12324230501teacher Manual English

Economy and Environment Program for
Southeast Asia
ENVIRONMENTAL
ECONOMICS
A
TEACHERS’ MANUAL
Undergraduate Level
By
Herminia A. Francisco
Bui Dung The
Pham Khanh Nam
August 2005
1
PREFACE
This manual was written to support the teaching of undergraduate environmental
economics course in Vietnam Universities. Some time in 2003, a number of senior researchers of
the Economy and Environment Program for Southeast Asia (EEPSEA) requested that EEPSEA
offers a 3-week training course for teachers of Environmental Economics in the country. The
request in turn was precipitated by the new mandate from the Ministry of Education in Vietnam
that makes Environmental Economics a required course in all Bachelors’ Degree in Economics
and Management for all colleges and universities. Aware that the capacity of teachers to teach
Environmental Economics varies across the country as training of teachers varies also from self-
study, short-term training, to a formal course in an undergraduate/graduate degree from local
universities or abroad, EEPSEA acceded to the request and offered the course in August 2005.
The course though can be used also in other colleges and universities in Southeast Asia.
The training course was designed to teach both the subject matter contained in an
internationally-comparable undergraduate environmental course and to enhance teachers’ skills in
teaching this subject. A teachers’ manual was developed to support the teaching of the training
course, but the intended use was to support the Environmental Economics teachers in their job.
The manual was refined during the training course based on feedbacks from the teachers' trainees
and teachers’ experiences on the use of the manual.
The manual follows the course outline for Environmental Economics given as part of this
manual. For each lecture topic, the teaching objective for the topic was indicated, along with the
main points that teachers should stress during the lecture, and a proposed topical outline. Each
lecture chapter was supplemented with a set of discussion questions/problem sets with solutions.
The proposed course outline is for a 4-unit teaching load (60 hours teaching). It could be
modified to a 3-unit teaching course in two ways: deleting the Natural resource Economics
Section OR deleting the Cost-Benefit Analysis section, particularly if a separate course on
Natural resource economics or Cost-Benefit Analysis is offered as part of the students’
curriculum in the College or University. It is understood that this manual is not to be given to
students at any time but should be used solely by instructors teaching this course. The
answers to questions and problem sets in the Manual can be found in a separate file
accompanying this manual.
This course manual relied heavily on the Instructors' Manual developed by Forsdyke,
Field, and Olewiler (2002), which in turn was used to support the use the textbook: Field B. and
N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian Edition. Needless to say,
many chapters of this book are used as recommended teaching materials for the course, along
with the books by Pearce, Turner and Bateman (1995) and many other references (see Course
Outline). A number of the discussion questions and the problems were also taken from the book
on Natural Resource and Environmental Economics (2003-3rd edition) by Perman, Ma,
McGilvray, and Common, downloaded from their website. Relevant chapters of other books in
environmental and natural resource economics and EEPSEA research reports as case study
materials have also been translated into the local language.
The training course, manual development, and translation of materials were funded by
the Economy, Environment, and Program for Southeast Asia (EEPSEA). Special thank goes to
Dr. Nancy Olewiler for providing technical guidance in the development of the course outline,
review of the manual and for granting access to F, F, and O (2002) manual. This EE Teachers’
Manual was developed by Herminia A. Francisco, Bui Dung The, and Pham Khanh Nam, with
inputs on certain section from Pham Thi Giac Tam.
EEPSEA Secretariat
2
PROPOSED COURSE OUTLINE

ENVIRONMENTAL ECONOMICS
I. Course Description & Prerequisite
Environmental economics is designed to enable students to understand the linkages

between economic activities and the environment and vice versa. It discusses the
theories and the tools that can be used to understand and measure said relationships
so that appropriate decisions on how best to manage the environment and the natural
resources can be identified.
Prerequisite: Microeconomics
II. Course Objectives
At the end of the course, the students are expected to have:
1. Understood the linkages between the various environmental (E) & natural
resource (NR) problems and the economic activities that affect them;
2. Learned how these E & NR problems could be addressed using
appropriate economic instruments and institutional/property rights
reforms;
3. Gained familiarity on the various valuation techniques that could be used
to monetize environmental impacts of economic activities/ programs/
policies; and
4. Appreciated how benefit cost analysis can be applied in evaluating various
resource/environmental management options.
III. Course Content No. of Hours
Lecture 1: Introduction: what is environmental economics……...……………2 hrs
A. Definition of what environmental economics covers.

B. The economic view on what causes environmental problems.
C. Role of incentives in explaining the environmental problem
D. Role of property rights
E. Economic manifestations of environmental degradation
F. The concept of Sustainable Development and growth
G. Benefit-cost analysis as a framework
Basic Reference:
Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian

Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 1.
Additional Readings: Panayotou, T. 1993. Green Markets: The Economics of

Sustainable Development. Chapter 1. The magnitude of the problem. pp. 1-38.
Lecture 2: Economy-Environment Linkages & Overview of Environmental/

Natural Resource Issues
3
Topic 1: Economy-Environment Linkages…...1 hr
Topic 2: Overview of Environmental and Natural Resource

Issues in Vietnam ……………………………………………………3 hrs
A. Water and Air Pollution

B. Land Degradation
C. Resource Depletion: Forest, Fish, and Minerals
D. Global Concerns: Climate change and Biodiversity
E. Sustainable Development
Basic Reference:

WB. 2001. Vietnam Report. Chapter 4: Trends in the Environment
Additional Reading:
Tietenberg, T. 2003. Environment and Natural Resource Economics. 6th edition. Chapters
1 & 2: pp 1-19.
Lecture 3: Causes of Environmental Problems…….………………… 3 Hrs
A. Market failures
C. Property rights
D. Policy failures
E. Implications on the approaches to control environmental degradation:
Basic References:
Turner, Pearce and Bateman. Environmental Economics: An Elementary

Introduction.1994. Chapters 5, 6, 15 (Box 15.3) and 23.

Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 3 & Chapter 4
Panayotou, T. 1993. Green Markets: The Economics of Sustainable Development.

Chapters 2 and 3.
Lecture 4: Brief Review of Welfare Economics Concepts
Topic 1: Economic efficiency and markets: Benefits (Demand)

and Costs (Supply) ………………………………………… 3 hrs
Basic reference:
4

Topic 2: Defining and Measuring Welfare Changes …... 3hrs
Basic Reference:
Freeman, Myrick.A. 2003. The Measurement of Environmental and Resource Values:

Theory and Methods. 2nd edition. Chapter 3. “Defining and Measuring Welfare Changes,
Basic Theory”, pp 43-70, 85-89.
Lecture 5: Pollution Economics
Topic 1: Optimal Level of Pollution………..………………………………… 3hrs
Basic References:
Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An

Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 5)

Topic 2: Coase Theorem and Property Rights ………………………………..2hrs
Basic References:


Edition, McGraw-Hill Ryerson Limited, Canada. (Chapter 10)
Topic 3: Environmental Standards ……………………………………………. 2hrs
Basic Reference:

Topic 4: Taxes and Subsidies ………………………….………………………...2hrs
Basic References:


5
Topic 5: Transferable Discharge Permits…...2 hrs
Basic Reference:

Topic 6: Evaluating Environmental Policy Instruments……..…………….. 2hrs
Basic Reference

Edition, McGraw-Hill Ryerson Limited, Canada. (Chapter 9 and 14)
Lecture 6: Environmental Valuation
Topic 1: Why Value the Environment and the

Concept of Total Economic value …….…………………….………….1 hr
Basic References:
J.T. Winpeny. Values for the Environment. 1991. Chapter 1: Introduction: Why Value
the Environment?
OECD. 1995. The Economic Appraisal of Environmental Projects and Policies: A

Practical Guide. Chapter 1: Introduction.

Introduction.1994. Chapter 8: Valuing Concern for Nature.
Topic 2: Steps in Valuation & Overview of Valuation Techniques……………1h30
Basic References:

Practical Guide. Chapter 3 &4

Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 8
ADB. 1996. Economic Evaluation of Environmental Impact - A Workbook. Environment

Division, Asian Development Bank. Manila.
Suggested Readings:
Dixon, John A; Louise Fallon Scura, Richard A Carpenter and Paul B Sherman. 1994.
Economic Analysis of Environmental Impacts. Chapters 1, 3 & 4.
Topic 3: Market-based techniques ………………….………………………….2 hrs

6
Basic References:


Sinden J. and Thampapillai, DJ. 1995. Introduction to Cost-Benefit Analysis. Longman.

Melbourne. Chapter 6
Topic 4: Travel Cost Method ………….…………………………………………2 hrs
Basic References:


Elementary Introduction. Harvester Wheatsheaf Publisher. Chapter 6

Topic 5: Hedonic Pricing Method…………………………………………….…2 hrs
Basic References:


Markandya A, Harou, P., Bellu, L, and Cistulli, V. 2002. Environmental Economics for
Sustainable Growth: A Handbook for Practitioners. Edward Elgar. Chapter 11.
Topic 6: Contingent Valuation Method (CVM) …………………..……………. 2 hrs
Basic References:

Additional Readings:
Callan, Scott J. and Janet M. Thomas. 2000. Environmental Economics and

Management: Theory, Policy and Application. Chapter 8: Assessing Benefits for
Environmental Decision Making.
7
Economic Analysis of Environmental Impacts. Chapter 5.
Bateman, I.J, Carson, R, Day, B., Hanemann, N, Hett, T. Hanley, N., Jones-Lee, M.
Loomis, G., Mourato, S., Ece Ozdemiroglu. 2004. Economic Valuation with Stated
Preference Techniques: A Manual. Edward Elgar Publishing. UK.
Topic 7: Benefit Transfer Techniques…………………………………………0.5 hr
Basic References:
Stale Navrud. 1996. The Benefits Transfer Approach to Environmental Valuation.

EEPSEA paper.
Lecture 7: Cost-Benefit analysis as a tool in Environmental/

NR Management…………………………………….………………………………………. 8 hrs
A. Overview of Cost-Benefit Analysis

B. Steps in Cost-Benefit Analysis
C. Issues in Cost-Benefit Analysis
Basic References:

Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 6, p.106-122

Melbourne. Chapter 8.
Boardman, A.E., Greenberg, D.H., Vining, A.R., and D.L. Weimer. 1996. Cost Benefit
Analysis: Concepts and Practice. Prentice Hall. New York. Chapter 1.
Lecture 8: Natural Resource Economics
Topic 1: Introduction to natural resource use,

Property rights, rent, and land value………………………..………… 1 hr
Hartwick, J. and N. Olewiler. 1998. The Economics of Natural Resource Use, 2nd edition:
Chapters 1 and 3 (pp57-73).
Topic 2: Non-renewable Resources............ …………………………………..…. 2 hrs

Chapter 8
Topic 3: Renewable Resources: Fishery and Forestry……………………….… 6 hrs

8
A. The fishery
B. The forestry: a simple model

Chapters 4 and 10
Lecture 9: Application of Environmental

Policy in Vietnam………………………………………………………….. 4 hrs
A. Framework Laws of Environmental Protection and Provisions in Vietnam.

B. Institutional Arrangements: Organization Structures of government;
Environmental institutions; environmental legislations;
C. Applications of environmental legislation in Vietnam: achievements and
constraints.
D. Environmental Problems where economic instruments are/could be useful.
Basic References:
www.luatvietnam.com.vn;
www.monre.gov.vn;
www.nea.gov.vn
9
ENVIRONMENTAL ECONOMICS
(TEACHERS’ COURSE MANUAL)
LECTURE 1: INTRODUCTION
TOPIC: What is Environmental Economics?

Objective:
To give students an overview of the type of problems confronting environmental

economists and how said problems may be addressed using basic analytic tools of
microeconomics. The students are expected to get a glimpse of what the various topics of
environmental economics are in this first lecture.
Main Points:
The main ideas that are critical to teach students in this topic are:
1) The critical role of incentives and property rights (or lack thereof) in producing
environmental degradation and in designing environmental policies.
2) The tradeoffs between economic growth and environmental quality, both in the
short and long term.
3) The need to analyze short- and long-term benefits and costs of environmental
improvements and how benefit cost analysis could play a role in such an analysis.
Teaching Hour: 2 hours
Suggested Topical Outline:
A. What environmental economics is and explain how it is similar and different

from other economic subjects.
B. The Economic approach to explaining what causes environmental problems.
C. Role of incentives in explaining the environmental problem by way of
examples—at the household & firm levels.
D. How property rights could also be used to explain why environmental
problems exist.
E. The economic manifestations of environmental degradation
F. The concept of Sustainable Development by showing tradeoffs resulting from
economy & environment linkages
G. Benefit-cost analysis as a framework for analyzing the tradeoffs between
economy and environment and in policy analysis. Introduce role of valuation
here.
Teaching Ideas:
• This section should set a positive tone that environmental economics is NOT anti-
environment, something that some environmentalists might be thinking as they
think of economists in general. Instead—the instructor should emphasize how
10
environmental economics can in fact be used to design appropriate environmental

policies. Its usefulness in evaluating the merits of economic policies by bringing
into the picture the value of the environment should also be highlighted. Yet—as
the usefulness of environmental economics is emphasized, one should also
highlight the limitations in the use of the tool—which is brought about mainly by
the limitations in our understanding about the economy-environment linkages and
by the limitations in the data available to understand these relationships.
• The use of local environmental problems to highlight the role of incentives and
property rights situation should be used and students should be encouraged to
participate in the analysis of why these problems exist.
• At this stage, the teachers may be wondering why we are introducing such
concepts like sustainable development and benefit cost analysis-- please be
reminded that the discussions at this stage are only brief and are made only to
provide students a glimpse of the key concepts in environmental economics,
which will be discussed in greater detail as the course progresses.
Basic Reference:

Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 1: What is environmental
economics? pp 2-19.

