INSTITUTE- University School of

Business
DEPARTMENT- B.SC (ECONOMICS)
Natural Resource Economics (20SET-305)
FACULTY NAME: Ms. Sheena Chopra

Lecture 14 and 15 : Cost benefit DISCOVER . LEARN . EMPOWER

analysis 1
 • Space for
visual (size
24)
Cost Benefit
Analysis
Course Outcome
CO Number Title Level

CO1 To Acquire the concepts of introductory Remember Will be covered in this

concepts of natural resource economics.   lecture

CO2 To Develop a thorough understanding about Understan

economic resource theory and its applications .
d
 

CO3 To Comprehend the concepts of natural Understan

resource management market. d

2
CO4 To understand the Sustainability and
 Analyze
Environment Accounting
CO5 To analyse the environmental indicators and Analyze
climate change
 Environmental problems are the result of our pursuit of
affluence. Therefore, we have to reconsider the
of pursuing affluence. Inmethod
other words we have
to reconsider the economic activities.

Environment

Material Economic Activities Environmental burdens

(pollution, waste, CO2,…)
Energy (production,
consumption)

For a long time, economists had focused on only economic activities (yellow part in the
figure). However we obtain materials and energy from the environment and inflict
burdens on the environment. Therefore, economic activities and the environment are
not mutually exclusive. We thus have to consider both the economic activities and the
environment.
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 Environmental economics
 Our economic activities (production
and consumption) have an impact on
the environment.
 Environmental economics attempts to
find the cause of environmental
problems and propose policies in terms
of economics.

4
 Keyword 1 “incentive”
 Economics regards human beings as “rational”
creatures.
→Most of us do not want to lose money.
→Most of us do not want to engage in troublesome
activities.
 To encourage “rational” people to take environmental-

friendly action, the government should construct a

society where we can save more money by conserving
the environment.
 The environmental policies can take into consideration

the self-interest of people instead of relying on only

moral fiber or the ethical view. 5
 Keyword 2 “cost and

benefit”
Sometimes we have a conflict of opinions on environmental
protection.
 Some people emphasize only the cost (disadvantage) of
environmental protection saying that stringent environmental
regulation worsens the economic situation.
 Some people emphasize only the benefit (advantage) of
environmental protection saying that protecting the environment
is very, very important.
 We have to take into consideration both the cost and benefit of
environmental protection. What we have to decide is to what
extent the environment should be protected.
Incentive
 An example of environmental
policies using incentive
 Carbon tax
 Levy tax on fossil fuels to reduce their
consumption amount
 Marginal abatement cost
(MAC)
 The cost of reducing an additional
one unit of emission.
→ MAC increases as the reduction
amount increases because a
company seems to take the easiest
(least cost) environmental measure
first. If the company has to reduce
more, then the company takes the
next step and takes the more costly
 Example of marginal
abatement
Marginal
cost (MAC)
abatement cost

The introduction of
the latest energy saving technology The cost of changing fuels
from coal to oil and natural gas

The amount of greenhouse

gas emissions
The amount of
greenhouse gas reduction

The cost of turning off lights

in empty rooms
 Marginal abatement cost curve
Marginal
abatement cost
 Connecting the
top of each
bar (in the Marginal abatement
cost curve
figure on Slide
10) with a line
gives us the
marginal
abatement cost
curve 0 emission

reduction
 Suppose a company has to pay T-amount of yen per
unit of emission. How does a company respond to the
introduction of the emission
tax?

Marginal abatement
cost curve

Tax C B
rate T

A The emission amount

E＊ EO
12
The reduction amount
• Case 1 : When no policy is implemented, the company does not
reduce the emissions (emit at E0) and does not pay tax.
• Case 2: However, after the introduction of tax policy, emitting at
E0 results in paying much tax. The amount of tax payment is
equal to □AEOBT.
• Case 3: The company is not happy with the large amount of tax
payment and decides to reduce emissions. When the company
emits at E*, the amount of tax payment is equal to □AE ＊ CT.
The emission reduction cost is equal to △EOE ＊ C. The company
can save △ CBEO by the reduction compared to Case 2.
• The company does not want to reduce the emission at the lower
level of E* because the additional reduction beyond E* takes
much reduction cost.
• When the tax policy is implemented, a company decides on the
emission amount so that the marginal abatement cost equals
the tax rate.
 Suppose that we want to reduce the pollution in
the
entire country at the smallest cost.
 There are many companies in the country. How do

we divide responsibility of reduction among

companies to achieve this purpose?

