentives and environmental policies be effectively designed to improve environmental quality and
deter environmental damage? Critical evaluation of economic incentives and environmental policies and regulations is
crucial to find out if they are yielding the intended objectives.
ESTIMATING THE VALUE
OF THE ENVIRONMENT
AND NATURAL RESOURCES

resource inputs have been divided by

assessors into: 2  renewable (also
called ‘stock resources’) which are
robust enough to withstand poor
 management; potentially renewable
(dependent on effective
management); and non- renewable
Some renewable resources can be converted to non-renewable  through poor management or natural
disaster. Certain resources cannot be remade if damaged or exhausted (e.g. biodiversity). The absorptive
capacity of the environment, its ability to absorb and neutralise damaging compounds or activities, should
be assessed  by economists. There may be opportunities to substitute for a given resource, using labour,
capital or alternative materials.
ENVIRONMENTAL ECONOMICS
ENCOMPASSES THE FOLLOWING CONCEPTS:

1. Sustainable Development
2. Market Failure
3. Externalities
4. Valuation
5. Cost-Benefit Analysis
1. SUSTAINABLE DEVELOPMENT

Sustainable development is defined by UNEP as “development that meets the needs of the present without
compromising the ability of future generations to meet their own needs.” The concept analyzes the role of
economic development in supporting sustainable development.
The four basic components of sustainable development are economic growth, environmental protection,
social equity, and institutional capacity.
2. MARKET FAILURE

Market failure occurs if the functioning of a perfect market is compromised; hence, it is unable to
efficiently allocate scarce resources at a given price as conditions for laws of demand and supply are not
met.
An example can be an environmental good such as clean oceans. It is difficult to price the value of clean
seas and oceans, and there exist no markets for clean water bodies where it is traded depending on the
degree of cleanliness. It is a standard case of market failure.
3. EXTERNALITIES

Externalities are inadvertent consequences of economic activity that affect people over and above those directly
involved in it. Externalities are also another form of market failure. They can either be negative or positive.
A negative externality creates unplanned outcomes that are harmful to the environment or directly to the
general public. An example can be pollution through industrial production, which results in unclean air and water
and other health risks. The polluting entities may not incur any costs to address the pollution, even though their
activities harm the environment and negatively affect the surrounding community.
A positive externality is a benefit to other people not directly involved in its generation. A community nature
park can benefit people outside the community who visit family and friends in the area and would not have
contributed to its development. People who benefit from an economic resource without contributing to its
establishment are called “free riders.”
 
4. VALUATION

Valuation is an important aspect of environmental economics, as it helps to evaluate a variety of options in

managing challenges with the use of environmental and natural resources. The valuation of ecological
resources is a complex process, as it is difficult to assign value to intangible benefits, such as clean air and
an unpolluted environment.
Resources that offer multiple benefits are difficult to value – for example, mountains may prevent flooding,
provide scenic beauty, direct river flow patterns, and provide fertile soils for agriculture.
Environmental resources can be assigned values depending on use and non-use methods. It’s easier to
assign value to a product in use by observing what consumers are willing to pay.
5. COST-BENEFIT ANALYSIS

Cost-benefit analysis (CBA) involves weighing the benefits arising from a policy against the perceived
benefits. Hence, the best policy is one in which there is the greatest surplus of benefits over costs.
CBA starts with a base policy where no changes are made to the status quo. A time horizon is selected
where the perceived costs and benefits are expected to be realized. Benefits are instances where human
well-being is improved, and costs decrease human well-being.
DEFINITION OF ECONOMIC VALUATION

Valuation can simply be defined “as an attempt to put monetary values or to environmental goods and
services or natural resources”. It is a key exercise in economic analysis and its results provide important
information about values of environmental goods and services. This information can be used to influence
decisions about wise use and conservation of forests and other ecosystems. The basic aim of valuation is to
determine people’s preferences by gauging how much they are willing to pay (WTP) for given benefits or
certain environmental attributes e.g. keep a forest ecosystem intact. In other words, valuation also tries to
gauge how much worse off they would consider themselves to be as a result of changes in the state of the
environment such as degradation of a forest.
• Economic valuation never refers to a stock, but only the change in a stock. If one speaks of the economic
value of biodiversity, then one always means the economic value of a change of biodiversity. It is not a
question of determining the ‘true’ value of biodiversity or ecosystems but valuing changes and
comparing them with their alternatives

• The economic benefit provided by an environmental good or service is the sum of what all members of
society would be willing to pay for it. For resources traded in markets such as oil, land, timber, and
crops, the value of small quantities of market goods can be measured by their observed price. In
competitive markets, prices reflect both the marginal cost of producing the good to suppliers and the
marginal value to consumers. Prices are readily observed and constantly updated.
EXTERNAL EFFECTS

• In “day-to-day” market economics, markets determine prices and quantities of products and services.
Theory says that due to demand and supply, an optimal mix of products and services is demanded and
supplied, leading to the highest possible welfare (given the physical production and consumption
limitations).
• However, for products and services that are not sold on the market, no direct market price information is
available, making it difficult to optimize the supply and demand of such services But although no prices exist
for “a forest”, “biodiversity”, “pollution”, it is clear that many individuals attach a certain value to such non-
priced goods and services.
• Even before environmental problems became visible and well understood, economic theory had to deal
with the problem of non-priced goods and services and the optimal supply and demand thereof. This
leaded to the concept of “externalities” (or external effects). This also became a key concept in valuation of
natural and environmental resources.
BENEFITS TRANSFER

Due to time and research funding constraints, it is unlikely that all of these resources will be subject to
individual and explicit valuation. It is therefore necessary to consider the opportunities that are available
for the use of environmental value transfer, more commonly referred to as benefit transfer.
Benefit transfer is defined as transferring values that have been estimated for one environmental attribute
or group of attributes from one site or location (termed the study site) to assess the benefits of a similar
site or location (termed the policy site (Robinson, 2001)
The objective of benefit transfer can be expressed as estimating the value of an environmental resource for
a policy site such that the mean square errors (MSE) are minimized subject to time and research funding
constraints.
METHOD FOR VALUING THE ENVIRONMENT

Two broad classes of methods can assess the economic value of environmental amenities and disamenities
in the absence of explicit markets: behavioral (revealed preference) methods and attitudinal (stated
preference) methods. Revealed preference methods seek natural experiments to estimate the demand
function for an environmental good. Researchers look for cases where people face exogenous differences
in environmental prices and the available quantity of goods; the relationship between price and quantity
can be estimated by observing consumers’ choices in these situations. However, because the experiments
are usually not randomized, the methodologies must control undesired variation using a combination of
carefully choosing experiments and controlling for remaining problems with statistical techniques.
MARKET-BASED TECHNIQUES (STATED
PREFERENCE)

The pioneers of natural and environmental resource valuation relied on the “law of demand” as a way to
measure the market values for natural resources and environmental amenities. While the same is true
today, the degree of sophistication in the measurement of these values has increased considerably. Three
market-based techniques that have recorded a significant history of natural and environmental resource
valuations are described here: the market price approach, the appraisal method, and resource replacement
costing (Wellman, 1997)
MARKET PRICE PROXIES

• Market price approaches consider the costs that arise in relation to the provision of environmental
goods and services which may be observed directly from actual markets. These costs can take the form
of opportunity costs or the cost of alternative provision as well as mitigation costs or the costs of
aversive behavior and shadow project costs
• Market price approaches can be proxies for direct and indirect use value but not non-use values. This is
because the price a consumer pays for a good or service is a minimum expression of their willingness to
pay for it they may in fact be willing to pay much more than the market price, i.e. consumer surplus is
not accounted for.