Chapter 1. The magnitude of the problem. pp. 1-38.
Discussion Questions: Cf: F & O (2005) and F, O, & F (2002)
Q1. Why should a tax on gasoline provide a larger incentive to reduce air emissions from
motor vehicles than an annual tax on owning a vehicle?
Q2. What factors influence the trade-offs illustrated in the production possibility frontier?
How can environmental policy affect these trade-offs?
Q3. Show how technological change could allow firms to produce goods and services
with less pollution. Show the answer graphically using the PPF.
Q4. Can you think of any incentives that you face that encourage you to behave in ways
consistent with sustainability? Can you think of any that have the opposite effects? How
could the latter be changed?
11
LECTURE 2: ECONOMY-ENVIRONMENT LINKAGES & OVERVIEW OF

ENVIRONMENTAL/NATURAL RESOURCE ISSUES
TOPIC 1: Economy-Environment Linkages

Objective:
The students should gain a clear understanding of how the economic system is linked to
the natural environment and what concepts are relevant in analyzing pollution problem.
Main Points:
This section discusses the material/energy balance relationship as the main basis for the
link between the economy and the environment. It then shows the ways by which one
may aim to reduce the residuals resulting from said linkage as targets of environmental
policies. Finally, the different concepts related to discussion of pollution/pollutants are
discussed.
Teaching Hour: 1 hour
A. Diagram of relationship between the economic system and the natural

environment is explained.
B. The law of thermodynamics as they explain the ability of natural resource system
to absorb wastes.
C. How is environmental economics different from natural resource economics?
D. Where are the residuals from economy-environment linkage coming from and
how these may be reduced?
E. Sustainable Development: Balancing Growth with Environment
F. Emissions, Ambient Quality and Damages Linkages
G. Types of Pollutants
Teaching Ideas:
• The use of power point/overhead presentation of Figure 2.1 in F & O book is

encouraged.
• The analysis of the economy-environment linkages should emphasize the

relationships between the raw material inputs coming from nature and the
residuals discharged to the environment—using law of thermodynamics. In
addition, one should also discuss that these inputs and outputs need not be
damaging in a state of ecological equilibrium. This happens when some of the
residuals get used as inputs as well—e.g. manure and compost as natural
fertilizers and recycling of some waste materials. One should also mention
that organisms other than humans could also pollute or damage the ecosystem.
The example cited is unicellular organisms that affect the ability of
photosynthesis thus producing oxygen as by-product, which could accumulate
to kill many organisms.
12
• The notion of Sustainable Development could be brought in here—as a way to

reduce environmental damages while pursuing economic growth.
Basic Reference:

Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 2: Linkages between the
Economy and Environment: Taxonomy
Additional Reading:
Tietenberg, T. 2003. Environment and Natural Resource Economics. 6th edition. Chapters
1 & 2: pp 1-19.
Discussion Questions: (Cf: F & O, chapter 2; and F, O, & F 2002)
Q1: How does population growth affect the balance of flows shown in Figure 2.1?
Q2: If all goods can be changed overnight so that they lasted twice as long as before,
how would this change the flows shown in Figure 2.1 in the short and long runs?
Q3: A given quantity of a residual discharged at one time and place can be a pollutant; if
it is discharged at another time or place, it may not constitute a pollutant. Why is this
true?
Q4: Why are long-lived cumulative pollutants so much harder to manage than short-
lived, non-accumulative pollutants?
Q5. Suppose that we observe that emissions of pollutants have decreased but that
environmental quality has not increased—what might be the explanation?
Q6. “An examination of natural resource matters ought to recognize technical/scientific,

economic, and socio-political considerations.” Explain (Perman, Ma, McGilvray, and
Common, 2003)
TOPIC 2: Overview of Environmental and Natural Resource Issues in Vietnam

Objective:
The main goal of this topic is to provide students an overview of the environmental and
natural resource issues/problems and challenges faced by the country—something that
students have to bear in mind as the course discusses how environmental economics tools
could be used to help address these problems.
Main points:
This lecture should provide an overview of the major environmental and resource
problems associated with: Water and Air Pollution, Land Degradation, Resource
Depletion: Forest, Fish, and Minerals, and Global Concerns: Climate change and
13
Biodiversity. Finally, the idea behind the concept of Sustainable Development should
likewise be discussed.
Teaching Hour: 3 hrs
Topical Outline:
A. Water and Air Pollution

B. Land Degradation
C. Resource Depletion: Forest, Fish, and Minerals
D. Global Concerns: Climate change and Biodiversity
E. Sustainable Development
Teaching idea:
This topic is best discussed as an assigned topic to group of students. They should be
assigned to prepare a term paper of these topics by group and to report on them in the
class. This means that the assignment should be given at least 2 weeks in advance.
Each sub-topic or resource issues should be further subdivided into three sub-groups,
with each group assigned to cover any one of the following research areas: a) Situationer
in terms of status of the natural resource/environmental resource; b) Extent of the
environmental problem/natural resource depletion; and c) Measures currently in place to
address the problems and major challenges facing the government in as far as that
specific sector/resource is concerned.
The students should be encouraged to look up at the most recent publications on this
topic.
The allotted lecture time could be used for students to provide information/report on the
topics assigned to them. The class should be encouraged to ask questions on the reported
topics.
Basic Reference:
WB. 2001. Vietnam Report. Chapter 4: Trends in the Environment.

14
LECTURE 3: CAUSES OF ENVIRONMENTAL PROBLEMS
TOPIC: What are the major causes of environmental problems in the world?
Objectives: The students should be able to explain the various underlying causes of
environmental degradation and understand how these causes may be addressed to reduce
the problems.
Main points:
The three major causes of environmental degradation are categorized into market failures,
property rights failures and policy failures. How these failures come about should be
explained to the students. Likewise, the ways in which they could bring about negative
effects on the environment should be discussed.
The concept of economic efficiency in a perfectly functioning competitive market system

will be a good way to start up discussion on market failures. The discussion should define
the baseline conditions—from which situations with market failures could be compared.
In here, the divergence between private and social costs is highlighted, resulting mainly
from the existence of external effects that markets are not able to capture. Illustration of
real life cases where such divergence exists should be used to make the concepts
concrete.
The discussion on property rights failures should make clear the distinction between
open-access situations and those with private and common-property rights. One should
drive the point that open access situation leads to faster resource extraction and hence,
should be addressed.
Policy failures can come about from policies directed to some other goals but have
unintended side effects on the environment or could come from government interventions
to mitigate market failures. Illustrations on cases of said policy failures could be used to
explain how they could cause environmental degradation.
Proposed Topical Outlines:
A. Market failures:
1. Concepts of Market Failures.

2. Externalities as a source of market failure: External costs and external
benefits.
3. The divergence between economic efficiency and social efficiency.
B. Property rights:
1. Concepts and types of ownership structures

2. Characteristics of well-defined Property rights
3. Public goods and the problem of free rider.
C Policy failures:
15
1. What are policy failures and what are their causes

2. Types of policy failures
3. Illustrations of policy failures
D. Implications on the approaches to control environmental degradation:

(Turner et al, p. 143-144)
Teaching Hours: 3 hours
Teaching ideas:
• The various types of externalities could be discussed with students, both from
consumption and production, and both positive and negative. It should be
emphasized as well to the students that pecuniary externality which is an external
effect transmitted through altered prices do not cause market failure. I wouldn’t
even discuss pecuniary externalities….just confuses my students.
• The discussion on property rights can be opened up by asking students the

different types of property rights that exist in the country and in their locality,
from private ownership to open-access situations. The various forms of property
rights can then be discussed and compared in terms of the characteristics that
define a non-attenuated/well-defined property rights (i.e., exclusivity,
transferability, etc). The situation prevailing under open-access condition should
then be elaborated with some examples on where this system prevails.
• In discussing the strength and weakness of the various types of property rights,
one should point that while one may think that one property right regime may be
better than the others in protecting the environment, this may not be true for all
instances. For instance, private ownership is impossible to impose when dealing
with public goods. In addition, it is worthwhile emphasizing that neither private
ownership in an unregulated market nor state ownership with poor-informed
regulatory agencies would assure one of a better environment.
• The discussion of policy failures should be put in the context of the outright
thinking of some to call for government interventions in the face of market
failures. In particular, one should send the clear message that government
interventions may be another cause of environmental problems. Further, the
introduction of the policy failures should emphasize that ignorance on unintended
or side effects of a public policy could also bring about environmental problems.
Government intervention should not be taken even it can achieve successfully the
goals if the costs of these interventions exceed the benefits it may bring in.
Basic References:

Introduction.1994. Chapters 5, 6, 15 (Box 15.3) and 23.

Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 3 & Chapter 4
16

Chapters 2 and 3.
Discussion questions and Exercises (cf: Analytical problems in Field& Olewiler, p.84,
F, O & F, 2002)
Exercises
E1. Below are portions of the demand curves of three individuals for air quality in their
neighborhood. Air quality (integer value only) is measured in term of µg/m3 (micrograms
of SO2 per cubic meter of air). If the marginal cost of reducing ambient SO2 is $40 per
µg/m3, what is the socially efficient level of air quality, assuming that “society” in this
case consists of just these three people?
Costs of Sulphur Quantity Demanded

Removal (dollars per A B C
microgram/m3)
60 1,400 1,200 1,500
50 1,300 1,100 1,400
40 1,200 1,000 1,300
30 1,100 900 1,200
20 1,000 800 1,100
10 900 700 1,000
0 800 600 900
E2. For the exercise in 1, prove that the socially efficient level of air quality maximizes
the net social value.
Discussion Questions (Perman, Ma, McGilvray, and Common, 2003)
Q1. What is the relationship between public goods and open-access resources?
Q2. Some seemingly public goods, such as radio waves, lighthouse services, and even
police and sanitation services, can be supply by private firms. Why is this so? Are there
differences between these public goods and environmental services? If so, what are they?
Q3. Discuss the relevance and application of the concept of externalities in

environmental economics.
Q4. Economists see pollution problems as examples of the class of adverse externality
phenomena. An adverse externality is said to occur when the decisions of one agent harm
another in an unintended way, and when no compensation occurs. Does this mean that if
a pollution source, such as a power station compensates those affected by its emissions,
then, there is no pollution problem?
Q5. While some economists argue for the creation of private property rights to protect the
environment, many of those concerned for the environment find this approach abhorrent.
What are the essential issues in this dispute?
17
Q6. “A clean environment is a public good whose benefits cannot be privately

appropriated. Therefore, private industry which is run for private gain will always be the
enemy of a clean environment.” Comment on this proposition.
18
LECTURE 4: BRIEF REVIEW OF WELFARE ECONOMICS CONCEPTS
TOPIC 1: Market Efficiency: Benefits (demand) and Costs (supply)

Objectives:
The students are expected to view demand and supply concepts now in terms of benefits
and costs measures. The use of demand and supply curves in environmental valuation, in
benefit cost analysis and in analyzing pollution problem should be made clear to students.
Main Points:
The concepts of willingness to pay to measure benefits and opportunity costs to measure
costs should be explained well in this section. It is also important to distinguish between
aggregate and marginal measures of benefits and costs. Finally, the equimarginal
principle should be discussed as an important topic in relation to discussion on economics
of pollution.
Teaching Hour: 3hrs
A. Review of what demand and supply represent in your basic economics course.
B. Relate WTP to demand measure and distinguish between Total WTP and
Marginal WTP. Relate benefits to Demand.
C. Review Supply concept in relation to Marginal cost concept and distinguish
between Aggregate Supply and Marginal Cost (MC).
D. Discuss how technology shifts MC functions
E. Introduce equimarginal principle in relation to goal of minimizing total cost of
producing a given quantity of output.
Basic reference:

Teaching Ideas:
• This section should rely heavily on graphical representation of two-by-two

relationships (e.g. Price and Demand/Supply) but students should be reminded
that this is a static analysis—that assumes other things are constant. However, the
real world is so complex but we could only work by presenting these concepts in
terms of building blocks to help understand abstract principles and relationships.
• A quick review of what the students have learned in their microeconomics course
on would be a good way to start the discussion on this topic. Specifically, students
could be asked what are the characteristics of perfectly competitive market
structure, the concept of market demand and supply, and what the equilibrium
price and quantity represent. The point to make clear is that the intersection of
19
demand and supply curves defines an economic efficient point—corresponding to

where social welfare is maximum.
• One should then define the non-optimal points resulting from the presence of
market failures---with some examples on how these market failures can come
about. The graphical illustration of the resulting level of production—when
externality effects are not considered should be shown graphically. Real-life
examples of cases that students can identify with most easily should be used to
understand how market failures could bring about resource/environmental
degradation.
• Since this section is just a review—one should try to get students actively
involved in class discussions. Selected students could be chosen to recall why
they have learned in their basic economics class.
Discussion Questions: F & O (2002), and F, O, and F (2002)
Q1: What happens to aggregate demand curves when consumers expect the price of the
good to rise (or fall) in the future? Would this situation undermine the theory developed
in the chapter?
Q2. The logic of equating benefits with willingness to pay could lead us to the conclusion
that cleaning the air to which low-income people are exposed would probably create
fewer benefits than if it were done for high income people. Does this undermine the idea
of defining benefits as equal to willingness to pay? How should economists deal with this
potential dilemma?
Q3. Explain to a non-economist why marginal values are so important in economic

analysis. How would you counter the argument of a non-economist that he or she never
makes decisions based on a marginal valuation?
Q4. Why should we care about attaining social efficiency?
Q5. Are socially efficient outcomes necessarily equitable? Should they be?
TOPIC 2: Defining and Measuring Welfare Changes

Objectives: The students are expected to be able to show and measure welfare impacts
resulting from price changes due to changes in environmental quality. The link of these
measures to the valuation and benefit-cost analysis part of this course should be
emphasized to students.
Main points:
This topic should orient students with how environmental quality changes could bring
about changes in welfare to consumers. The different welfare measures resulting from
price changes should be illustratively explained and compared. The students should be
able to relate compensating and equivalent variation measures of welfare to willingness
to pay and willingness to accept measures commonly referred to in the environmental
20
economics literature. Finally, the use of these measures in evaluating social policy should
be discussed.
Teaching hour: 3hrs
Proposed Topical Outline:
A. How changes in environmental quality can affect individual’s welfare.