＊ This purpose is sometimes important. Because the resources in

society are limited. When we devote some money to environmental
protection, we cannot use the money for other purposes.
 A simple example.
There are only two companies (A and B) in the country. T
marginal abatement cost is
shown in the figure.
Company A Company B

Marginal abatement cost

Marginal abatement cost

23
20
18 17 17 14
15 13
10 8 7 10 8 7
4 6 4 3
2 1
emission

10 9 8 7 6 5 4 3 2 10 9 8 7 6 5 4 3 2 1
reduction emission
1
reduction
(The unit of the marginal abatement cost is 1000 yen.) 15
 Case 1: When no policy
implemented…
is
 The situation of each company
 Company A
 [emission 10 units] [reduction 0 units]
 [total abatement cost 0 yen]
 Company B
 [emission 10 units] [reduction 0 units]
 [total abatement cost 0 yen]
 Sum of the emissions from the two companies equals 20
units.
 Sum of the total abatement cost of the two companies
equals 0 yen.
 In Case 1, there are 20 units of emissions in
the country.
 Now, suppose the government wants to
regulate the emissions to reduce the
emissions by 10 units at the smallest cost in
the entire country.

How does the government allocate the
reduction responsibility between the
companies?
Case 2: Each company is
allowed to emit 5 units
 The situation of each company
 Company A
 [emission 5 units] [reduction 5 units]
 [total abatement cost 4+7+8+10+13=42 yen]
 Company B
 [emission 5 units] [reduction 5 units]
 [total abatement cost 1+2+3+4+6=16 yen]
 Sum of the emissions from the two companies equals 10
units.
 Sum of the total abatement cost of the two companies
equals 58 yen.
 Case 3: Company A is allowed to emit
units, while company B is
allowed to emit 4 units.
The situation of each company

 Company A
 [emission 6 units] [reduction 4 units]
 [total abatement cost 4+7+8+10=29 yen]
 Company B
 [emission 4 units] [reduction 6 units]
 [total abatement cost 1+2+3+4+6+7=23 yen]
Sum of the emissions from the two
companies equals 10 units.
Sum of the total abatement cost of the two
companies equals 52 yen.
 Case 4: Company A is allowed to emit
units, while company B is
allowed to emit 3 units.
The situation of each company

 Company A
 [emission 7 units] [reduction 3 units]
 [total abatement cost 4+7+8=19 yen]
 Company B
 [emission 3 units] [reduction 7 units]
 [total abatement cost 1+2+3+4+6+7+8=31 yen]
Sum of the emissions from the two
companies equals 10 units.
Sum of the total abatement cost of the two
companies equals 50 yen.
Case 5: Company A is allowed to
emit 8 units, while company B is
allowed to emit 2 units.
 The situation of each company
 Company A
 [emission 8 units] [reduction 2 units]
 [total abatement cost 4+7=11 yen]
 Company B
 [emission 2 units] [reduction 8 units]
 [total abatement cost 1+2+3+4+6+7+8+10=41
yen]
 Sum of the emissions from the two
companies equals 10 units.
 Sum of the total abatement cost of the
two companies equals 52 yen.
 Summary
Case Sum of the Emissions from Sum of the total
emissions from Company Ａ and Ｂ abatement cost of the
the two companies two companies
1 20 units A 10, B 10 0 yen

2 10 units A 5, B 5 58 yen

3 10 units A 6, B 4 52 yen

4 10 units A 7, B 3 50 yen Min.

5 10 units A 8, B 2 52 yen
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In Case 4, the sum of the total abatement cost of the
two companies is the smallest. How much is the
marginal abatement cost of each company in Case
4?

Company A emits 7 units.

 The marginal abatement cost equals 10 yen.
Company B emits 3 units.
 The marginal
abatement cost equals
10 yen.
When the marginal abatement cost of each
company is the same, the total abatement
cost of the two companies is the smallest.
Comparison of environmental policies
1. Direct regulation
The government limits the emission amount from each source.
This type of policy has been used to tackle industrial pollution (air pollution, water
pollution…). The advantage of this policy is the immediate effect on the pollution
reduction. When what is important is the emission amounts from each source
rather than the total amounts in the entire country, this policy should be used.
※On the other hand, the degree of global warming depends on the total
emission amounts in the world.