B. Review of basic theory of individual preferences and demand: utility function of
individuals, properties of non-satiation and substitutability, and derivation of
Marshallian demand curve.
C. Marshallian and Hicksian surplus measures (Consumer surplus, compensating and
equivalent variation and compensating and equivalent surplus) for changes in
prices
D. Relationships of CV and EV to WTP and WTA measures
Basic Reference:
Freeman, Myrick.A. 2003. The Measurement of Environmental and Resource Values:

Theory and Methods. 2nd edition. Chapter 3. “Defining and Measuring Welfare Changes,
Basic Theory”, pp 43-70, 85-89.
Teaching Ideas:
• The book of Freeman has both mathematical and graphical approach to the
topic—but the use of graphical measures to illustrate the various welfare
measures is suggested for undergraduate class. The underlying assumptions need
to be made clear, however. For instance, we usually assume a two-good world
when making graphical presentation—but students could be reminded that these
could be bundles of goods so that the good depicted in the graph is actually a
composite good, that can be treated as an index of the consumption levels of all
other goods, except the one being analyzed. This assumption though is valid only
if we assume also that the prices of these other goods move in the same
proportion or that there are no changes in the relative prices of the goods that
make up the composite good.
• It is important to keep in mind that the price changes being analyzed could be
linked to changes in environmental quality—to keep the students into the
‘environmental economics-thinking mode’.
• In the comparison of CS, CV and EV, instructor must emphasize that only CV
and EV do represent the welfare relevant measures, even if CS has intuitive
appeal as a welfare indicator.
• The students need to distinguish compensating variation (CV) and equivalent

variation (EV) measures and to relate these to willingness to accept and
willingness to pay values. The use of illustrative example that students can relate
to is suggested.
Exercises/Analytical Problems (cf: F & O, 2002, chapter 3)

21
Q1. Alvin’s demand for bottled water is given by the equation QdA = 8 – 0.5P. Betty’s
demand function is QdB =6 –P. Calculate Alvin and Betty’s marginal and total willingness
to pay for four bottles of water and illustrate graphically.
Q2. With the same equations as given in question 1, compute the aggregate demand for
bottled water, assuming Alvin and Betty are the only consumers. Derive aggregate
demand curve if there were five people with Alvin’s demand curve and 5 people like
Betty.
Q3. A person’s demand for bottled water is given by the following equation:
Q= 6- 0.5p + 0.0001I
Where Q is the quantity demanded at price p when the person’s income is I.

Assume initially that the person’s income is $40,000.
a) At what price will demand fall to zero? This is sometimes called the choke
price because it is the price that chokes off demand.
b) If the market price of bottled water is $10, how many will be demanded?
c) At the price of $10, what is the price elasticity of demand for bottled water?
d) At the price of $10, what is the consumer surplus?
e) If the price rises to $12, how much consumer surplus is lost?
f) If income were $60,000, what would be the consumer surplus loss from a
price rise from $10 to $12?
Q4. Suppose that an individual has the utility function:
U = E0.25 + Y 0.75
Where E is some index of environmental quality and Y is income. From an initial

situation where E =1 and Y=100, calculate CS and ES for an increase in E to 2 and for a
decrease in E to 0.5.
Q5. ‘Only the highest standards of environmental quality will do if society’s welfare is to
be maximized.” Discuss
22
LECTURE 5: POLLUTION ECONOMICS
TOPIC 1: Optimal Level of Pollution

Objective:
The objective of this topic is to explain to the students what the optimal level of pollution
is and how identify the optimal level of pollution theoretically. One should also
demonstrate how changes in market conditions and in the production and abatement
technology would change the optimal level of pollution that the society desires.
Main points:
The optimal level of pollution is the pollution level associated with certain level of
production and consumption that allows the society to attain the maximum net social
benefit. It needs to stress that having no pollution is not an optimal situation.
The identification of optimal pollution level is based on the equimaginal principle that the
marginal cost of abatement (either through output reduction or using abatement
technology) must equal the marginal benefit of pollution control (the marginal damage).
Abatement cost will change as changes in market conditions and production and
abatement technology take play. This will result in a new level of optimal pollution.
Teaching hour: 3 hours
Proposed Topical outline:
A. Definition of optimal pollution

B. Identification of optimal pollution
o When output reduction as the only way to reduce pollution load
o When using abatement technology
C. Factors affecting optimal pollution level
D. Class examples and exercises
Teaching ideas:
• It is necessary to make clarification that in identifying optimal pollution level for

simplicity first we assume that reducing output level is the only way to reduce
pollution load. It is suggested to use a numerical example and graphical
illustration to explain to the students several related concepts such as MNPB,
MEC and MNSB and ask student to take part in the process of identifying optimal
level of pollution where MNPB equal MEC.
• We can then relax some of the earlier set of assumptions, say by, introducing the
use of abatement technology to reduce the pollution load. The society now can
use either output-reduction measure or abatement technology. Suppose it is
cheaper to use the technology, and then optimal level of pollution is where MAC
equals MD/MEC.
23
• Putting the two curves MAC and MNPB in the same diagram. The relative
position of the two curves would show which of the two measures (output
reduction and abatement technology) is the cheaper solution. You may wish to
ask students, which measure the society, will prefer and what is the optimal level
of pollution.
• It is possible expand this topic and relate it to other issues. For example, we can
ask students to measure the benefit to the society of the abatement technology and
then ask them if the pollution level we have now in the real world is optimal?
Why or why not? We can also raise a number of questions as an introduction to
the next related topics such as “Can we attain optimal pollution level through
market mechanism/bargaining?” “What government can do to attain the optimal
level of pollution?” But we do not expect their answer for these questions at this
stage but it is important to get them thinking along these lines.
Basic References:

Field B. and N. Olewiler. 2005 Environmental Economics, Updated 2nd Canadian

Discussion Questions and Exercises: (F, O, and F, 2002)
Q1. Let MNPB = 1000-10Q and MEC = 10Q. Suppose for every unit of output produced
one pollution unit will be generated. Please identify optimal level of output and the
optimal level of pollution in terms of damage or external cost.
Q2. What sort of factors will influence the shape of marginal cost curves? Will they
differ substantially within industries?
Q3. Suppose that a wood pulp mill is situated on a bank of Mekong River. The private
marginal cost (MC) of producing wood pulp (in $/ton) is given by the function:
MC = 10 + 0.5 Y
Where Y is tons of wood pulp produced. In addition to this private marginal cost, an
external cost is incurred. Each ton of wood pulp produces pollutant flows into the river,
which cause damage valued at $10. This is an external cost, as it is borne by the wider
community but not by the polluting firm itself. The marginal benefit (MB) to society of
each ton of produced pulp, in $, is given by: MB = 30 – 0.5 Y
a) Draw a diagram illustrating the marginal costs (MC), marginal benefit (MB),
external marginal cost (EMC), and social marginal cost functions.
b) Find the profit maximizing output of pulp wood, assuming the seller can obtain
marginal revenue equal to the marginal benefit to society derived from pulp
wood.
24
c) Find the pulp output which maximizes social net benefits
d) How large would the marginal external cost have to be in order for it to be
socially desirable that no wood pulp is produced?
TOPIC 2: Coase Theorem and Property Rights

Objective:
The aim of this topic is to show students that optimal pollution is automatically attained
through market mechanism, when property rights are well defined, transactions cost is
zero, and when there is no informational asymmetries (i.e., everyone knows the curves)
and no asymmetry in bargaining power. Unfortunately, transaction cost is hardly zero in
real work and the assumption of perfect information and no asymmetry in bargaining
power hardly exist in reality.
Main points:
The message of the theorem should be made clear to the students: When property right is
non-attenuated and the transaction cost is trivial, the bargaining between polluter and
pollutee will always take place. The bargaining will lead to the same solution, given the
assumptions cited earlier.
The Coase theorem has several limitations, however. Particularly, its two assumptions do
not hold in the real world. High transaction cost and ill-defined property right as well as
the transboundary and transgeneration nature of the pollution problem prevent bargaining
to take place. And even if bargaining takes place the outcome is unlikely to be the
optimal pollution because it is very difficult to identity MNPB/MAC and MEC/MD.
The implication of the theorem is that strengthening property right is one important
measure to improve pollution outcome. The limitations of the theorem, however, justify
government interventions in pollution control.
Teaching hours: 2 hours
A. The assignment of property right and bargaining

1. Property right with the pollutee
2. Property right with the polluter
B. Coase theorem
1. The theorem
2. Its limitations
C. Implications: applicability of property rights to environmental problem
Teaching ideas:
25
• It is important to explain clearly the assignment of the property right in each of

the two bargaining scenarios. When the pollutee holds the property right MNPB
and MEC are MB and MC of polluter in the bargaining, respectively. When the
polluter holds property rights MEC and MNPB are MB and MC of the pollutee in
the bargaining, respectively. That is why the pollution outcome of the two
scenarios is the same, where MNPB = MEC. It should be noted that MNPB could
be used instead of MEC if the polluter uses abatement technology.
• Start the discussion on the limitations of the theorem by asking students “what are
assumptions we have made for the bargaining between polluter and pollutee to
take place?” Relate the answer to the questions also to the justification for the
government intervention. This could serves as an introduction to the next topic on
pollution control instruments. At this point, the teacher could ask the students
how well they bargain and whether they think outcomes are dependent on who
knows more about the product they are bargaining over.
• It is possible to expand the topic by introducing transaction cost to the bargaining

process and to ask students how transaction cost could affect the bargaining
outcome. The distribution of transaction costs and benefits of the bargaining will
affect the two curves (MNPB and MEC), shifting these curves. This will change
the bargaining outcome.
Basic References:


Discussion Questions & Exercise: (cf: F, O, and F, 2002; (Perman, Ma, McGilvray,
and Common, 2003))
Q1. Suppose the polluter has property rights and the pollutee bears all the transaction
cost. What would be the pollution level as compared with the case of zero transaction
cost?
Q2. Under what situation the bargaining is likely to take place and help lead to efficient
level of pollution?
Q3. Distinguish between private and public goods externalities. Discuss the likelihood of
bargaining leading to an efficient allocation of resources in each case.
TOPIC 3: Environmental Standards

Objective:
A primary objective of this topic is to show students that the use of standards, while
deceptively simple and apparently straightforward in application, is more difficult to
manage and problematic in terms of results than is often thought. The topic discussion
26
stresses that standards have weaknesses in terms of short- and long-run cost-
effectiveness, but that they have advantages in terms of compliance monitoring.
Main points:
There are three main types of environmental standards: ambient, emission, and
technology based (also called design or engineering standards).
The economics of standards includes several aspects such as the level of the standard,
uniform standards, and incentive impact of standards. Environmental standards should
set where marginal benefits equal marginal abatement costs. This implies that they should
be set at different levels where these circumstances differ. However, when the economic
circumstances are heterogeneous (numerous polluters with different MACs); regulators
often do not set individual standards but set uniform standards, which often lead to
inefficiency. In terms of incentive effects the problem with standards is that when they
are being met there is no incentive to do better than the standards.
Another issue with standards is enforcement. Effective enforcement is really important to

ensure that set standards are met. The enforcement costs are high meanwhile regulators
have limited enforcement budget.
A. What are environmental standards?

B. Types of standards
1. Ambient standards
2. Emission standards
3. Technology standards
C. The economics of standards
1. Setting level of standards
2. Uniformity of standards
3. Standards and equimarginal principle
D. Incentive effects of standards
E. The economics of enforcement
Teaching ideas:
• We are surrounded by publicly prescribed standards including environmental

standards. Take this advantage by asking the students to list out a number of
standards especially environmental standards. Group the listed environmental
standards by type and explain to the students the different types of standards.
• Ask the students why regulators set environmental standards and how the level of
the standard should be set. Facilitate the discussion process by introducing an
example and using graphical illustration to discuss how the standard level should
be set. It is necessary to stress that in the real world there are many polluters with
different MACs. Therefore, it is impossible to set a single standard that meets the
27
equimarginal principle for all pollution sources. Ask students to compare

individual and uniform standards in terms of efficiency and cost effectiveness.
• It is necessary to stress the savings in implementation costs that uniform standards

might entail, relative to policy approaches that treat sources differently. Most of
arguments for uniform standards are based on two ideas: equity, through treating
everyone alike, and “leveling the economic playing field,” through requiring that
very source meets the same environment requirements.
• A point that is perhaps not stressed enough is the perverse incentive that an
agency might produce if it sought to set standards so as to equalize marginal
abatement costs. This means that firms with lower marginal abatement costs will
be required to reduce the emission more than firms with high MACs. This could
create a disincentive for firms to search for ways of lowering their abatement
costs.
Basic Reference:

Discussion Questions & Exercises: (F, O, and F, 2002; (Perman, Ma, McGilvray, and
Common, 2003))
Q1. List and explain, using graph to assist your answer, three problems with technology
based standards.
Q2: What kind standards would you use for a non-point pollution source (e. g., run-off of
pesticides from agriculture use) where pollution per polluter cannot be measured?
Explain why?
Q3. Suppose a regulator agency has a limited budget for enforcement. It is better from
society viewpoint to use its limited resources to monitor sources that emit large amounts
pollution and prosecute vigorously if they violate the standards, or to monitor all
polluters? Defend your viewpoint.
Q4. People have suggested that it would be equitable for all countries to adopt the same
emission standards. If, for example, the United State has higher standards than Vietnam,
then, Vietnam could be able to produce pollution-intensive goods more cheaply, gaining
an advantage in the world marketplace, and also might become a pollution haven. From
what you have covered in this topic, do you agree with this suggestion? What are the pros
and cons from an economic standpoint?
Q5. Consider the figure below. It shows two marginal damage functions. MDU and MDR
are marginal damage functions for urban and rural areas respectively.
MDR = 5ER; MDU = 10EU and MAC = 600 – 5E
Solve for the two efficient equilibria for the two MD functions for carbon monoxide
pollution. Suppose the regulator imposes a uniform standard at the emission level
28
midway between the two efficient emission levels. What are the excess damages from
under-control in the urban area and over-control of damages in the rural area?
$
MDU
600 MAC
MDR
Emission of carbon
TOPIC 4: Taxes0and Subsidies
40 60 120
monoxide (kg/month)
Objective:
The objective of this topic is to show students the way environmental taxes and subsidies
work and to examine the advantages and disadvantages of using taxes and subsidies to
achieve improvements in environmental quality.
Main points:
Pigovian tax is an optimal tax. The level of the Pigovian tax per unit of pollution is equal
to marginal damage/marginal external cost associated with optimal level of pollution. To
identify the optimal tax we need to know MNPB/MAC and MEC/MD.
The essence of tax approach is to provide an incentive for the polluter themselves to find
the best way to reduce pollution, rather than having a central authority determine how it
should be done.
In case of imperfect information, however, the socially efficient level of tax and
standards may not be achieved. This brings about policy failures.
Total private cost of compliance of an emission tax is different form the social cost of
compliance. The former includes abatement cost and tax bill for the polluter. But, the
latter includes only the real resources used to meet the environmental target.
When MACs differ among polluters, social compliance costs are lower under a tax than a
uniform standard meeting the same target level of emissions because the tax is cost-
effective the uniform standard is not.
Emission subsidies would have the same incentive effect on individual polluters, but they
could lead to increases in total emission levels. One place where subsidies have been
used effectively is in deposit-refund systems, which are essentially tax and subsidy
systems in combination.
29
A. Pigovian tax
1. What is Pigovian tax
2. Pigovian tax and property right
B. Emission tax
1. The basic economics of emission taxes
2. Emission tax and cost effectiveness
3. Emission tax versus standards
4. Emission taxes and non-uniform mixing of emission
5. Emission tax and the incentive to innovate
6. Emission tax, enforcement cost & distributional impacts
7. Subsidies: abatement subsidies and deposit-refund systems
Teaching ideas:
• Start the discussion by recalling the limitations of Coase theorem and problems
with using property right as a means of pollution control as the justifications for
government interventions. It is suggested to use the graph and numerical example
in the “Optimal pollution” topic to explain how a tax should be to achieve the
optimal level of pollution.
• It is important for students to see that taxes involve the firms in two types of
costs: abatement costs and tax costs, and that firm will try to minimize the total of
these. This means that firms will try to equate marginal abatement costs and the
tax.
• How to determine the best rate of the tax is one complicated problem in this topic.
This requires information on the true marginal damage function—which is not
easy to get. This fact should be emphasized to the students as they are introduced
to the general field of valuation in the latter part of the course.
• Likewise, the difficulty of getting information on the marginal abatement costs

from the various firms should be mentioned—although it is worth citing that there
are some studies on this topic by a number of WB economists.
• A common reaction from beginning students is that polluters will simply pay the
tax, pass burden on to consumers through higher prices and continue emitting the
same quantities as before. Have them work through the diagrams to see that this is
unlikely unless the MAC curve is very steep. A firm that does not produce where
the tax = MAC will be inefficient (higher cost solution) and in a competitive
market, will lose out to others who are incurring lower costs. One could also tell
a tax incidence story – the tax is shifted forward to consumers in the form of
higher prices or backwards to shareholders in the form of lower return on their
investment. This part will have to explain the distribution impacts of taxes and
should focus on the standard conclusion regarding the regressive effects of price
increases due to tax. The discussion relating to looking at emission taxes more as
‘sin taxes’ (e.g. taxes on alcohol and cigarettes) should be brought in here also.
30
• One should also point here that the tax revenues can be used by the government to
pursue different objectives, which could include encouraging investment in
pollution control measures by firms that paid the tax. The tax revenue also
creates an opportunity for tax shifting. This means that there will be lower taxes
(e.g. income taxes) decreasing distortions elsewhere or providing revenue for
other public goods. This may serve to attract labor to the region serving to help
the industry. It is important to note, however, that these effects are diffused
throughout the economy, while the pollution tax burden falls squarely on the
polluters.
• The various ways to prevent polluters from leaving the region, by way of
incentives include deposit-refund systems or lump-sum rebates to the polluters in
question. This may be a good time to introduce the discussion on pollution haven
argument.
• On the subsidies—one should point out that this needs short-term tax increases or
expenditure cuts elsewhere, with uncertain long-term impacts on the economy.
Basic References:


Questions & Exercises: (F, O and F, 2002)
Q1. Suppose that we institute an emission tax on a particular pollutant, and we use the
proceeds of the tax to help subsidize the short-term capital costs by firms in the same
industry of installing emission – reduction equipments. Will this approach upset the
incentive effects of the emission tax?
Q2. Suppose the government proposes a tax on SO2 emissions. The tax is to be levied on
the sulfur content of the fuel used by utilities and other industries because emissions from
these sources are difficult to measure. But cases where firms have ways of measuring the
SO2 content of the exhaust gases, the tax will be levied on the SO2 content of the gases.
Will this system lead to a socially efficient equilibrium? (You will need to make some
specific assumptions to answer the question).
Q3. Opponents of emission charges argue that polluter will be simply pay the taxes and
pass the cost on to consumers without reducing emissions. Is this correct? Explain.
Q4. For the figure below and the equations MAC1 = 200 – 5E and MAC2 = 160 – 4E,
compute the cost savings to the polluter if it adopts the new technology (MAC2) after the
introduction of an emission tax of $100 per tonne. Compute the cost saving under a
standard that is set at 20 tonnes, Explain why the tax provides a larger incentive to
innovate than does the standard.
31
200 MAC1
160 MAC2
Tax =100
c
per tonnes
a
e d b
0 15 20 40 Emission
(tonnes per year)
TOPIC 5: Transferable Discharge Permits

Objective:
The aim of this topic is to acquaint students with the rudiments of transferable discharge
permits (TDP) as a cost effective approach to pollution control and to help students to
understand the strength and weaknesses of the approach.
Main points:
A transferable discharge permit (TDP) creates a transferable property right to emit a

specified amount of pollution. The TDP system operates like a hybrid between imposing
standards and using taxation to reach a target. Because the total number of permits is
fixed, there is effectively a standard that cannot be exceeded. But because the permits are
transferable, the market will achieve uniform price at which polluters’ marginal costs of
abatement are equal. Like a tax, transferable permits that traded in a competitive market
are a cost-effective policy.
A role playing exercise on Transferable Discharge Permits available at www.eepsea.org

is a handy illustration to explain to students how a TDP system works.
There are several issues in setting up a TDP market. These include the initial right
allocation, establishing trading rules, non-uniformly mixed emissions, competition and
enforcement. The major point to emphasize in each of these issues should be discussed
with the students.
A. General principles:
1. TDPs
2. Demand and supply of TDPs
32
B. Issues in setting up a TDP market

1. The initial rights allocation
2. Establishing trading rules
3. Non-uniformly mixed pollution
4. TDPs and problems of competition
5. TDP program and enforcement
6. TDP and the incentive for R&D
Teaching ideas:
• This is a complicated topic. Since the TDP approach is based on the functioning
of markets, it is important to stress the basic principles of market operation and
the factors that are critical to their success or failure. Those that are often glossed
over when discussing basic market principles but are critical to this topic are: the
need to have a clear and reasonably stable rules and laws to govern
trade/exchange and expectations that the market will not be subject to excessive
political manipulations in the future, among others. However, market for
discharge permits is still new and regulators are still developing new rules and
regulations governing trade. How different rules will affect trade and the
efficiency of the TDP system is one topic that is open for investigation.
• An important issue in this topic is how public authorities can affect the total
number of permits in circulation and what factors do affect the uncertainty in the
market and its ability to function efficiently. These issues should be discussed as
these would lead to better understanding of how the system is meant to work by
students. The ways by which the government could control total number of
permits—either by buying them in the open market or expropriating them
regularly or even retiring them through time could be discussed.
• An illustration to show how the initial allocation of permits (give away and
auction) would affect the market equilibrium price of the permit and the number
of permits that each market participant uses could also be discussed here.
• After the basic permit system is described, the instructor can stress that in theory
TDPs look great; however in practice there are lots of problems. Permit trading
games offer a concrete way to introduce this quite abstract topic.
• The issue of permit trading for greenhouse gases is sure to generate student
interest based on the huge controversies and moderate amount of media attention
given to the issue of using TDPs in the Kyoto Protocol. The instructor will want
to emphasize that TPDs are being used more and more in the real world with
varied success.
Basic Reference:

Questions & Exercises: (cf: F, O, and F 2002)

33
Q1. The government has set up a TDP system where it gives away permits to the
polluters then asks them trade thereafter. How this system responds to new firms that
enter the industry and have positive level of pollution? Do you foresee any problem?
Explain.
Q2. What are the pros and cons of letting anybody (e.g., bank, private citizens,
environmental groups, government agencies) buy and sell transferable discharge permits
in addition to the pollution sources themselves.
Q3. Suggestion has been made to set up a transferable permit system for wildlife
preservation and habitat protection. How might this work?
Q4. Two polluting firms can control pollution of a pollutant by incurring the following
marginal abatement costs:
MAC1 = $300 – 10 E1 and

MAC2 = $90 – 5 E1
Assume the target level of pollution is 30 units. We do not know if this is the socially
efficient level or not.
(a) Compute the level of emission per firm that is cost-effective for society.
(b) Explain how a tradable discharge system could be applied to achieve the
target level of emission. Assume the regulator initially assigns 15 permits to
each polluter. The government gives these permits to the firms without
charge. Solve for the number of permits each firm holds after a permit market
operates, the price of the permit and total private cost of the permit system.
How would the private costs to each polluter change if the government
initially auctioned to the polluters?
Q5. Which policy instrument uniform standard, individual standard, emission tax, or
TDP provides the largest incentive to invest in R&D to lower MACs? Prove your answer
graphically.
TOPIC 6: Evaluating Environmental Policy Instruments

Objective:
The objective of the topic is to discuss with students the various criteria used in
evaluating environmental policies/instruments. They should be taught how to use these
criteria to evaluate the instruments/policies that have been discussed in previous topics.
Main points:
There are five important criteria for the evaluating environmental policy instruments.
These are efficiency and cost effectiveness, fairness, incentives for innovation,
enforceability, and moral consideration. It is important to differentiate efficiency and cost
effectiveness.
34
Economic instruments often lead to cost effectiveness as they allow the profit
maximizing agents to choose the ways to respond. Therefore the equimarginal principle
is met for each pollution sources. Furthermore, economic instruments provide more
incentives for innovations.
A. Criteria for evaluating environmental policy instrument
1. Efficiency and cost effectiveness

2. Fairness
3. Incentive for innovation
4. Enforceability
5. Moral consideration
B. Contrasting policy instruments:

1. Uniform standard
2. Individual standard
3. Uniform tax
4. TDPs (given away)
5. TDPs (auctioned)
Teaching ideas:
• There may be other criteria that one wishes to discuss, though we have tried to set
the criteria broadly enough so they will incorporate other as special cases. One
possibility, for example, is whether policies incorporate perverse incentives that
tend to undermine their objectives, but this can be presumably be included in the
first criterion (factors leading away from efficiency), or perhaps the fourth
(factors leading to attempts to hide emission or inflate base level emission rates,
etc.).
• Political acceptability is obviously a criterion of importance, but we have not

included it in the discussion. This is an extremely slippery factor that we think is
best left to political science discussion. What are politically acceptable changes
from one time to another, depending critically on the shifting strategic situation
and the resources that policy makers are willing and able to spend. While political
factors are of obvious importance in the real world, our feeling is that the
discussion of this topic should focus on economic factors.
• In contrasting the instruments, it is advisable to use graph and numerical example

to illustrate the cost (social and private) of achieving the same pollution target
using different instruments. It is also important to compare incentives for
innovation that different instruments provide polluters.
Basic Reference
35

Edition, McGraw-Hill Ryerson Limited, Canada. (Chapter 9 and 14)
Discussion Questions & Exercises: (cf: F, O, and F, 2002)
Q1. How do market-based policies differ from command and control policies with
regards to incentive created by the policy to reveal information about the polluter’s
MAC curve to the regulator?
Q2. Why is cost effectiveness a desirable goal of environmental policy? How is it

achieved?
Q3. Why do pollution taxes have a more uncertain impact on the level of pollution than
does a standard?
Q4. Suppose you are a government regulator that is trying to design a pollution control
for a non-degradable water pollutant such as dioxin. Your objective is to get an
immediate reduction in the emission plus provide an incentive to firm to switch to
production technologies that yield fewer emissions of these compounds. Which one of
the following three policies would you recommend, and why? The policies are uniform
standards, uniform tax, or individual standard. Support your answer graphically and/or
algebraically.
Q5. Suppose there are two polluters with different MAC curves. Show how the regulator
would aggregate these MAC curves and then use them to determine the socially efficient
equilibrium level of emission, E*. Once E* is determined, how would the regulator
ensure that the sum of emission form each polluter total E*? (Hint: Aggregation should
reflect the equimarginal principle).
Q6. Compare and contrast the cost-effectiveness of:

a) a sulphur dioxide emission tax
b) a sulphur dioxide emission tax levied at the same rate as in a), together with
an arrangement by which emission tax revenues are used to subsidize capital
equipment designed to ‘scrub’ sulphur from industrial and power generation
emissions.
36
LECTURE 6: ENVIRONMENTAL VALUATION
TOPIC 1: Why Value the Environment and the Concept of Total Economic Value
Objective: To explain to students the importance of undertaking environmental valuation
and to introduce the concept of total economic value.
Main Points:
The concept of total economic value stresses the point that value results not only from
use of the resource but from the many other roles/functions of the resource that are not
necessarily link to use value. In particular, the non-use value of the resource, consisting
of existence, bequest, and option values and those that are indirect in use (ecological
values, biodiversity value, etc.) are quite important components of the total economic
value of the resource/environment.
Teaching Hour: 1 hour
A. The importance of valuing the environment

B. The Total Economic Value: Use and Non-Use Values
C. Limitations of Valuation
Teaching Ideas:
• The rationale for resource/environmental valuation is explained by discussing

how the absence of such valuation limits decision making, both in the
economic and environmental arena.
• The concept of total economic value is then introduced. Teaching of the

concept can be facilitated by applying the total economic value concept to
value a particular resource. Students could then be asked to identify total
economic value components for the particular resource on their own. It should
be emphasized that valuation is held by people (anthropocentric) while the
intrinsic value (or non-use value) is inherent to or resides in the good. The
limitations of anthropocentric valuation should be highlighted. Specifically,
one should emphasize the need to respect rights of non-human beings.
Basic References:
J.T. Winpeny. Values for the Environment. 1991. Chapter 1: Introduction: Why Value
the Environment?