From the viewpoint of the equalization of the marginal abatement cost, it is almost
impossible for the government to limit the emissions amount for each source to
equalize each marginal abatement cost. This is because the information of the
marginal abatement cost of each source (such as the figure in slide 15 ） is not
available to thegovernment.
 In the example above, the information on the slide 15 is not available to the
government. Therefore, the government cannot set the limits as in Case 4 (company
A is allowed to emit 7 units, and B is allowed to emit 3 units.)
Comparison of environmental policies
2. incentive based policy such as tax
From the viewpoint of the equalization of the
marginal abatement cost, it is possible for the
government to equalize the marginal abatement cost
of each source.
Please recall slide 12 and 13. When the tax policy is
implemented, a company decides on the emission
amount so that the marginal abatement cost equals
the tax rate. When the tax rate is the same for each
company, the marginal abatement cost of each
company becomes the same.
This means that the total abatement cost of society
becomes the smallest.
Marginal abatement cost

Marginal abatement cost

Company A Company B

Tax
Tax rate T
rate
T

emission emission

reduction reduction
Cost and Benefit
Video Resource: Documentary

https://www.youtube.com/watch?v=lnoAqqisD3U
 Cost and Benefit
 Any policy involves both the good and
the bad.

→When we decide something, we have to

take into consideration both its cost
and benefit.
 An example
A controversy over dam construction
Suppose that there is a plan to construct a
dam with deforestation.
Some people want the dam. But some people
do not want the dam since they want to
protect the forest.

We need the dam!

We do not need the dam!
 Let’s compare the cost and
benefit of the dam construction.
cost benefit
・ Cost for purchasing the land ・ Benefit of preventing
・ Cost for purchasing the flood
materials ・・・・ etc.
・ Costetc.
・・・・ for hiring people
・ Cost for losing the forest

This is called the cost benefit analysis

 What is the cost for losing the
forest?
 While a forest gives people “happiness”, certain aspects of it
do not have a market price. This is because the aspects are
not sold in the market.
 Example: When we enjoy a beautiful view of the forest, we do
not have to pay money unless the forest is part of a park where
we have to pay an entrance fee.
 Because of the feature of the no market price, sometimes the
aspect is dealt with as if it had no value. This is one of the
causes of deforestation.
 Environmental economics tries to measure the value of these
aspects and give a monetary value to the environment so that
the value can be taken into consideration.
 How can we measure the monetary value of the environment?
 Value of a forest

Use value Non-use value

Direct use Indirect use

Option value Bequest value Existence value
value value
・ recreation ・ leave the
・ timber
production
・ preventing for which we can use ・ leave
options ・ wildlife
landslide ecosystems ・
・ food production resources in the future to the future
generation wildwood
・ etc. ・
・ etc. ・ etc. ・ etc.
etc.
 Example 1:
Giving monetary value to the water-
retaining function of the forest.
How much does it cost to construct a dam which has the same
amount of water-retaining function as the forest? Suppose the
forest can retain 10 times the water that a dam can retain.
Then 10 times the cost needed to construct a dam can be
assumed to equal the monetary value of the water-retaining
function of the forest.

＝ ×10
 Example 2:
Giving monetary value to the recreation
function of a forest.
How much are people willing to pay as the travel cost to go
to the forest ? If they decide to go to the forest, they think
that they will evaluate the satisfaction of going to the
forest higher than the travel cost.

1,000 yen per person

 Example 3:
Giving monetary value to the clean air.
The price of a house is influenced by many factors. One of them is
the degree of air pollution in the area. Suppose there are two
houses and the characteristics of the houses are the same except
for the air pollution. The size, layout, distance to the station,
distance to the shops, and so on are the same about the two
houses. But the degree of air pollution is different. In this case the
difference of the house price can be considered to be the
influence of the air pollution.

Dirty Clean
air air

10 million yen 20 million yen

 Example 4:
Giving monetary value to the function not
related to the human use.
Examples 1, 2 and 3 are all related to human use. However, the forest has the
function where it is not used by humans. In the valuation of these functions,
price information cannot be used. Suppose an endangered animal lives in the
forest. The forest provides food, water and so on to the animal. Humans do not
use this habitat function. However, we may think this function is important.
How do we give monetary value to the importance? In this case we can use a
questionnaire to ask people how much they are willing to pay for the forest
preservation for the animal.
 Using these methods, environmental
economics tries to give monetary value
to the environment so that the values
can be taken into consideration.
 IIT ROORKEE NPTEL LECTURE:
https://www.youtube.com/watch?v=W1jIl5YEkIM
 REFERENCES
Reference Books:
1. Harris, J.M. 2006. Environmental and Natural Resource Economics: A Contemporary Approach, 2nd edition.
Houghton Mifflin. ISBN: 978-1138659476.
2. Field, Barry C. 2008. Natural Resource Economics: an Introduction. Waveland Press. ISBN: 978-1478627807

Reference Website:
https://nptel.ac.in/courses/130106113

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 Blackboard
Assessment Pattern

Components HT-1 HT-2 Assignment Surprise Test Business Quiz GD Forum Attendance Scaled
Marks

Max. Marks 10 10 6 4 4 4 2 40

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