Introduction.1994. Chapter 8: Valuing Concern for Nature.
37
Discussion Questions: (Perman, Ma, McGilvray, and Common, 2003)
Q1. Imagine a wilderness area of 200 miles in Cu Phuong Park. How would you expect
each of the following factors to affect people’s willingness to pay for its preservation?
a) Size of the wilderness area still remaining in the Cu Phuong Park.

b) Presence of rare species in this particular area.
c) The level of national wealth.
Q2. An analyst wishing to estimate the benefits of preserving a wetland has combined
information obtained from two methods. First, she surveyed those who visited the
wetland—fishers, bird watchers, etc—to determine their willingness to pay for these
uses. Second, she surveyed a sample of residents throughout the state about their WTP to
preserve the wetland. This second survey focused exclusively on nonuse values of the
wetland. Then, she added her estimate of use benefits and nonuse benefits to get an
estimate of the total value of preservation of wetlands. Is this a reasonable approach?
(Assume that respondents in two surveys do not overlap).
Q3. Is the loss of a species of plant or animal necessarily of economic concern? Is this
true for every species that currently exists? Do we now suffer as a consequence of earlier
extinctions?
Q4. “If the market puts a lower value on trees as preserved resources than as sources of
timber for construction, then, those trees should be felled for timber?” Comment
TOPIC 2: Overview of Valuation Techniques and Steps in Valuation

Objective: To give students a practical skill on how to conduct an economic valuation
and to give them an overview of the different methods to value environmental
benefits/costs.
Main Points:
A sequence of steps to be conducted for valuation will be presented. The objective of this
sequence is to clearly define how to identify the environmental impacts and values that
need to be subjected to valuation. The choice of the valuation techniques should also be
discussed. The various considerations in the choice of the environmental impacts to be
included in the valuation process and the considerations in the choice of the techniques
should be made clear to the students.
There are numerous valuation techniques that are available to the analysts. An overview
of what these valuation techniques are should be discussed in class. The lecture should
emphasize that the choice of the technique depends primarily on appropriateness of the
technique to the environmental good/bad to be valued but also considers availability of
information and the cost of collecting the information.
There are several ways to classify and group different valuation techniques. A general
approach, however, is to group them into direct approach (or Market based Method) and
Indirect approach (or Revealed Preferences and Stated Preferences).
38
The Direct approach measures the benefits/costs based upon the linkage between a
contaminant and its associated damages that are expressed by market values. This
approach has the weakness of underestimating total economic value as it is often limited
to measuring use values only. The technique also may not be applicable if the physical
linkage cannot be defined or measured.
The correct measure of benefits/cost is the change in consumer surplus, which can derive
from either the shift of demand curve, or the change in prices. This in turn calls for the
imputation of willingness-to pay.
The Indirect approach consists of various techniques aimed at imputing willingness-to-

pay. These include preventive expenditures, hedonic method, travel cost and contingent
valuation methods.
Teaching Hour: 1h30 minutes
A. Overview of valuation methods

1. Direct methods
2. Indirect methods
B. Steps in valuation
1. Identifying environmental impacts
2. Impact screening
3. Choice of valuation methods.
4. Undertaking the valuation with chosen methods
Teaching Ideas:
• One can start discussion of this topic by presenting an economic project such
as dam construction. Then, the economic and environmental impacts of this
project could be identified and presented to the class. It is worth mentioning
here that identification of the various environmental impacts is a major
concern in any Environmental Impact Assessment (EIA) process. This process
is expected to result in a long list of environmental impacts. The need to
screen these impacts and basis for the screening should then be discussed in
class. One should emphasize that while it is ideal to measure and consider all
the environmental impacts into consideration—doing so is costly and may not
be optimal. An effect that is expected to have very small impact on overall
project outcome but which may be very costly to value should not be valued
at all. Not only are their effects expected not to make any difference in project
decision making, but valuing them would also compete with the use of the
limited resources.
• The major economic impacts of a change in environmental quality are

reduction in productivity; health care costs and loss of human capital;
reduction in amenity (recreational benefits, aesthetic); and the loss of unique
habitat or species (existence value). Alternatively, one could also value the
impacts in terms of costs of providing substitutes for the lost environmental
goods and services--this cost can be very large.
39
• One way to classify all possible economic and environmental impacts is to

categorize them into on-site and off site effects, positive and negative effects
and even into: with and without market values.
• The different valuation techniques that could be used to value the

environmental effects should then be presented. One should start by making a
broad distinction between market-based techniques; an example of direct
estimation is presented for the illustration of how it is applied and what
weakness it produces. This opens way to discuss the second approach-
indirect approach to impute willingness-to-pay.
Basic References:
ADB. 1996. Economic Evaluation of Environmental Impact - A Workbook. Environment

Division, Asian Development Bank. Manila.


Suggested Readings:
Economic Analysis of Environmental Impacts. Chapters 1, 3 & 4.
Discussion Questions: (Perman, Ma, McGilvray, and Common, 2003)
Q1. What valuation technique would you use to measure the value of preserving a
tropical rainforest? Why?
Q2. Discuss the arguments for and against the exclusion, or deduction, of defensive or
preventive environmental expenditure from GDP. Identify other components of GDP,
which could be excluded for identical or similar reasons.
Q3. Given the valuation problems inherent in assessing many forms of environmental
damage or degradation, is it better to concentrate efforts on developing a comprehensive
system of physical environmental accounts, rather than attempt to incorporate
environmental costs and benefits in the conventional system of national accounts?
TOPIC 3: Market-based Techniques

Objectives:
The main objective is to provide students with an overview of the various approaches that
can use market prices to reflect WTP. The lecture also aims to show students the uses of
these market-based techniques and what their strengths and weaknesses are.
40
Main points:
A change in the environment may alter economic activities resulting in changes in

monetary revenues and costs from/of these activities. The changes in these revenues and
costs thus can sometimes be used to value the change in the environment. The range of
techniques that uses changes in market values of economic activities/goods or services
include: Change-in-Productivity, Cost of Illness, and cost-based approaches like
replacement cost technique and defensive expenditures.
The change in productivity measures the loss productivity of an ecosystem that was
subjected to environmental deterioration or gain, in the case of environmental
improvements. This loss (gain) is values using market price (properly adjusted to reflect
net price or less of all production cost, marketing cost, and margin for profit).
The cost of illness approach measures the hospitalization cost (inclusive of cost of
treatment and associated cost for clinic visits) and forgone income due to work-loss days
or reduced activity days as a consequence of exposure to environmental ‘bads’. An
example of an environmental bad is intake of polluted water or exposure to polluted air
that brings about health impacts.
The cost-based techniques measure the cost of replacing a damaged ecosystem (e.g.,
reforestation cost for deforested areas; value of inorganic fertilizers for eroded fertile
soils, etc); or preventing the harm from taking place (e.g. cost of buying bottled water to
avoid intake of polluted water, etc). The limitation of the cost-based approaches in the
sense that they do not really measure the value of environmental benefits foregone should
be emphasized.
Teaching hours: 2 hrs
The lecture should give an overview of each of the various market-based techniques,
describing the situations when the technique is found applicable, the basic approach, and
the strengths and weaknesses of the approach.
A. General steps for measuring impacts.

B. Change in productivity.
C. Cost of Illness Approach
D. Cost-based techniques: Replacement cost and Defensive expenditures
Teaching ideas:
• Given that there are various techniques to be covered in this short period of time,
the use of case studies to demonstrate use of each of these techniques will be
useful. EEPSEA has a number of these case studies from its list of research
reports---including those that are done in Vietnam. The students may be assigned
by group to do a case analysis cum presentation in class of these case studies.
41
Basic References:
Turner, R. K; D. Pearce; and I. Bateman. 1994. Environmental Economics: An

Elementary Introduction. Harvester Wheatsheaf Publisher. Chapter 7.


Discussion Questions & Exercises: (Perman, Ma, McGilvray, and Common, 2003)
Q1. Why don’t total expenditures on a good represent the net benefits from purchasing
that good? Why are increases in output due to lower levels of pollution likely to be an
overestimate of benefits?
Q2. One cost to society of preserving native forests is the loss in timber output following
preservation. How to measure this loss?
Q3. Suppose the government wants to launch a sulphur oxide control campaign.
Theoretically, show how Change in Income technique can be used to estimate the
benefits to health from the policy.
TOPIC 4: Travel Cost Method

Objective:
The main objective is to show the fundamentals of TCM and to demonstrate how this
method has been used to measure the economic use value of a recreation area.
Main Points:
This is a surrogate market technique because actual behavior of a rational individual will
show how she weighs up the costs of a recreational visit against the benefits of the visit.
The basic premise of the TCM is that the time and travel cost expenses that people incur
to visit a site represent the “price” of access to the site. Thus, peoples’ willingness to pay
to visit the site can be estimated based on the number of trips that they make at different
travel costs. This is analogous to estimating peoples’ willingness to pay for a marketed
good based on the quantity demanded at different prices.
The trip demand function is very important for students to understand how the method
has been used to measure the recreational value of a site. From the general function, the
ITCM and ZTCM functions are developed. It is also important to differentiate ZTCM and
ITCM: from theory to practice.

42
A. Fundamental insight of the method.

B. Zonal Travel Cost Method (ZTCM).
C. Individual Travel Cost Method (ITCM).
D. Strengths of TCM and difficulties encountered in TCM.
Teaching ideas:
• One possible way of starting the lecture is to tell students about the origin of the
TCM. That is a letter of the U.S park system director to economists asking them
for the value of park recreation which would be used to justify the required costs
of the parks. Only Hotelling answered with an idea of which is now known as
ZTCM.
• One needs to explain what constitutes travel costs. Travel costs basically include
3 things: transportation cost (or gasoline cost), opportunity cost of time and other
costs (souvenir, accommodation, foods and drinks etc.).
• The next step is to talk about the quantity of visit/demand for visit. Lecturer may
ask them how many ways to express the quantity of visit (basically two ways:
number of trips an individual make to the site yearly, and number of trip/visit
from a region to the site)
• Remember to remind students that the recreational demand depends not only on
travel costs but on other factors like income, age; sex etc. (may ask students to list
these factors). Don’t forget substitute sites as an important factor.
• When teaching the Zonal Travel Cost Method, let’s start by simply saying that if
the quantity of visit in figure 1 is number of trip/visit from a region to the site, we
have the ZTCM. Tell students that in ZTCM we estimate travel cost of a trip from
a zone and quantity of visit for a zone, not for an individual visitor/consumer as
usually seen.
• Draw circles around a centric point. The point represents for the site and each ring
represents a zone. The zones are different in distances to the site then different in
travel costs then different in number of visits.
• Explain the components of the function. Can ask students why using the Vj/Pi, not
the Vj. And then ask them describe what variables are potentially relevant to Xi.
• Regarding the ITCM, stress that ITCM bases on individual information, which is
visitor’s travel costs, number of visit, and socio-economic factors.
• Regarding critique on TCM, lecturer may require students to look at the

recreational demand function again and imagine how information on dependent
variable and explanatory variables should be collected and processed. Tell
students to remember their own trips and relate it to the function to find out any
problems that can be occurred in an actual TCM research.
43
• Then tell them some difficulties encountered in the TCM: Multi-purpose visits;
multi-site visits utility/disutility from traveling, sampling biases in surveys.
Possible Extension: There may be two possible extensions:
• The first one is if time permits, lecturer may show main steps in carrying out a
TCM study to provide students how a TCM should be done in practice. There are
five steps. It’s good to use a case study to illustrate the steps. May distribute the
case and ask student to read it before the lecture. The steps are as follows.
Lecturer is free to re-organize it as a table or figure and then show students.
Step 1: Identification of recreational sites: (1) Assessment of recreational potential of

the site; and (2) Secondary data collection (tourists flows…)
Step 2: Questionnaire design: (1) Introduction; (2) Socio-economics information and

(3) Questions on the dependent variable and explanatory variables.
Can distribute a sample questionnaire here!
Step 3: Survey of sampled visitors: (1) Sampling technique; (2) Survey strategy: how,
when and where to run interviews; (3) Training of enumerators; and (4) Pretest
survey.
Lecturer may focus on sampling technique and survey strategy. Ask students why
they are important.
Step 4: Database creation and data analysis: (1) Verification of data; (2) Elimination
of invalid questionnaires; (3) Derived variables building; and (4) Data analysis.
Lecturer may show how data can be structured (coding…).
Step 5: WTP estimation: (1) Choice of ZTCM or ITCM; (2) Implement model; and
(3) Annual individual or zonal average WTP
Lecturer should remind students that estimated WTPs for recreation here are just for
one year. Researchers can derive annual net benefits and then discount these values to
get the NPV of recreation.
• The second one is if time permits, in point 2 and 3, lecturers may present formulas
and procedures to calculate CS.
Basic References:


Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 6).
44
Sinden J. and Thampapillai, DJ. 1995. Introduction to Cost-Benefit Analysis.

Longman. Melbourne. chapter 6
Discussion Questions & Exercises:
Q1. Would the travel cost approach be a good technique in valuing a policy to increase
coral cover in the Hon Mun MPA? Defend your answer.
Q2. What happens with the ITCM when the recreational site is not a popular one (in
remote areas, strange recreational products?
Q3. Could you suggest solutions for the multi-site visits problem?
Exercises:
Exercise 1: The entrance fee to Cat Tien National Park is $10 per person for a one-day
pass. If the daily demand curve for recreation at this park is given by Q = 40 – ½ P, then
the consumer surplus for visitors to the park will be $1225 per day. True or false?
Explain your answer.
Exercise 2: You are given the following survey data concerning hikers on the Bruce
Trail:
Distant TravelTravel Cost Population (inHiking daysVisitation rate Cost of travel
(km) ($) thousands) at that
distance
0-50 25,000 500 20,000
51-100 50,000 2500 75,000
101-150 75,000 5000 100,000
151-200 100,000 3000 30,000
(a) Graph the implied demand for hiking on the Bruce Trail.
(b) fit a straight line equation to your data (graphically or algebraically)
(c) Compute the total benefit derived from the Bruce Trail by the residents of the areas
reported.
(d) Assume that people further away from the Bruce Trail have more nearby substitutes
for hiking.
How would this bias your estimated total benefit of the Bruce Trail?
TOPIC 5: Hedonic Pricing Method

Objectives:
The students are expected to understand the basic approach in estimating environmental
value using Hedonic Property Price Method (HPM).
Main points:
The HPM falls within the category of surrogate market technique (or revealed preference
technique). The discussion of conceptual framework will help to know the reasons. The
price paid for a property directly reflects the benefits of the characteristics of the
45
property. In this way, environmental characteristics such as clean air, peace, quiet and
beauty are traded in property market. The HPM derives the value for a particular
characteristic from the price paid for the property.
The discussion of the HPM covers the two points:
• Identify how much of a property differential is due to a particular environmental

difference between properties. This requires estimation of the house (or hedonic)
price function. It is noted that economic theory does not provide much
information on the shape of the hedonic price function. A possible hedonic price
function, which is suggested by Freeman (1993), is concave from below.
• Infer how much people are willing to pay for an improvement in the
environmental quality and what the social value of the improvement is. Because
the hedonic price function itself cannot permit estimation of WTP, a common
procedure to infer WTP is a “two-stage procedure” which includes calculation of
the ‘implicit marginal price’ of the environmental good for each observation and
estimation of the implicit inverse demand function of the environmental attribute.
For illustration of the method, a numerical example should be presented.
A. The conceptual framework.

1. The intuitive concept.
2. The house price function.
3. The implicit price function.
4. Estimation of consumer surplus.
B. A numerical example of the HPM

C. Discussions of strengths and weaknesses.
Teaching ideas:
• The house price function may be illustrated by a graph. The graph is essential to
show the relationship between the house price and the environmental attribute.
• Given the vast amount of theoretical and empirical work recently in HPM, this
topic represents just a very brief excursion into the subject. Some lecturers may
want to just give the students intuitive concepts of the method and then show
some very simple examples of how value of environmental attribute is extracted
from house price. In some classes, when students ask for more elaboration to
understand the model, lecturers have to show them the statistical models. Students
often ask for more just simply because with the intuitive introduction they think
they can do something with the model, which is about what they feel familiar like
price of house, house structure and so on.
46
• The intuitive concept of the HPM can be described as follows. The price paid for
a property directly reflects the benefits of the characteristics of the property. In
this way, environmental characteristics such as clean air, peace, quite and beauty
are traded in property market. The HPM derives the value for a particular
characteristic from the price paid for the property. Data are collected on prices
paid and characteristics of the property. The amount of the price attributable to the
characteristics is then identified through statistical analysis. In essence, if two
houses differ in only one characteristic, the difference in price is the value of that
characteristic.
• A good numerical example can be found in Markandya, Harou, Bellu and Cistulli
(2002).
Basic References:

Elementary Introduction. Harvester Wheatsheaf Publisher. (Chapter 8).

Melbourne. chapter 6
Markandya A, Harou, P., Bellu, L, and Cistulli, V. 2002. Environmental Economics for
Sustainable Growth: A Handbook for Practitioners. Edward Elgar. Chapter 11.
Q1. A worker, who is typical in all respects, works for a wage of $40,000 a year in a
perfectly safe occupation. Another typical worker does a job requiring exactly the same
skills as the first worker, but in a risky occupation with a known death probability of 1 in
1,000 per year, and receives a way of $44,000 a year. What value of a human life for
workers with these characteristics should a cost-benefit analyst use?
Exercise 1: Cost of noise. Assume that everybody near an airport owns similar houses. If
a new runway were established, houses in area A will gain in value because they become
quieter. But houses in area B, under the new flight path, lose value because they become
noisier. The table below gives the number of houses and changes in value in each area.
Complete the right hand column to calculate the changes in land value.
Houses Values $’000 Number ofChange $m
Before After houses
A Quieter 250 280 10,000 ?
B Noisier 250 210 5,000 ?
a. What are the benefit, cost and net benefit from changes?
b. For simplicity, assume that changes in noise are the only source of benefit or cost.
Under what conditions is the new runway and actual Pareto improvement? A
potential Pareto improvement?
47
Exercise 2: Benefits of a water-supply pipeline. The benefits of installing a new water

supply to farms should be captured in the extra price buyers will pay for farms with a
pipeline. Some farms in a district are already on a pipeline and some are not. A survey
and analysis of these farms yields the following hedonic model to relate price paid to
characteristics of the farms.
Land value = 500 + 200 SCHEME – 0.2 AREA + 1.8 RAIN
Where mean property size (AREA) in the district is 1000 hectares and mean rainfall
(RAIN) is 150 millimeters, and land value is dollars per hectare. SCHEME is defined as
1 = with the pipeline scheme, 0 = without.
Calculate the benefits of the scheme with hedonic pricing, by following this procedure.
a. Insert the mean values of AREA and RAIN in the equation, and re-express it as
follows.
Land value = Constant + 200 SCHEME
b. Calculate land values per hectare with and without the scheme. What is the
increase in value per hectare, with the scheme?
c. Calculate the increase in value per property, with the scheme.
TOPIC 6: Contingent Valuation Method (CVM)

Objective: To introduce to students to the use of contingent valuation method by way of
an illustration of its application.
Main Points:
Contingent Valuation Method has the advantage of being able to measure total economic
value and is often the only means available for measuring non-use values.
Contingent Valuation Method uses surveys to inquire about individuals’ willingness-to-

pay for some environmental initiative based upon hypothetical market conditions. The
results are, therefore; dependent or contingent upon the hypothetical market.
The success of CVM depends to a large extent on the design of the questionnaires. This
process needs to rely heavily on results of focus group discussions and series of pre-tests
to ensure that the hypothetical market is clearly understood by the respondents and to
derive the bid levels that will closely approximate the bid levels of the target respondents.
There are major biases that one has to watch for in the design and implementation stage
of this study. Students need to be aware of these biases and must understand fully well
that a poorly designed CVM could yield results that are wrong. Strategies on how said
biases could be minimized need to be discussed also.
A. What is Contingent Valuation Technique?

B. Steps in CVM analysis
C. The contingent valuation questionnaires
48
D. Applications of the CVM

E. Critique of CVM
Teaching Ideas:
• Sample CVM questionnaires should be introduced to point out the main structure
in a CVM survey. Some examples of mistakes in wording that would create
biases in responses.
• Presenting different methods that can be used to elicit respondents’ willingness-

to-pay: Bidding games, Payment card, Open-ended questions and Close ended
question (Dichotomous choice or Referendum will be emphasized).
• In designing CVM questionnaires, one should keep in mind that the purpose is to
give information about the goods or services in hypothetical conditions as much
clearly as possible in order to get the true willingness to pay as if the respondent
really pays for the offered goods/ services. The purpose is not to persuade the
respondent to “buy’ it, therefore; the provided information must be clear,
adequate and truly reflected.
Basic References:

Callan, Scott J, and Janet M. Thomas. 2000. Environmental Economics and

Management: Theory, Policy and Application. Chapter 8: Assessing Benefits for
Environmental Decision Making.
Economic Analysis of Environmental Impacts. Chapter 5.
Bateman, I.J, Carson, R, Day, B., Hanemann, N, Hett, T. Hanley, N., Jones-Lee, M.
Loomis, G., Mourato, S., Ece Ozdemiroglu. 2004. Economic Valuation with Stated
Preference Techniques: A Manual. Edward Elgar Publishing. UK.
Discussion Questions
Q1. Suppose the researchers estimated demand curves from the CVM questionnaires
illustrated in the chapter. Show graphically and explain how these demand curves would
measure WTP for improving air quality for each of the scenarios.
Q2. Critique the contingent valuation example in the chapter. What sort of biases might
the analyst has introduced? Is the scenario too hypothetical? Would respondents have any
incentive to misrepresent their preferences?
49
Q3. The construction of a dam that would provide hydroelectric power would result in
the loss of two streams: one that is now used for sport fishing and another that does not
support game fish but is part of a wilderness area.
a) Imagine that a contingent valuation method is used to estimate the social cost
of the loss of each of these streams. Would you be equally confident in the
two sets of estimates?
b) Consider two general approaches to asking contingent valuation questions

about the streams. The first approach attempts to elicit how much
compensation people would require to give up the streams. The second
approach attempts to elicit how much people would be willing to pay to keep
the streams. Which approach would you recommend and why?
TOPIC 7: Benefit Transfer Techniques

Objective: To introduce to students the Benefit Transfer Techniques and its application.
Main Points:
The benefit transfer method is a procedure wherein environmental values derived

elsewhere are transferred or used to the study area, after some adjustments to reflect local
conditions. This method is advocated when there are limited time and financial resources
to undertake primary valuation studies. Several agencies have built benefits transfer
databases, such as ENVALUE, EVRI, and VALUASIA. The latter was developed
specifically for conditions in Asia.
The instructor should demonstrate the basic adjustments that need to be done and the
various ways of transferring environmental values. Specifically, there are three
approaches to transfer values: a) Transferring mean unit values; b) Transferring adjusted
unit values; and c) Transferring demand functions. There are limitations to this approach
and these should likewise be discussed. In particular, the weakness of this method lies in
the comparability of the study site with the policy site, i.e., where the environmental
values were taken.
Teaching Hour: 0.5 hr
A. What is Benefit Transfer method?

B. Three approaches to benefit transfer method.
C. Adjustments that need to be done to undertake benefits transfer
D. Weakness and cautions when using Benefit Transfer method
Teaching Ideas:
• One should start by discussing what circumstances could lead to the use of
benefits transfer. The need to make adjustments to the ‘transferred values’ to
make it applicable to the study sites should be discussed. On this end, the
50
VALUASIA website developed by Saplaco (2002) will be a useful tool to

illustrate these various adjustments.
• Students could be referred to journal articles where benefit transfer values were
compared with values from actual studies. The range of differences in the values
obtained should be highlighted to emphasize the need to be cautious in the use of
benefits transfer.
Basic References:
Stale Navrud. 1996. The Benefits Transfer Approach to Environmental Valuation.

EEPSEA paper.
Saplaco, Rommel. 2002. EEPSEA website link.

51
LECTURE 7: COST-BENEFIT ANALYSIS AS A TOOL IN

ENVIRONMENTAL/NR MANAGEMENT
Objectives:
The main objectives are to review the theoretical concepts and empirical issues
underlying benefit-cost analysis and to illustrate the application of these principles and
methods in real life setting using case studies and exercises.
Main points:
The lecture presents an overview of benefit and cost analysis and how it is used in
evaluating projects/policies. The difference between financial and economic analysis
should be explained, particularly in relation to projects/policies dealing/affecting the
environment. The uses of benefit cost analysis should likewise be discussed.
The steps in conducting BCA should then be presented. The most important elements in
each of the steps will be discussed in class. The theoretical discussions will be
supplemented with case study illustrated for better appreciation of the various steps.
Finally, the various issues relating to the use of CBA in natural resource and
environmental decision-making will be addressed. These issues relate to discounting, risk
and uncertainty, and distributional concerns.
A. Overview of Cost-Benefit Analysis
1. Definition of Cost-Benefit Analysis

2. Types of Cost-Benefit Analysis
3. Decision criteria
B. Steps in Cost-Benefit Analysis
Step 1: Identify the problem and specify the set of alternative projects to solve it.
Step 2: Decide whose benefits and costs count (standing).
Step 3: Identify impacts (costs and benefits).
Step 4: Predict the impacts quantitatively over the life of the projects.
Step 5: Estimate monetary value of all costs and benefits.
Step 6: Discount costs and benefits to obtain present values.
Step 7: Compute the net present value of each alternative.
Step 8: Perform sensitivity analysis.
Step 9: Make a recommendation based on the NPV and sensitivity analysis.
C. Issues in Cost-Benefit Analysis

1. Discounting.
2. Distributional issues.
3. Risks and Uncertainty.
52
Teaching ideas:
• The lecture needs 8 teaching hours that include theory, concept, exercises and a
role-play.
• It is important to emphasize that CBA essentially about identifying and measuring

in monetary terms as many relevant costs and benefits as possible relating to a
particular plan, programme or project. The goal is to evaluate in efficiency
grounds the net gain or loss in welfare terms to society from said
projects/policies.
• Note that the decision criterion to use in CBA, which pertains to Pareto optimality
condition, Pareto improvement criterion, and the potential Pareto (Kaldor –
Hicks) should be differentiated to the students. It is important to note also that
while the Kaldor–Hicks compensation is the basis of CBA, the compensation is
hypothetical, not actual. Hence, it is still important to address distributional issues
in the context of CBA.
• Using a case study to illustrate may be a good way to understand the basics and
steps in CBA. In two hours needed for presenting CBA steps, it is quite difficult
to make students understand thoroughly all the steps. To optimize the limited
time, many lecturers would want to focus on the two key economics steps:
valuing costs and benefits and discounting. For valuing costs and benefits,
lecturers would remind students to look back at lecture 7. Students may ask what
happens if costs or benefits (impacts) cannot be monetized. Normally, it can be
treated as constraints upon the project and handled with care. For example, if it is
felt that impacts on certain wildlife cannot be monetised then it may be advisable
to set ecological limits for acceptable impacts. Many lecturers would remind
students that even for costs and benefits those have market prices, CBA
researchers always use “shadow prices” to value them. The concept of a shadow
price often takes students awhile to grasp, so be sure to give many examples.
E.g., what’s the shadow price of an unemployed worker? What’s the shadow
price of a good that is subsidized by the government? When we are imputing
environmental values through techniques such as CVM, hedonics, etc., we are
using shadow prices.
• Among many criticisms of CBA, it is common to believe that discounting,

distribution, uncertainty are pretty relevant to discuss given limited time of the
lecture. Among environmental advocates it is pretty standard to believe that we
should not discount the future heavily, may be even using a zero rate of discount.
The appropriate discount value method is contentious. Two common approaches
to estimate the social discount rate are time preference approach and opportunity
cost approach. The discussions on distributional issues focus mostly on
establishing the terminology: regressive, proportional, progressive. We have not
gone into exactly how distributional issues should be handled, except to say that
we need to be more aware of how benefits and costs are distributed. The
discussion on uncertainty is about the idea that many outcomes are probabilistic,
and to introduce the concept of expected values and attitudes toward risk. Risk
analysis is discussed.
53
• It also seems hard to make students understand the mechanics of discounting, the
problem of what discount to use and the effects of different discount rates on the
decisions. Students may know the mechanics of discounting beforehand from
other course. It is important to differentiate private discount rate and social
discount rate, which is used in CBA. Many lecturers will find that the best way to
illustrate the effects of discounting is through an example with data.
Basic References:

Edition, McGraw-Hill Ryerson Limited, Canada. Chapter 6, p.106-122

Melbourne. Chapters 8.
Boardman, A.E., Greenberg, D.H., Vining, A.R., and D.L. Weimer. 1996. Cost Benefit
Analysis: Concepts and Practice. Prentice Hall. New York. Chapter 1.
Q1. Are low discount rates “good” or “bad” for the environment? Defend your answer.
Q2. Suppose the government of a municipality is trying to determine how to deal with
pesticide contamination of its water supply. It wants to undertake a benefit-cost analysis
of two alternative policy options for controlling pesticides:
- Upgrading its municipal water treatment plant to remove the pesticides, or

- Banning the use of the offending pesticide in the metropolitan area.
Assume that either technique reduces the pesticides to a level that does not adversely
affect human health. The costs of these control options are as follows:
- Municipals treatment upgrades: Capital costs = $20 million. The new plant is
constructed over the course of the initial year. It starts operating at the end of this
year. Once the plant begins operation, it has operating costs of $1 million per
year. One constructed, the plant lasts for five years, and then must be replaced
with a new plant.
- Pesticide ban: annual operating costs due to substitution of non-toxic methods of
controlling “pests” = $3.5 million each year.
Let the discount rate be 5 percent. The municipality’s planning horizon is 10 years.
Suppose the NPV of the benefits of the project are $40 million. Which project should the
municipality adopt?
Assume now that the benefits differ by the type of treatment option chosen. In particular,
they remain at a present value of $40 million for the pesticide ban, but there would be
additional benefits in the form of less damage to ecosystems from the treatment plant.
How high would these benefits have to be each year to make the government indifferent
between choosing the treatment plant or the pesticide ban?
54
Q3. The Ministry of Transportation (MOT) is deciding whether to invest in a new tunnel
through the mountain, which has an existing mountain pass. MOT has spent $3 million
(in 2000 dollars) on a feasibility study and has found that the new tunnel would reduce
travel times for the nearly 200,000 commuters who would ride the tunnel. A recent
analysis indicates that the tunnel would save the tunnel rider approximately 33 hours of
travel time per year. A study conducted in 1992 showed that the commuters value their
time at $11 per hour (in 1990 dollars). You can assume that the real value of commuting
time is constant. The tunnel would cost $1 billion (in 2000 dollars) to build and will take
6 years to complete. Once the project is completed, the operation and maintenance cost of
the tunnel is projected to be $25 million per year (in 2000 dollars). The real cost is
believed to remain constant over time. The MOT has agreed to finance the initial
construction costs, but the operation and maintenance costs must be covered by an
increase in fares.
1. For each perspective, identify whether each entry in the table would be counted as
a benefit (B), cost (C) or not counted as either (NC) in determining the net benefit
of the project.
MOT Commuter Society

Feasibility Study
Time Saved
Construction Cost
Operation and
Maintenance Cost
Subsidy
Fare Increase
* You could argue that commuters would be paying for the subsidy through higher taxes.
2. What are some of the simplifications in the analysis that limit the accuracy of the
assessment?
3. What are other potentially important costs or benefits that we should consider in
the net benefits assessment?
4. From the societal perspective, what is the present value of the cost of the project
in 2000 dollars if the time horizon is 30 years and the annual discount rate is 3
percent? Use the annuity factor to calculate your answer and assume that the
payments are due at the beginning of the period.
5. From the societal perspective, what is the present value of the benefits of the
project in 2000 dollars if the time horizon is 30 years and the annual discount rate
is 3 percent? (Note: Use the CPI given in lecture notes). Again, use the annuity
factor to calculate your answer but for simplicity, assume that the benefits are
accrued at the end of the year.
6. What is the present value of net benefits in 2000 dollars?

55
LECTURE 8: NATURAL RESOURCE ECONOMICS
TOPIC 1: Introduction to Natural Resource Use, Property Rights, Rent,

and Land Value
Objectives: This section should provide students a broad overview of the various natural
resources available on earth and of the critical factors: time, property rights, and location,
as they affect allocation of natural resource use over time.
Main Points:
An overview of the various types of natural resources available on earth: water,

atmosphere and land, including those that lie within the water and on or under land is
presented to students. The value/uses of these natural resources as provider of inputs to
the economic system is then presented using Figure 1.1 in H & O book. The concept of
property rights, rent and location (accessibility) are then introduced and linked to natural
resource use. This section also discusses the value of time (through compounding and
discounting) since inter-temporal allocation of natural resource use is the key issue in
natural resource economics.
Teaching Hour: 1 hr
A. What are the natural resources available on earth and discuss how time is a
critical factor in the analysis of natural resource use. Differentiate renewable
from nonrenewable resources.
B. Summarize the role of natural resources in the economic system by way of
Figure 1.1. Of H & O (1998) and explain role of economics in this context.
C. Property rights and natural resource use: private property vs. open access
situation
D. Decision making over time: compounding, discounting, and present value
calculations.
E. Concept and Determinants of Economic Rent and Application
Teaching Guides:
• Students could be asked to name the various natural resources they are familiar
with and say something briefly about their uses and the current problems that they
face. They could also be asked what they consider the single most important
natural resource and why? Follow-up question on whether they think their daily
life is directly affected by the location of this resource and If so, how, could also
be asked
• In the course of discussion—take out those factors that are relevant to the
succeeding discussions, such as rapid depletion over time, lack of property rights
over them, some resources closer to communities being extracted faster, etc.
56
• The concept of time value of money should be made clearly by way of examples
and some illustrative calculations but should be kept short, as this topic will be
discussed also under discounting. The point to emphasize though is the need to
consider present value of these resources in resource allocation decisions.
• The use of Figure 1.1 is meant to fast track discussion on this topic and meant to
provide a holistic picture of how natural resource system is linked to economic
system. Slide (power point or overhead) for Figure 1.1 should be prepared in
advance. Note that a similar presentation was given in Lecture 3 but the focus
then was on the flow of residuals to the environment. Make that distinction clear
to the students.
• The role of property rights and location can be explained by citing cases where
these are clearly seen in this country—forest resources under different
management vs. no-management (open-access) and status of natural resources as
a function of distance to communities.
• The discussion of rent could be facilitated by the use of graphical illustrations.
Main Reference:
Chapters 1 and 3 (pp57-73).
Discussion Questions:
Q1. Suppose that you are considering buying a gold deposit. It will cost $1 million per
year to construct a mine over three years so that gold can be extracted beginning in year
4. Each year the mine operates, it will yield a net return (total revenue less total cost) of
$800,000. What will you pay for the gold deposit if:
a) Interest rates are 10% and gold can be extracted for 10 years?
b) Interest rates are 5% and gold can be extracted for 6 years?
Q2. Are non-renewable resources becoming more or less substitutable by other

productive inputs with the passage of time? What are the possible implications for
efficient resource use of the elasticity of substitution between non-renewable resources
and other inputs becoming a) higher and b) lower, with the passage of time
Q3. Assume a world that consists of two time periods. Denote the individuals in period 1
as generation 1 and the individuals in period 2, as generation2. Assume a world of just
two goods, cases of beer and boxes of tea. Further, assume that individuals in generation
1 are willing to trade beer for tea at the rate of two cases for one box of tea, and
generation 2 is willing to trade beer for tea at the rate of one case for one box of tea.
Currently, each generation has 10 cases of beer and 10 boxes of tea. Is the current inter-
temporal allocation of beer and tea efficient? Explain. (Assume that tea and beers are
divisible—that is, generation 1 would trade one case of beer for one half box of tea and
generation 2 would trade half box of tea for a half case of beer).
57
Q4. What do you suppose will happen to the prices of clean water and non-perishable
food in areas hit by natural disasters? How will markets respond? Will the price changes
help or hurt the relief and recovery efforts?
Q5. Discuss the contention that it is more appropriate to regard natural forests as non-
renewable than as renewable resources. (Perman, Ma, McGilvray, and Common, 2003)
Q6. How about a question on rates of time preference and inter-temporal substitution?
E.g., I have $1000. If I deposit my money in the bank, it will earn 5% interest per year.
If I use that money to buy goods, I’ll have the enjoyment of the goods. What do I do?
What factors does this decision depend upon?
TOPIC 2: Non-renewable Resources

Objectives:
The main objectives are to show how nonrenewable resource differs from reproducible
goods and to discuss the underlying economic theory of extraction in determining
efficient extraction path of the resource.
Main points:
The backbone of discussion on nonrenewable resource is the economic theory of

depletion. The economic theory of depletion explains the flow of production over time
and how quickly the resource stock is exhausted. When discussing the theory of
depletion, two main points should be emphasized: a) The Hotelling theorem and b) The
effect of changing parameters on the rate of resource extraction.
The Hotelling theorem could be posed by way of a question: Given a finite stock of some
exhaustible resource, at what rate should that resource be depleted? The general answer is
that it should be depleted in such a way that the well being (welfare, utility) generated by
using the resource is maximized. More analytically, it should be depleted so as to
maximize the present value of the flow of consumption goods coming from the use of the
resource. A simple mathematical and graphical model with two-period should be
developed to illustrate the derivation of an efficient extraction profile.
There are various ways of investigating what happens when there are changes in the
factors influencing the rate of resource extraction (for examples a change in discount rate,
a change in reserves, a change in cost of extraction etc.).
A. The nonrenewable resources.

B. The Hotelling theorem
1. The objective function and the constraint
2. The demand equation
3. Derivation of the Hotelling rule using the Lagrangean multiplier
4. The basic Hotelling equation and the optimal rate of extraction
58
5. Some simulations/exercises
C. The effect of changing parameters on the rate of resource extraction.
Teaching ideas
• The topic needs at least two hours of lecture including theory and sample
exercises. Some lecturers may want to leave the effect of changing parameters as
homework and make corrections in the next lecture.
• One should start by showing the features that differentiate nonrenewable

resources from reproducible goods. In the case of finite stock of the resources, the
usual maximization condition (MR = MC) is modified in 3 fundamental ways: (1)
the opportunity cost – the cost of using up the fixed stock at any point in time or
being left with smaller remaining reserves; (2) the value of the resource rent over
time; and (3) the stock constraint – the total amount of resource extracted over
time can not exceed its total stock of reserves.
• The discussion on optimal extraction path usually starts with a two-period model
with mathematical and graphical illustrations to explain the Hotelling theorem.
For the class discussion, the use of numerical and graphical illustration is
recommended. The model is built up in the following sequence:
i. The objective function: U = NSB0 + NSB1/(1 + ρ)

ii. The constraint: S = R0 + R1
iii. The demand equation: Pt = a – bRt
iv. Derivation of the Hotelling rule using the Lagrangean multiplier:
• L=NSB0 + NSB1/(1 + ρ) - λ[S- R0-R1] or
• L= (aR0+b/2*R02 –cR0)+(aR1+b/2*R12 –cR1)/(1 + ρ) - λ[S- R0-R1]
• The basic Hotelling equation: P0 – c = (P1 – c)/ (1 + ρ)
v. Derivation of optimal rate of extraction: R0=(bS+aρ)/b(2+ρ)

If assume c=0
vi. Some simulations/exercises
vii. Intuition behind the Hotelling rule
viii. The 4-quadrant diagram illustration.
• In the above presentation of the Hotelling theorem, there is a tricky step that many
students find it difficult to understand. That is, how one could derive NSB0 =
(aR0+b/2*R02 – cR0). The instructor may wish to use the demand diagram to
illustrate how one can calculate the NSB (TWTP minus expenditure at the
extraction quantity).
• The Hotelling theorem is the most important section of the lecture. So it is

common to spend most of the allocated time on this topic. It often looks simple
also but the intuition in the theorem should be explained clearly to the students.
For instance, it is worth emphasizing that the net price in period 0 equals the
discounted value of the net price in period 1. This net price is usually known as
resource rent, resource royalty, user cost, or depletion premium. Second, we may
59
derive the optimal price for each period. Third, we can reformulate the Hotelling
rule in terms of the discount rate. So, the Hotelling rule for the optimal depletion
of resources can be formulated in various ways: in terms of price, royalty and the
discount rate.
• Make sure you emphasize the role of natural resource rents…the return to the
natural resource (netting out all other costs). It is rents that must be equal over
time (in present value) which is why price minus marginal cost is positive in each
time period for a depletable resource being extracted efficiently. Compare this to
efficient production of a reproducible good where price = marginal cost is the
efficient solution.
• A possible simulation of the Hotelling Rule may look like this. Let:
S=2500; b = 0.25, a = 500 to give the demand curve P=500-0.25R

ρ=0.05 (i.e. 5%)
We have R0 = [(0.25)*(2500)+(500)*(0.05)]/[0.05 + (0.25)*(0.05)] = 1,268. The

value of R1 is immediately derivable from the constraint S = R0+R1 to give R1=
1,232.
Notice that the quantity extracted in the second period is less than in the first period.
To find the optimal prices, substitute R in the demand equations:

P0 = 500-0.25*(1268) = 500-317 = 183
P1 = 500-0.25*(1231) = 192
As the model predicts, prices rise through time. Note that the discounted value of 192
= 192/(1.05) = 183, which is the price in the first period. Again, this is exactly what
we predicted: the present value of the price is the same in every period (if costs were
positive, the result would be that the present value of the royalty would stay the same
over time).
Basic Reference:

H & O, chapter 8.
Discussion questions
Q1. If the discount rate is zero, what is the value of resource rent over the extraction
profile of the mine?
Q2. True, False, Uncertain. Explain your answer: “The economically efficient allocation
of a resource stock over time is the one in which extraction in each year is the same, so
that the total net benefit of the resource is maximized”.
60
Q3. Name three factors mitigating the scarcity of oil, and on a diagram (or set of
diagrams) involving marginal benefit and marginal cost curves (including marginal user
cost curves, as presented in class), illustrate how these factors affect the current
consumption of oil.
Q4. Explain why there is a natural tendency for the price of non-renewable resources to
rise over time.
Exercise:
In 2002, the Unocal Corporation discovered a natural gas mine with an estimated stock of
71 billion tones in the West South Sea of Vietnam. Currently Unocal is making the
feasibility plan that is going to exploit the gas mine in 2 periods. Extraction cost, which
includes costs of establishing the drilling platform, pipe system costs and operating costs,
are estimated at USD200 per tons. Marginal extraction cost is assumed constant. The
demand curve for the gas product in two periods is P = 1200 − 23Q , with unit of P is in
USD/billion tons and Q is billion tons. Discount rate is 10%/period.
a) Calculate the optimal rate of extraction in each period.

b) Suppose government now decides to tax the resource. The tax is USD50/ton.
Recalculate the question a.
c) Suppose when approving the Unocal project, the government conducts another
survey to assess the stock again and discover that the stock of natural gas now is
82 billion tons. With the tax of USD50/ton, calculate the optimal rate of
extraction in each period.
TOPIC 3: Renewable Resources: Fishery and Forestry

Objective:
The main objective of this section is to for students to be able to discuss the basic
economic models for analyzing renewable resources like fishery and forest extraction.
The lecture aims to answer these questions: when should we cut a stand of tree and what
is the optimal fish harvest and open access of fishery?
Main points:
This section will focus on understanding the analytical tools to find out the current state
of the renewable resources and how to determine the optimal use of those resources. Two
types of resources will be discussed: fisheries and forestry.
The basic model of fishery economics to be discussed in class will only consider the one
species model. More complex models consider multiple species but that is usually
discussed in fishery economics course. The basic model is to maximize the benefits
minus the costs of fish harvest subject to the constraint that we maintain a steady-state. In
the forestry problem, the critical element is that the growth function is a function of time,
not a function of stock. The forestry problem solves for the optimal time to harvest the
entire stock, and the solution gives the optimal length of each rotation of stock. A simple
model to derive the maximum “mean annual increment” by choosing the rotation T that
maximizes the annual value of harvest is first discussed. For simplicity, this model
61
ignores discounting. We then expand the model with the Fisher solution, which considers
a forest as a capital asset, but assumes no future use for the land. The Faustmann model
follows that links the MAI and Fisher models to give a `full' economic approach that
considers both discounting and future land use.
Suggested Topical Outline
A. The fishery
1. Characteristics of Fishery Resources
2. Modeling stock growth and Maximum sustainable yield
3. Economics in the fishery: Optimal fish harvest in the steady state and Open
Access
4. Conclusions and observations
B. The forestry: a simple model

1. Characteristics of Forestry Resources
2. Mean Annual Increment (MAI)
3. Fisher solution and Faustmann solution
4. Forest Policies
Teaching ideas:
• The fishery models can be presented in both mathematical and diagrammatic

approaches. However it is evident that most students feel comfortable with the
latter approach. One should be careful in moving from the biological growth
curve to the economic curve (with effort in the horizontal axis and revenue in the
vertical axis.
• Note that the basic model in fishery economics may not yield socially optimal
level because we have not shown that it is socially optimal to be in a steady state
or described the conditions under which this premise holds. Thus, the problem we
are about to solve is a second-best problem. Nonetheless, it is an important
second-best problem because policy-makers and their constituents often want
steady-state solutions due to the economic stability and predictability that they
provide.
• One should also show clearly the diagram for optimal fish harvest under private
property and open access conditions.
• Emphasize that the difference between forests and fish is the following: (1) After
an initial harvest of a natural forest, the forest is replanted. Therefore, while the
biological characteristics of the forest are important, they are less so than for the
fishery because reproduction is controlled by the forest operator. (2) Trees don’t
swim, so it is more likely that the forest will be managed under private property
or government-set harvesting rights and thus, typically no open access issues. If
the forest was open access, then show them that the privately efficient solution
would be to cut a natural forest, then move on to the next natural forest. There
would be no reforestation.
62
• Similarities between fish and forests is that, in principle, they can be managed
sustainably over many cycles of planting/harvesting/planting for forests and
harvesting a portion of the fish stock, allowing the remaining stock to reproduce
and become larger. The basic dynamic equation is the same: harvest when the
value of the biological growth (biomass marginal product) equals the opportunity
cost of the harvest (harvesting costs, restocking costs, and the opportunity cost of
the land in the case of forests). Both types of resources have problems reaching a
sustainable equilibrium the longer the life of the species (e.g., slow growing trees
or fish species that don’t reproduce until they are 20 years old). Uncertainty
about future prices, interest rates, costs, makes the management problem more
difficult.
• One can also point out that the fish models can apply to the management of other
types of wildlife (e.g., hunting wild species versus preserving them for future
hunting or wildlife viewing.
Basic References:

Chapters 4 and 10.
Discussion questions & Exercises:
Q1. How does the biological growth of each of these resources influence how each is
harvested?
Q2. Why is it that fishery management looks at how much to harvest and forestry
management looks at when to harvest even though both are renewable resources?
Q3. Discuss how the level of effort in fishing affects the efficiency of harvesting fish.
Q4. Consider the effort/revenue curve for a fishery. Suppose the fishery is currently at
the open access point where TR=TC.
a. What does it mean for the implied shadow price to be zero at this point? Why is
this undesirable?
b. Is this point sustainable? Explain.
c. Give three reasons why the MSY level of effort might be preferred to the open-
access level of effort.
d. Why might ESY be preferred to MSY?

63
Q5. In what circumstances, and on what criterion, can the conversion of tropical forestry
into agricultural land be justified?
Q6. Demonstrate that a tax imposed on each unit of timber felled will increase the
optimal period of rotation (that is, the age of trees at harvesting) in an infinite rotation
model of forestry. What effect would there be on the optimal rotation length if the
expected demand for timber were to rise?
Q7. How would the optimal rotation interval be changed as a result of”
a) an increase in planting costs
b) an increase in harvesting costs
c) an increase in the gross price of timber
d) an increase in the discount rate
e) an increase in the productivity of agricultural land
Discussion question: What are some of the causes of deforestation in Vietnam, why do
they arise, and what can be done about it?
LECTURE 9: APPLICATION OF ENVIRONMENTAL POLICY IN YOUR

COUNTRY
Objective: To introduce to students the legal structure of environmental planning in

Vietnam and to discuss the major environmental policies currently existing in Vietnam.
Cases wherein economic instruments have been used to address the country’s problems
will also be discussed.
Proposed Topics for Term Papers:
Environmental Protection Law

Laws on Forestry Protection and Development (2004)
Mines Laws (1996)
Oil and Gas Laws (1996 amended in 2000)
Water Resource Laws ( 1999)
Aquaculture Laws (2003)
Land Laws (2003)
Proposed Topical Outline for the Assigned Term Paper:
A. Framework Laws of Environmental Protection and Provisions in your country.
B. Institutional Arrangements: Organization Structures of government;

Environmental institutions; environmental legislations.
C. Applications of environmental legislation in the country: achievements and

constraints.
64
D. Environmental Problems where economic instruments are applied.
Teaching Ideas:
• This topic will largely be a term paper to be assigned to group of students. The
assignment should be given middle of the semester of the course to give students
ample time for research works.
• The students will be asked to provide a brief overview of the

environmental/natural resource laws and relevant provisions as they affect
environmental policy making in the country
• Students could also be encouraged to compare organizational structures of the

environment department in your country vis-à-vis other countries in the region.
• Cases on the applications of environmental policies in the country should also be

included in the term paper and report, to emphasize: achievements, obstacles and
lessons learnt, as well as future directions.
Basic References:
Students should visit website of the various offices responsible for these topics. They
could also visit these offices for some materials. Library materials in your University
should also be explored.
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Economy and Environment Program for

PROPOSED COURSE OUTLINE

I. Course Description & Prerequisite

Environmental economics is designed to enable students to understand the linkages

II. Course Objectives

At the end of the course, the students are expected to have:

III. Course Content No. of Hours

Lecture 1: Introduction: what is environmental economics……...……………2 hrs

A. Definition of what environmental economics covers.

Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian

Additional Readings: Panayotou, T. 1993. Green Markets: The Economics of

Lecture 2: Economy-Environment Linkages & Overview of Environmental/

Topic 1: Economy-Environment Linkages…...1 hr

Topic 2: Overview of Environmental and Natural Resource

A. Water and Air Pollution

Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian

WB. 2001. Vietnam Report. Chapter 4: Trends in the Environment

Lecture 3: Causes of Environmental Problems…….………………… 3 Hrs

Turner, Pearce and Bateman. Environmental Economics: An Elementary

Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian

Panayotou, T. 1993. Green Markets: The Economics of Sustainable Development.

Lecture 4: Brief Review of Welfare Economics Concepts

Topic 1: Economic efficiency and markets: Benefits (Demand)

Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian

Topic 2: Defining and Measuring Welfare Changes …... 3hrs

Freeman, Myrick.A. 2003. The Measurement of Environmental and Resource Values:

Lecture 5: Pollution Economics

Topic 1: Optimal Level of Pollution………..………………………………… 3hrs

Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An

Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian

Topic 2: Coase Theorem and Property Rights ………………………………..2hrs

Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An

Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian

Topic 3: Environmental Standards ……………………………………………. 2hrs

Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian

Topic 4: Taxes and Subsidies ………………………….………………………...2hrs

Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian

Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An

Topic 5: Transferable Discharge Permits…...2 hrs

Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian

Topic 6: Evaluating Environmental Policy Instruments……..…………….. 2hrs

Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian

Lecture 6: Environmental Valuation

Topic 1: Why Value the Environment and the

OECD. 1995. The Economic Appraisal of Environmental Projects and Policies: A

Turner, Pearce and Bateman. Environmental Economics: An Elementary

Topic 2: Steps in Valuation & Overview of Valuation Techniques……………1h30

OECD. 1995. The Economic Appraisal of Environmental Projects and Policies: A

Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian

ADB. 1996. Economic Evaluation of Environmental Impact - A Workbook. Environment

Topic 3: Market-based techniques ………………….………………………….2 hrs

Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An

Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian

Sinden J. and Thampapillai, DJ. 1995. Introduction to Cost-Benefit Analysis. Longman.

Topic 4: Travel Cost Method ………….…………………………………………2 hrs

Field B. and N. Olewiler. 2005. Environmental Economics, Updated 2nd Canadian

Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An

Sinden J. and Thampapillai, DJ. 1995. Introduction to Cost-Benefit Analysis. Longman.

Topic 5: Hedonic Pricing Method…………………………………………….…2 hrs

Turner, R. K, D. Pearce, and I. Bateman. 1994. Environmental Economics: An

Sinden J. and Thampapillai, DJ. 1995. Introduction to Cost-Benefit Analysis. Longman.

Topic 6: Contingent Valuation Method (CVM) …………………..……………. 2 hrs